Proposed Tax Changes for Private Corporations

On July 18, 2017 Department of Finance, Canada announced its intention to introduce changes affecting private corporation taxes whereby it sought to plug the tax loopholes with a view that everyone pays a fair share of taxes. Attached is the link below:

https://www.fin.gc.ca/n17/17-066-eng.asp

As soon as above proposed tax changes were tabled by the Finance Minister Mr. Bill Morneau, lots of opposition were raised expressing their resistance to new rules imposing very high tax burden on such private corporation.

Let us look at them as to what are those proposed changes. These changes were in three major areas as follows:

1. Income sprinkling in the private corporation.
2. Holding of passive investment in such private corporation.
3. Converting Private Corporation’s regular income into Capital Gains ( since Capital Gains are taxed at a lower rate)

Income Sprinkling In the Private Corporation: (Salary and Dividends Paid) Rules for Minor and Major Family Members:

Salary:

Currently, if the private corporation pays reasonable salary to the family members, the same is allowed:

• If the salary paid is reasonable.

Proposed Rule:

Salary paid to children over 25 years of age will be taxed at the maximum marginal tax rates, unless:

• The salary paid is reasonable and
•  It is equivalent to the Fair Market Value of services rendered.

Salary paid to children of 18-24 years of age will be taxed at the maximum marginal tax rates unless:

• The salary paid is reasonable and
• Is equivalent to the Fair Market Value of services rendered
• Children must be engaged on a regular, continuous and substantial basis in the activities of the corporation.

Dividend Payment:

Currently, if the private corporation pays Dividend to the family members as shareholders, the same is allowed.

Proposed Rule:

Dividend paid to children over 25 years of age will be allowed:

• If the same is paid at the Market Rate of Return

 Dividend paid to children of 18-24 years of age will be allowed at the prescribed interest rate which is 1% p.a.

Example Scenario:

• Steven (24) receives the Dividend of $100,000 from his father’s corporation because he is the preferred shareholder of the corporation.
• Steven also receives the salary of $30,000 when the market value of his services is $50,000,the calculation will be done as under:

Total Dividend Paid	$100,000
Less: Child being 24, Dividend allowed is at 1% pa on $100,000	< 1,000>
Less: Fair market of services rendered $50K-Salary paid of $30K	< 20,000>
Tax at Maximum Marginal rate on unreasonable dividend	$80,000

Action Required:

Consider making the dividend payments to the adult shareholders who do not contribute to your corporation.

Life Time Capital Gains Exemption on Sale of Small Business Corporation Shares:

Currently if the children are the shareholders, then each child is entitled to Life Time Capital Gains Exemption on the disposition of such shares. The maximum deduction allowed is $835,716 ($1 Million for Qualified Farm Property or Qualified Fishing Property)

However, going forward, no life time capital gains exemption will be allowed if the shareholder child is under the age of 18 years and if such shares are included for taxing the split income as shown above.

Also, it is proposed that there will be no life time capital gains exemption for non-arm’s length dispositions of a small business corporation shares.

Latest News:

Somewhere around October 20, 2017, Finance Minister Bill Morneau and the agricultural minister Lawrence Mac-Aulay made the announcement that the current government would not go ahead for implementing this part of their proposal since it would create difficulty for Family Farm to pass on the same to the next generation.

Passive Income Generated in the Private Corporation:

It was proposed in the new rules as regards the income generated by private corporation that it be taxed at a much higher rate by eliminating the tax that can be refunded in case if such private corporation pays dividend to its shareholder.

Latest News:

The Finance Minister has announced somewhere at the end of the third week of October that Government will not levy additional tax as indicated above up to a limit of $50,000 income from passive investments considering 5% per annum return on an investment of $1 million in a private corporation.   

At around same time it was also announced that the small business corporation’s Federal Rate of tax would be reduced from 10.5 % as at present to 9% giving out some more tax relief to private corporations which are the back bone of The Canadian economy.

It would be interesting to see how the above private corporation tax changes are finally crystalized and implemented. It is expected that these changes will be passed at the end of this November.

Disclaimer: Any discussion on this blog relating to tax matters is purely for educational purposes and not taking any specific actions based the general tax rules described therein. Your tax situation could be different and as a result there may be different tax strategies applicable in your case. We do not claim the tax situations described above to be exhaustive or conclusive. In case of any specific tax situations or problems, you are advised to seek professional advice.