[Private Corporation Tax Proposals: What’s Important & What to Do]
[Jamie Golombek, Managing Director, Tax & Estate Planning, CIBC Financial Planning and Advice]
Perhaps the hottest issue this entire year so far, in fact in the last 40 years, is the changes proposed to the private corporation tax rules.
So, this has gotten an enormous amount of attention both in the tax community and the widespread business community. This is being argued in Parliament on a daily basis. This is the hottest issue for sure of the summer and in many decades.
There are fundamental changes to private corporation tax rules. I'm not here to tell you what those changes are. I'll summarize them briefly.
What I am here to tell you is what you need to do, as a business owner, to take action to make sure you maximize your tax benefits, assuming that all the rules go through as planned.
[Private Corporation Tax Proposals]
The four main things that the government is looking at, number one is Income Sprinkling.
So, there are new rules coming into play on January 1, 2018 that will prevent you from paying dividends that are not reasonable, whatever that means, to not actively involved family members. So, your spouse, your kids. We already had rules for kids under the age of 18. This will apply to a broader definition of relatives, so it's kids, grandkids, nieces, nephews, uncles, aunts, brothers, sisters, etc.
Anyone who is receiving dividends from a private company would be caught and taxed at the highest rate if they haven't made a contribution, either labour or capital that's reasonable after 2017.
The second thing that they're looking at is the multiplication of the Lifetime Capital Gains Exemption (LCGE).
Currently when you sell shares of a private company, assuming it qualifies as QSBC shares, the first $835,000 or a million dollars for farming and fishing property, is tax free.
There are techniques, either involving an estate freeze or otherwise, to multiply the exemption among family members, spouse and kids, as long as the kids were of a certain age, then you could multiply this exemption out and claim multiple capital gains exemption.
That is ending at the end of this year.
Thirdly, there are rules in place to prevent the Conversion of Dividend Income into Capital Gains.
And these are somewhat complex transactions. Those will obviously be stopped altogether.
It does however affect something called the pipeline transaction, which I'll talk about in just a moment. You need to be very careful on the death of a shareholder.
And finally, probably the most serious one for many of people in our particular line of business is the Passive Investment rules.
So, the government is concerned that, even though the tax rates are ultimately the same when you earn income personally or corporately, if you earn income in a corporation you can defer tax on those retained earnings until you take them out as a dividend.
So, for example if you earn $100 of income personally and you're in a 50% tax rate, you have $50 to invest.
If your small business earns $100 and you pay only 15% tax, you have $85 dollars to invest. That's 35 percent, that's a typical average tax deferral.
The government doesn't like this, and they're proposing rules to tax the income on that 35% additional capital at rates as high as 73%.
[What to Do About the Private Corporation Tax Proposals]
What I want to take you through is some very specific action steps. Each of these four areas that you need to do to be able to make sure that you are properly planning for these new rules.
When it comes to income splitting what can you actually do?
First of all, if you're a private company and shareholders like a spouse partner or other relatives as shareholders, consider whether it makes sense to pay additional dividends to family members who are in lower tax brackets in 2017, to maximize any income sprinkling opportunities before the rules come into place in 2018.
Also, starting next year consider delaying dividend payments to any related adults until they are at least 25 years old. There are very special rules for capital contributions for related children.
And similarly, also review your dividend compensation strategy for any adults over 25 because that could be considered to be caught by the new rules.
[Lifetime Capital Gains Exemption (LCGE)]
When it comes to the Lifetime Capital Gains Exemption, there are also a couple of strategies there.
First of all, there is an election that's available to be able to crystallize the lifetime capital gains exemption in 2018.
To be able to qualify for that particular exemption, more than 50% of the assets have to be as an active business. They've relaxed that test from two years to one year.
But then you need to consider whether any steps need to be taken before the end of this year to reduce or purify that corporation and withdraw the non-active assets. That test is met at some point in 2018.
Similarly, if you're planning to make the election to claim the exemption consider whether or not you do need to do a valuation of the corporation, so that you can claim that on the deemed capital gain on any of the increase in value of the shares, because penalties could apply if you use an inaccurate fair market value.
When it comes to converting income to capital gains on the death of a shareholder, pay very particular attention to what we call the pipeline transaction, which theoretically is dead. What that tries to do is avoid double taxation on death. So, in the case of a death of a private company shareholder, you ought to be very, very careful, speak to your tax advisors, and see if there's other techniques that you might use to avoid double, or in some cases triple taxation, on death.
[Passive Investment Income]
And finally, when it comes to Passive Investment Income, there's really nothing you can do right now.
We don't have an effective date for when those rules will come into play, and therefore, it's business as usual, leaving money in the company until you need it.
In the future, when we have an effective date, then you'll need to consider whether or not it makes sense to fully withdraw all the income from the corporation that you don't need, so that you're not taxed at punitive rates of over 70%.
For a more detailed explanation of anything that I've talked about today, please be sure to download a copy of our CIBC report called Taking action: What you need to know and do in light of the CCPC tax rule changes.
[This video is provided for general information purposes only and does not constitute financial investment, tax, legal or accounting advice nor does it constitute an offer or solicitation to buy or sell any securities referred to. Individual circumstances and current events are critical to sound investment planning: anyone wishing to act on this document should consult with his or her advisor. The information contained in this video has been obtained from sources believed to be reliable and is believed to be accurate at the time of publishing, but we do not represent that it is accurate or complete and it should not be relied upon as such. All opinions and estimates expressed in this video are as of the date of publication unless otherwise indicated, and are subject to change. ®The CIBC logo is a registered trademark of the Canadian Imperial Bank of Commerce (CIBC). The material and/or its contents may not be reproduced without the express written consent of CIBC.]