juillet 21 2017
Newly Proposed Legislative Actions Could Impact Tax Planning with Private Corporations
On July 18, the Department of Finance Canada announced the launch of a consultation on the subject of tax planning using private corporations. The Government is asking Canadians for their opinion on the following tax strategies: income splitting among family members, deferred taxation using a holding company, and multiplication of capital claim exemptions.
The Department mentioned different situations that it wishes to address with legislative measures. For example, it mentions the case where a person owns a private corporation and uses it to divide the income among family members who are not involved in the corporation. Another example mentioned is individuals who generate passive income (e.g., a holding corporation) inside a corporation with funds taxed initially at 18.5%, without reinvesting it in the company. Lastly, the Government also wishes to address strategies where income in a corporation is withdrawn as capital gains, instead of more traditional options, such as salaries and dividends.
The proposed legislative changes would maintain the tax benefit on corporations’ business income, i.e. lower tax rate, on the condition that such income be channeled as active investment in the company.
Among the possible changes, the Government proposes to extend to adults, under certain circumstances, the tax on split income (the so-called “kiddie tax”), which is at the moment limited to minors. For individuals between 18 and 24 years of age who receive dividends and other amounts derived from a business, the amount received could be subject to the “reasonableness test” and risk being taxed at a higher rate. The “reasonableness test” refers to an individual’s real contributions to the company.
Other proposed measures would limit the multiplication of capital gains exemption. Under one of the proposals, individuals would no longer qualify for exemptions for gains realized or accrued before they reach 18 years of age. Furthermore, accrued gains on property held by a trust could no longer benefit from an exemption, subject to certain terms and conditions.
Furthermore, the Government proposes to abolish the benefit related to deferred tax on passive income received by private corporations on earnings taxed at a lower rate and not reinvested in the business. Different approaches are being considered, including a system where the tax rate on investment income would be equal to the higher individual rate, but there would no longer be tax refunds to corporations when a taxable dividend is paid to shareholders.
The federal Government also proposes to change the current tax system which prevents surplus stripping. Individual shareholders could no longer use transactions between individuals who do not deal at arm’s length with each other to obtain funds from a corporation by generating a capital gain, which benefits from a better tax rate than more traditional channels, such as a salary or a dividend. However, the Government proposes to facilitate transfers of family business to the children, following many requests on this subject from the tax community.
These possible changes are complex and technical and could upset current tax planning practices. We strongly recommend that you consult our tax professionals for expert advice on the subject.