Amendments to Income Tax Act to Affect Business Owners & Professionals25-Jul-17
By Mike Harris
On July 18, 2017, the Department of Finance announced a number of proposed amendments to the Income Tax Act. These amendments are intended to reduce what the Federal government sees as unfair advantages available to the shareholders of closely held private corporations, including professional corporations. In particular, the proposed legislation would restrict two common planning tools available to private corporation shareholders: income splitting, and taking advantage of multiple capital gains deductions.
Income splitting is a common tax planning strategy where the shareholder of a private corporation (the “principal shareholder”) introduces his or her spouse and adult children as shareholders of a private corporation, so that dividends can be paid to them. By declaring dividends in favour of individuals with lower annual incomes, the dividends are taxed at lower marginal tax rates. The result is that the total tax payable on the dividends is lower than it would be if it was received by the principal shareholder (who is likely taxed at the highest marginal rate).
The proposed changes with respect to income splitting will expand the tax on split income, or “kiddie tax”, which currently only applies to dividends received by children younger than 18 years old. The new tax on split income will now apply to anyone related to a person who can influence a business if the related person receive dividends in excess of what is considered to be “reasonable”, based on the related person’s contribution to the business. These rules are particularly strict in respect of children younger than 25. These rules will greatly reduce the ability of a principal shareholder to split income among family members who are not active in the business. This is particularly true for professional corporations, which likely have very little family involvement.
In addition to income splitting, a second common planning strategy is to make use of the lifetime capital gains deduction through a family trust, or by having additional family members hold shares in the private corporation that will one day be sold. By using these structures, each shareholder or beneficiary of the family trust is able to access a separate capital gains deduction (approximately $836,000 per person in 2017) when the shares are sold. The proposed amendments to the Income Tax Act will greatly reduce the ability of a family to take advantage of multiple capital gains deductions in future years.
The proposed changes to the rules surrounding income splitting are proposed to come into effect for the 2018 taxation year. There may still be opportunities in 2017 to maximize whatever tax savings are available under the existing rules for income splitting. Our office is happy to review your current structure with you to determine if there are any steps that should be taken this year before the rules change.
In addition, the proposed restrictions on using multiple capital gains deductions will be subject to a grandfathering rule. This will allow taxpayers to intentionally trigger capital gains during the 2018 taxation year and use their capital gains deduction under the current rules (rather than the new rules), reducing the potential tax bill in future years when the shares are actually sold. It is critical that taxpayers review their current shareholdings and eligibility for the capital gains deduction to ensure that they do not miss the opportunity to take advantage of this transition period. Our office would be happy to assist taxpayers and their accounting advisors with this review, including any planning necessary to ensure that shares of a private corporation meet the criteria for the capital gains deduction.
The changes proposed by the Department of Finance on July 18th are just two of the latest in a string of several significant tax changes which have been enacted over the last few years. Alone, any of these changes would be significant, but together the aggregate effect is that most business structures put into place a few years ago are no longer effective and may not be advisable. We recommend that all corporations, but especially those who have set up specific structures for tax reasons, revisit their corporate structure in light of recent and proposed tax changes to determine if changes should be made.