This week, the Department of Finance issued two news releases, being their initial responses to the vast number of submissions received during the consultation period related to the July 18, 2017 tax proposals. Further information is expected to be forthcoming.

Small Business Tax Rate

The Government announced its intention to lower the federal small business tax rate from 10.5% to 10% effective January 1, 2018, and to 9% effective January 1, 2019. This tax rate applies to the initial $500,000 of qualifying active business income of a Canadian-controlled private corporation.

Income Sprinkling Measures

The Government announced its intention to move forward with a simplified form of measures proposed to limit income sprinkling using private corporations. As originally announced, the tax on split income rules will introduce a reasonableness test for family members aged 18-24, as well those 25 and older. The intention of these tests will be to demonstrate an adult family member’s contribution to the business through a combination of the following four principles:

  • Labour contributions;
  • Capital or equity contributions to the business;
  • Financial risk taken on, such as co-signing a loan or other debt; and/or
  • Past contributions in respect to previous labour, capital or risks.

The Government promises to simplify the proposed measures in the draft legislation released on July 18, 2017 in order to reduce the compliance burden, better target the proposed rules and address double taxation concerns. How the rules will be simplified is yet to be seen; however, the tax on split income rules will be effective for the 2018 and subsequent taxation years.

Lifetime Capital Gains Exemption

The Government will not be moving forward with the proposed measures that prevent the multiplication of the lifetime capital gains exemption (LCGE). The originally proposed rules sought to disallow the LCGE for capital gains that accrue before the year an individual turns 18 years of age and those that accrue during the time the property was held by certain non-qualifying trusts. However, it appears capital gains may still be subject to the tax on split income rules, which may limit the LCGE claim.

Anti-surplus Stripping

The Government has also abandoned the proposed measures relating to the conversion of dividend income into capital gains. The proposed rules would have created increased taxes for intergenerational business transfers, increased taxes on private company shares held upon death, and uncertainty around capital dividend account balances.

Passive Investments

The Government announced its intention to move forward with measures to limit the deferral benefits of passive investments in private corporations while:

  • Ensuring passive investments already made by private companies, including the future income earned from such investments, are protected;
  • Protecting the ability of businesses to save the funds they need for contingencies or future investments;
  • Including a passive income threshold of $50,000 per year, below which would not be subject to an increase in tax, for future go-forward investments; and
  • Working with venture capital and angel investment sectors to ensure continued investment in the next generation of Canadian innovation.

Currently, it is unclear as to what measures will apply to track income from grandfathered passive investments and those that are subject to the new rules.  Further the scope of passive income is yet to be defined, particularly whether certain capital gains may be scoped out.

The Department of Finance intends to release the related draft legislation as part of the 2018 Budget. Any proposals will apply on a going-forward basis.

Next Steps

Significant concerns were raised during the consultation period in response to the July 18, 2017 tax proposals. The Government announced it will address the unintended consequences of these proposals and will make changes to the tax treatment of private corporations with the intention to reflect the following five guiding principles:

  • “Support small businesses and their contributions to our communities and our economy.
  • Keep taxes low for small businesses, and support owners to actively invest in their growth, create jobs, strengthen entrepreneurship and grow our economy.
  • Avoid creating unnecessary red tape for hard-working small businesses.
  • Recognize the importance of maintaining family farms, and work with Canadians to ensure we don’t affect the transfer of a family business to the next generation.
  • Conduct a gender-based analysis on the finalized proposals, to ensure any changes to the tax system promote gender equity.”

 

For more information on this proposed policy contact one of Smythe’s tax advisors here.

 

 

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