Have a Corporation? Tax Changes Coming...

Since the Liberal Government unveiled the March 2017 budget, there has been a large amount of backlash surrounding the proposed tax law changes. Much of the ongoing discussion revolves around small and medium size business owners, however, these are not the only individuals affected. Doctors, Dentists, and Lawyers also benefit from the ability to incorporate and shift much of their income into their corporations. From discussions with friends and acquaintances, I quickly realized that many that may become affected had no idea how or what these potential changes may mean for them. I’m going to avoid discussing politics, and focus on what this means for the above individuals. I will say, I can empathize with many of the small and medium-size business owners and entrepreneurs out there. I come from a family of business owners, whom all started with nothing, and took large amounts of risk with no guarantees, pensions, or vacation time; all while creating jobs along the way. 

I wanted to outline the two proposed changes that will affect a large number of the individuals mentioned above. These include:

1. Taxation of passive income in a corporation
2. Income sprinkling and multiplication of the capital gains exemption

Passive Income in a Corporation - Incorporated business owners currently have the ability to defer taxes by leaving income earned inside their corporation and investing it for the future. These funds which are now invested potentially earn interest, dividends, or have capital appreciation (growth of original capital). Earnings on these invested funds are not from direct operations; this is what CRA defines as passive income. Many business owners earn active income and shift earnings that are not needed in the immediate future into a holding company. As it stands today, corporations that earn income eligible for the Small Business Deduction or SMB (First $500,000 earned) pay a federal tax rate of 10.5% on active income and have the rest left over to invest inside their holding company for either retirement, future business expenses, or whatever other financial goals they may have. The advantage here is that a company has more dollars to invest as they were originally taxed at 10.5% versus an employee who may have paid up to 50.4%. (highest tax rate in Manitoba). The proposed changes are looking to remove this so-called advantage for those who are incorporated by creating disincentives to holding passive money inside your corporation. When the owners want to access this money later they may pay themselves a dividend which at the current moment had a refundable portion. This refundable portion looks like it may be removed if the income was earned passively, leaving no advantage to holding funds for future use inside your corporation. In many cases, it will actually be a disadvantage to do so as you will be taxed more than if you had paid yourself a salary or dividend when you received the funds as active income. Investing inside a corporation has been the primary retirement planning tool for business owners and incorporated professionals, who for the most part have no pension plans for themselves. If the proposed changes come into law, this strategy will no longer be available. 

Income Splitting and Multiplication of the Capital Gains Exemption - Many times corporate structures are created with family members owning shares of the corporation either directly or through being a beneficiary of a family trust that owns the shares. Business owners were able to pay dividends to lower income family members who were in lower tax brackets. In 1999 the “kiddie tax” was introduced, meaning private company dividends that were being paid to minors would be taxed at the top personal tax rate. If you want to income split with minors today, you must pay them a reasonable salary for the work they perform for the business. The 2018 proposed changes will take the same approach for all related family members (adults or children). You will have to prove that what you pay your spouse is a reasonable amount in order to not be taxed at the highest personal tax rate when receiving a salary or dividend. If your spouse is the primary caregiver to your children and primary keeper of your home, this will not be a reasonable role that warrants receiving an income.

The capital gains exemption which is currently $836,000, allows business owners the ability to sell their business and not be taxed on $836,000. For example, if you sold your business and had a capital gain of $1,000,000, $836,000 is exempt from being taxed while $176,000 would be subject to capital gains tax. Currently, through the use of family trusts, you are able to have members of the family own shares of the business allowing you to multiply the capital gains exemption. In the above example, you and your spouse could each own 50% of the business through a family trust. The business would sell for $1,000,000. You would each receive $500,000 that was exempt from tax, netting a total of $1,000,000 without being taxed. The proposed changes will be eliminating the ability to multiply this capital gains exemption. 

Currently, these changes are only what has been proposed. There has been a lot of backlash but it seems that the Liberal’s are remaining firm on their proposal. Many tax experts believe that what was meant to be a consultation paper looked more like drafted legislation. This will be affecting many of our clients; we are already reviewing each situation with our team’s tax accountant in preparation that these proposed changes become law. There is no need to make any rash decisions. We believe it’s best to continue to have conversations and to be prepared, but ultimately we must wait until October to see what legislation the Liberals will look to pass. If you feel as though you may be affected and have questions, feel free to reach out to my team and I. We’d be happy to discuss. 

So what can you do?

I recently attended a presentation put on by the tax team at BDO. They made four suggestions to individuals who feel the proposed changes are negative to Canada and its economy, these suggestions include:

• Contact your MP to voice any concerns you may have.
• Discuss with your business colleagues to ensure they understand the impacts and encourage them to do the same if they have concerns.
• Voice any concerns you may have to any relevant professional associations as there is strength in collective representation.
• Meet with your tax advisor and discuss any planning strategies which may apply to you.