Tax Reform Update

As you may be aware, Canada is currently in the process of shaking up the tax structure, with a focus on business owners and professionals. Basically, Ottawa wants to "even out the playing field" between the average middle-lower income earners and the higher income earners. The concerns for the higher income earners is that they are generally the ones creating jobs and greasing the economic wheels and don't believe they should not be penalized for this with even higher taxes.

 Another major concern that I am hearing is that most business owners and professionals do not have any form of pension and must create this on their own. This in many cases has been done through retaining earnings inside of their company/hold co./PC where they are able to differ the tax owed until they withdraw the funds at a later date i.e. retirement. This still has limited benefits as the income is taxed at the highest rates but does offer the tax deferral which also offers the potential of redeeming the funds at a lower rate in the future. The main problem that Ottawa sees with this (among others) is that they don't want tax being deferred, they want it now!

 There are several other gates that Ottawa wants to close such as income sprinkling and other more complex strategies such as restructuring corporations to convert income to capital gains, capital gains exemptions and more.

Our tax and legal advisors have put together a very brief update on this tax reform and the most recent updates. When you have a moment, take a read through and let me know if you have any questions. I would be happy to help and/or introduce you to the right people.

In addition to the tax update, I have added several articles with further information on the potential tax changes and outcomes from other sources at the bottom of this email for your review.

 Taxation Update 2017

BY INVESTORS GROUP / OCTOBER 2017

PROPOSALS IMPACTING PRIVATE CORPORATIONS

On October 16, 2017, Federal Finance Minister Bill Morneau released new measures designed to counterbalance the proposals that were previously announced on July 18 of this year. This summary contains highlights of these new announcements and modifications to the previous proposals, which are not yet law. Clients should contact their Investors Group Consultant for information on how these proposals may affect their financial plans.

 Lowering the small business tax rate to 9%

Effective January 1, 2018, the small business tax rate that applies to the first $500,000 of active business income will decrease from 10.5% to 10%. A further reduction from 10% to 9% will occur on January 1, 2019, ultimately resulting in a potential maximum tax savings of $7,500. This rate decrease was first discussed as part of the 2015 federal election campaign.

Next steps

The federal government has acknowledged a number of concerns over the July 18, 2017 proposals:

• The complexity of the proposed income sprinkling measures would impact small family businesses and therefore there is a need to simplify the proposals;
• Unintended consequences regarding the proposed measures on the conversion of income to capital gains, and the multiplication of the Lifetime Capital Gains Exemption (LCGE), could impair estate planning and impact the ability to transfer businesses to the next generation; and
• Passive investments are used by small and medium-sized businesses to manage personal income risk, sick leave and/or maternity/paternal leave. Additionally, passive investments are used by small business owners as a flexible retirement savings tool since Registered Retirement Savings Plans, etc., cannot provide funds when business volatility strikes.

What is being proposed in the October 16 announcements to address the above concerns?

• The federal government will no longer proceed with measures to restrict access to the    LCGE.
• The federal government has expressed its intention to simplify the proposals pertaining to income sprinkling, and reasonableness tests will still be a key component of the proposals. However, demonstrating contribution to the business will now be based on any combination of the following: labour contributions; capital or equity contributions to the business; accepting financial risks of the business (such as co-signing for debt); and/or past contribution in respect of previous labour, capital or risks. The income sprinkling measures are still intended to apply on January 1, 2018 and beyond.
• Upcoming revisions to the proposals and draft legislation, anticipated to be released later this fall, will also include measures to address concerns over double taxation.

Gender impacts

The Department of Finance indicates that the majority of owners of private corporations are men, and men represent over 70% of higher-income earners initiating income sprinkling strategies. The federal government indicates that it will consider the gender impacts of measures proposed to address tax planning involving private corporations, but has not provided any details to date on how that might be accomplished.

More to come

Mr. Morneau has indicated that over the next couple of days and weeks, more announcements will be forth coming. He indicated that the informal consultation process continues through ongoing conversations with small business owners, stakeholders, local chambers of commerce, etc. It is anticipated that these future announcements will also include comments on how the government intends to proceed with measures relating to holding passive investments in a private corporation. Investors Group will follow these announcements closely and will communicate the impact they may have on your plan.

For more information on the July 18, 2017 proposals, read our take below:

Should you incorporate? Until recently, the answer was fairly simple: if you needed to use all the income you made in a given year, then there wouldn’t be much of a tax benefit to incorporating. If some money wasn’t needed for personal use, but rather could be kept inside the company where it would be at a low corporate tax, then putting an Inc. next to your business name made a lot of sense.

In mid-July, though, the Federal government announced it wanted to change some of the rules around how income earned within (or distributed from) a corporation is taxed, throwing entrepreneurs and professionals – and their accountants and financial planners – for a loop. While some rules are still to-be-determined, the question of whether to incorporate has suddenly become more complicated to answer.

More money for the government

The main reason why the government is changing the rules is that it feels as though business owners – including professionals, such as doctors, lawyers and accountants – are keeping too much money inside their corporations and unfairly taking advantage of the lower tax rate, says Jack Courtney, vice-president of private client planning.

The lower rate, which, depending on the province, is between 10.5% and 18.5% for businesses that make less than $500,000 in revenue, was originally designed to encourage investments within the business, not to create a way for people to store – and then invest in the market – lower taxed money. However, professionals and other entrepreneurs argue that running a business comes with a lot of risk and that the lower tax rate helps them continue taking those risks.

The most significant difference will be how excess dollars people keep inside a corporation and that aren’t being used to grow the company will be taxed.

Tax on passive income

In any case, the government has indicated the rules are changing. The most significant difference will be how those excess dollars that people keep inside a corporation and that aren’t being used to grow the company will be taxed. No longer will people be able to pay the corporate tax rate on those passive dollars. Instead, they’ll likely have to pay a rate more commensurate with their personal rate. “There’s an intention to introduce legislation that will essentially not give a tax advantage to those who don’t invest money back into their business,” says Courtney.

How the government will go about taxing passive income is still an open question. It indicated an option would be to place a tax on funds set aside for passive investment that would get refunded if that money was paid out as a dividend, at which time it would be taxed at your personal rate. “That approach would not penalize you for past investment activity,” says Courtney. “It would apply on a go-forward basis.”

However, the government said it’s not inclined to take that approach. They have indicated a preference to remove various tax mechanisms, such as the refundable tax you get back when distributing investment income in the form of a dividend, essentially forcing people to pay the highest marginal tax rate on that passive income. The way Courtney sees it, such an approach could apply to money that has been saved and invested inside the corporation for years.

No more income splitting

The other big change affects income splitting, which has long been an important tax-mitigating strategy for entrepreneurs. Up until now, business owners could pay a dividend to a spouse, or a child aged 18 or older, and have that money taxed in their hands. Typically, the family member would be in a lower tax bracket than the business owner, so that money would be taxed at a lower rate. This will no longer be allowed – unless, potentially, the family member is working in the business – and any money paid out will be taxed at the top marginal tax rate, regardless of whether the entrepreneur is taxed at the highest rate. “That’s huge,” says Courtney.

With the exact changes still being discussed, there’s not a lot business owners can do right now. Those who haven’t yet incorporated may want to wait until the rules become clearer; those who have incorporated will have to be patient. If you are incorporated, you may want to consider paying a higher dividend to your adult children in the 2017 tax year as that rule won’t be implemented until next year, but other than that “it’s a bit of wait and see,” says Courtney

This report specifically written and published by Investors Group is presented as a general source of information only, and is not intended as a solicitation to buy or sell specific investments, nor is it intended to provide legal or tax advice. Clients should discuss their situation with their Consultant for advice based on their specific circumstances.