There are several actions that clients who are incorporated small business owners or professionals could consider taking in light of the federal government's proposed tax changes to private corporations, according to a new white paper from Canadian Imperial Bank of Commerce (CIBC) entitled Taking Action: CCPC Tax Proposals.
"If you take the position that the rules are going to go through as they are drafted — and we do have draft legislation [included in the consultation paper] that was released July 18 — there are some very specific things that someone could do," says Jamie Golombek, managing director of tax and estate planning with the bank's wealth strategies group, who wrote the report along with Debbie Pearl-Weinberg, managing director of tax and estate planning.
The federal government's consultation paper, released this past summer, outlined the government's concerns in three main areas: income sprinkling; the retention of passive income in the private corporation; and the conversion of regular income into capital gains. The deadline for submissions to the consultation paper closes on Mon. Oct. 2.
Of course, clients will have their own set of specific circumstances in terms of their individual corporations, so they should consult with a tax advisor to discuss what steps, if any, to take in light of the proposed changes. However, here are a few of the major actions the CIBC paper recommends they could consider taking in the near term:
> Pay as much dividends as you can before the end of 2017 if you have adult family members who are not involved in the business and who are in a lower tax bracket. This type of income splitting will be effectively stopped starting Jan. 1.
The consultation paper includes draft legislation proposing to expand the so-called kiddie-tax rules, which apply to income splitting with minors, so that they would apply to more types of income and cover more adults.
The expanded "tax on split income" rules would apply a "reasonableness test" to take into account an individual's contribution, in terms of labour and capital, to the business, along with considering prior return and remuneration. Dividends received by these individuals might be considered split income and taxed at the highest marginal rate.
"[The Department of Finance Canada] could have shut it down on July 18, but it didn't do that," Golombek says. "[The government will] shut it down as of 2018. So, that's giving [incorporated clients] one final opportunity to pay a spouse or partner, or other adult relatives, if they are at least 18, additional dividends, if they are in a lower bracket. That's probably the main thing that people can do."
> For 2018, consider delaying dividends until children are at least 25 years old, unless they are fully involved in the business, and review other types of compensation family members are receiving to make sure they are reasonable.
The rules for individuals between the ages of 18 and 24 receiving dividends, in particular, have been tightened. For a return on a capital contribution to be considered "reasonable," individuals younger than 25 years of age will be limited to receiving a rate of return equal to the prescribed rate, which is currently 1%.
Unless the individual's contribution of labour was "regular, continuous and reasonable," any dividends paid in excess of the prescribed rate would be subject to the tax on split income rules. Delaying paying dividends until an individual is older than 25 years of age would avoid the income being caught under these rules.
Incorporated clients should also review the dividend compensation strategy for related adults over the age of 25 for services provided to the private corporation to determine whether they could be considered split income.
> Consider making an election to crystallize the lifetime capital gains exemption (LCGE).
Ottawa indicated in the consultation paper that it was concerned with multiple family members accessing the LCGE on the disposition of private company shares. For 2018 and after, the government has proposed eliminating access to the LCGE for individuals younger than 18 years of age; disallowing the eligibility of capital gains for the LCGE if the gains are taxable under the split income rules; and eliminating access to the LCGE to beneficiaries of trusts.
As part of these proposed changes, the government provided transitional rules that would permit certain shareholders to elect to crystallize a capital gain in 2018 so that they can claim the LCGE. However, in order to do so, more than half of the assets within the corporation must be used in an active business for at least one year prior to making the election.
"The 50% test has been relaxed a little bit [for purposes of the transition]. Normally it's two years prior to date of sale, they're indicating it will be 12 months prior to date of sale," Golombek says. "So, you want to make sure that more than 50% of the assets in your [client's] corporation are used in an active business between now and the end of this year so [clients] meet the one-year test should [they] choose to elect to crystallize at some point in 2018."
Of course, the government's proposed tax changes are still under consideration, and no one knows what final form the rules may take, Golombek says.
"The most important thing is that people get advice, and not to panic yet," he says. "I don't think we've seen the [final shape] of the rules, and I don't think these rules will go through without amendments."
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