During the ensuing 75-day consultation period, in which the government sought the input from the public, the department received over 21,000 responses from accountants, lawyers and other concerned interest groups. By Oct. 18, they introduced amendments and of the four original proposals, only two will proceed (in a watered down version). Further adjustments and announcements will be forthcoming. 

Normally such consultation process would take a number of years. Why the rush and how could they possibly have reviewed all the proposals?  

The intent is to “introduce fairness” between taxpayers that use corporations and individuals who do not have access to private corporations. The perceived unfairness is a result of the growing gap between corporate taxes (16-26.5 per cent in Ontario) and top personal income tax rates (53.53 per cent) and hence the increased benefits associated with tax planning using private corporations. 

The proposals initially failed to take into account the fact that many small business owners used corporate tax deferred savings and existing income tax rules to help finance startup, downturn, sick, maternal or parental leave and retirement planning.  

The end result of these proposals is a huge broadening of the number of individuals who may be subject to additional tax, uncertainty, complexity, increased potential litigation and increased administrative costs that may not exceed the benefits.

PROPOSED CHANGES

Income Sprinkling

Effective Jan. 1, 2018, dividends or certain taxable benefits received from and/or the taxable sale of shares of a private limited company by an adult individual, who is related to an owner of a company or to someone who has “significant influence” over various aspects of a company, will be subject to reasonableness tests. These tests will be more stringent for 18-24 year olds (many of whom are attending post-secondary schools).    

The reasonableness tests will be based on the contributions made by the individual to the business compared to an arm’s-length situation.   

These reasonableness tests will be a lot more difficult to meet in the case of a “professional corporation” (i.e. medical doctor) than a non-professional corporation.  To the extent that the amount is not reasonable, the top marginal tax rate will apply to the dividends (commonly referred to as Tax on Split Income or TOSI).  

Income received from shares inherited from the death of a related person could potentially be excluded from these proposals on the basis that the individual will also inherit the “contribution” factors of the deceased, until the beneficiary reaches the age of 24.

Multiplication of the Lifetime Capital Gains Exemption (LCGE)

The proposals are aimed at limiting the multiplication of the LCGE when used in a family trust setting. The LCGE is currently $835,716 per person on the sale of Qualifying Small Business Corporation (QSBC) shares and $1 million on the sale of Qualified Farm or Fishing Property, assuming certain tests are met in the 24-month period prior to the sale. Due to major issues raised by intergenerational transfers of family businesses and entrepreneurship, the LCGE proposals were dropped in the Oct. 18 announcements.  

Passive Investment Income

Corporations can earn either “active business income” from conducting a business and/or “passive income” derived from portfolio investments. 

The perceived unfairness is that corporations that pay low marginal rates of 16-26.5 per cent have more after-tax funds to make passive investments than would an individual subject to higher personal tax rates. 

There is no specific draft legislation in this area and the Finance Department sought input as to how to implement this. 

Income tax advantages (the refundability of passive investment taxes) and the lower “eligible dividend” tax rates would be removed when taxable dividends are paid to personal shareholders.

Moreover, it is proposed to eliminate the normally untaxed half of the capital gains when the gain arose on the disposition of passive properties. 

These are fundamental concepts that have been engrained in the Income Tax Act since 1971.

On Oct. 18 the Department announced that a maximum of $50,000 of investment income could be earned per annum and any dividends paid from such pool would not be subject to the rules. 

The threshold amount assumes $1 million of investable assets earning a 5 per cent rate of return per annum. 

The amount was introduced to allow for some accumulation of funds within corporations. Any dividends over these thresholds will bear a combined corporate and personal tax rate of 73 per cent.

 The Department has indicated that such new rules will apply on a prospective basis and not on already accumulated investments.    

Converting Dividends to Capital Gains

When an individual passes away, assuming that the assets are not left to a surviving spouse, there is a deemed disposition of all of their assets at fair market value at that time. 

To minimize taxes on death and avoid double tax on holding of shares in a private company, the Income Tax Act has certain allowable provisions. 

The proposals would have eliminated the effective use of these provisions and given rise to an overall income tax rate exceeding 70 per cent. 

This unintended result would have eliminated many intergenerational transfers of small businesses in Canada. It also would be more taxing to sell a business to an existing family member than to a stranger. Given these unintended results, the Department decided to not proceed with these proposals.

IMPLICATIONS FOR ESTATE PLANNING

Estate planning for individuals who do not own shares or receive certain benefits in privately held companies has not been affected by the July 18 proposals. In order to preserve assets and minimize taxes on death, traditional probate and income tax planning strategies are still valid.

Consider the following to minimize probate taxes on death (as high as 1.5 per cent in Ontario):  joint ownership of assets, named beneficiaries in RRSPs, RRIFs and pension plans, transfer assets prior to death to special purpose trusts and establish multiple Wills. 

Strategies to minimize income taxes on death would include: specifying spouse or financially dependent children as named beneficiaries in RRSPs and RRIFs, consider an “estate freeze” of private company shares, spousal trusts set up in a Will, purchase of life insurance and creative use of charitable donations.

Remember, the Finance Department proposals are still subject to revisions as they receive feedback. Each person’s situation is different so it’s important to consult a professional advisor if need be. 

(Anthony M. Cusimano, CPA, CMA, CA is a chartered professional accountant practising in the Greater Toronto Area.)