In March of this year the government announced that some tax changes in Canada would be coming, and private corporations would be affected by it. The claim is that some people has been using corporations in their tax panning, using them to pay less than their fair share of taxes.
There are three tax-planning tactics the government is looking to shut down:
Some business owners sprinkle income to family members by way of salary or wages, or dividends, to reduce the family’s overall tax burden. There are already rules in place to prevent unreasonable salary or wages from being paid to family members who are not truly earning the compensation they receive. There are even “kiddie tax” rules to prevent dividends paid to minor children from being taxed at their lower rates.
To prevent that to happen, the government wants to now restrict the ability to pay salary or wages, or dividends, to adult children between the ages of 18 and 24, by extending the “kiddie tax” rules (formally called “tax on split income (TOSI) to them.
When a corporation generates income, it’s eligible for a pretty attractive rate of tax (about 15 per cent, but it varies by province) on the first $500,000 (federally) of active business income. If a business owner doesn’t need all of his earnings to support his lifestyle, it’s common to leave the rest in the corporation to invest – perhaps in a portfolio earning passive income. So, there’s an advantage to earning business income in a corporation if you earn enough that you won’t spend it all.
The government is exploring how to limit the perceived benefit of leaving excess earnings inside a corporation to grow in a passive portfolio. Mr. Morneau is looking for comments from Canadians on a couple of primary options: (1) implementing a refundable tax that would apply to ineligible investments (the tax would be refunded once the capital is either paid out to you as taxable dividends personally, or is used in the active business), or (2) change the current refundable tax system on annual passive income so that the tax is no longer refundable if the investments were made with excess business income taxed at low rates.
Converting income to capital gains
Some corporate owners have taken steps to convert what would otherwise be taxed as salary or dividends into capital gains. This has been done using a complex set of steps involving selling of some shares to another company related to the shareholder. The government proposes to close these opportunities by tweaking section 84.1 of our tax law, which was intended to prevent this type of planning but doesn’t quite do the trick.
If you have a small business and want to make sure to cope with all the possible changes, contact us or visit us on 505-1055 West Broadway, Vancouver, BC.
This post was based on this article from Tim Cestnick.