On July 18, 2017, the federal Department of Finance issued a highly anticipated consultation paper, which addressed some of the tax strategies that incorporated business owners and professionals use in their tax planning. The view of the government is that private corporations provide high income individuals with an unfair tax advantage that is not generally available to other Canadians.
One issue is commonly referred to as “income sprinkling.” That is an arrangement that results in income that would otherwise be realized by an individual facing a higher personal income tax rate to instead be realized by family members who are subject to lower personal tax rates. The result, of course, is that the income in question, by its distribution or “sprinkling”, results in an overall tax rate that is lower than would be the case if the strategy had not been employed. Again, the government has taken the view that this is “unfair” as it is a strategy not available to all Canadians.
The tax legislation currently deals with income sprinkling used by private corporations by using a reasonableness test. The way this works is a little complicated, to say the least. The test applies whenever salary is paid to family members. If the amount paid is basically fair market value for the work done, in all the circumstances, then that’s fine. If not, CRA will have a problem.
But, in general, this test does not apply to the payment of dividends. As well, a Tax on Split Income (TOSI) applies to dividends on unlisted shares (as well as other types of income paid to minor children under the age of 18) of a related individual. Under the TOSI rules, dividends paid to minor children are taxed at the top personal marginal rate.
The government proposes to extend the TOSI rules that currently only apply to minors to adult family members as well in certain circumstances. The reasonable test, it is proposed, will apply not only to salary, but to dividends as well. For many taxpayers, this could mean that dividends paid to spouses and adult children would not be taxed as dividends, but rather taxed at the top personal marginal rate of the recipient.
There are also proposals dealing with the multiplication of the Lifetime Capital Gains Exemption (LCGE). These would restrict the ability to sprinkle the exemption in certain cases, beginning after 2017. The government is also concerned with respect to the fact that private corporations who qualify for the small business deduction can benefit from significant tax deferral advantages that “average” Canadians cannot.
Finally, anti-avoidance rules are a focus, and tightening in that area is proposed.
The bottom line is that these proposals, if enacted, will totally change the tax landscape for incorporated small business owners and their families in terms of the tax treatment of the revenues emanating from those businesses.
To the government’s line of thinking on all of this I would say that what is really unfair is to (as is proposed) penalize individuals who have taken on the enormous risk of starting a small business and employing other individuals in it. Small business is extremely important to the Canadian economy. One can easily get the impression that the government cannot see the forest for the trees on this issue.
It is true that not everyone has what it takes to launch a small business. It is also true that not everyone has what it takes to be a professional athlete or performer.
The rules currently in place exist because they have, over time, encouraged small business growth and, by extension, overall economic growth in Canada. If these proposals actually become law, the result will be two-fold: first, those who are currently small business owners will have the proverbial rug pulled out from under them. Second, many who would have considered launching a small business will have serious second thoughts. The result, I fear, will be a decline in the small business sector, and a weakening of an economy that is hardly robust.
All of that said, fairness, like so many other things, is in the eye of the beholder. These proposals may well become law. The issues are extremely complex, and anyone who may be affected by the proposed changes would be wise to seek the counsel of their tax advisors sooner rather than later.
President, HG Partners Limited
Director, Private Client Group &
Senior Financial Advisor,
HollisWealth Advisory Services Inc.
This article was prepared solely by Howard Goodman who is a registered representative of HollisWealth Advisory Services Inc. (a member of the Mutual Fund Dealers Association of Canada and the MFDA Investor Protection Corporation). The views and opinions, including any recommendations, expressed in this article are those of Howard Goodman alone and they are not those of HollisWealth Advisory Services Inc.
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HollisWealth Advisory Services Inc. does not provide income tax preparation services nor does it supervise or review other persons who may provide such services.
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