On July 18, 2017, the Honourable Bill Morneau, Minister of Finance, announced the next steps in the government’s intention to close loopholes and deal with tax planning strategies used by private corporations. The Government of Canada released a consultation document that asks Canadians what actions should be taken to ensure high-income individuals cannot use tax planning strategies involving private corporations to gain unfair tax advantages or to evade paying taxes.
“When you have an economy that works for the middle class, you have a country that works for everyone. That’s the spirit in which we are asking Canadians for input into how to close loopholes and address tax planning strategies that give unfair tax advantages. Many of the richest Canadians are unfairly exploiting the tax rules designed to help businesses thrive. We know that businesses, including small businesses, help grow the Canadian economy. These tax advantages are in place to help these businesses reinvest and grow, find new customers, buy new equipment and hire more people. We want to make sure those rules are used to do just that, and not to give unfair tax advantages to certain – often high-income – individuals,” said Morneau.
The consultation document focuses on three tax practices being used to gain tax advantages by private corporations or shareholders.
This practice involves “transferring” income from a family member in a high tax bracket to a family member in a lower tax bracket. This is done by paying a family member a wage or dividend, regardless of the extent of their involvement with the business. Additionally, upon disposal of a Qualified Small Business there were mechanisms in place to multiply the usage of the Lifetime Capital Gains Exemption.
In many cases, the income splitting is completely appropriate, but the government believes in some cases, a spouse or child may be getting paid although they have no role in the business.
The government would like to propose restricting a company’s ability to pay dividends to other shareholders as well, so this is not only restricted to wages being paid to family members. It would also see a stricter test for payments made to 18-24 year-olds (kiddie tax already applies to dividends paid to minor children).
This practice can result in substantial tax savings for individuals. This means tax officials could have the difficult task of figuring out what a family member’s contribution is worth or if that income is being used to avoid paying taxes. Although there are already reasonability tests in place for wages, like what kind of risks are assumed, what kind of work is performed and what kind of capital is being contributed, the government would like to see these reasonability tests extended to dividend income.
Passive Investment Income
Canada has the second lowest corporate tax rate in the G7 which is to help encourage investment in businesses and economic development in the country.
However, according to the Government of Canada some individuals are retaining passive investments in a corporation not to help grow the business but rather to shelter the funds from a higher personal tax rate. Instead of using the funds to acquire more business assets or expand its operations, the funds are being invested, often in investment portfolios.
The new proposals hope to find some middle ground, aiming to restore a balance between the taxation of savings inside and outside of a corporation.
This practice is a little more complicated and is much less common. Normally an individual will receive distributions from a corporation through the payment of dividend income or wages. However, through some complex tax planning that usually involves flowing income through multiple companies, shareholders are able to receive distributions from the corporations in the form of capital gains. As capital gains are only 50% taxable, individuals can receive a significant tax savings as a result of re-characterizing the distribution of corporate surpluses from dividends to capital gains.
What Do These Changes in Tax Planning Strategies Mean
Our partners have researched the proposed legislation thoroughly and can address your questions and concerns appropriately.
For individuals who are regularly employed and receive regular pay cheques, these changes won’t affect them as these proposals are targeted towards people who own private corporations.
These changes will also only affect people who have been using these tax strategies to minimize tax payments. If you have been using income sprinkling, you may be required to prove a family member’s contributions, which could mean creating formal job descriptions, or other steps to justify a person’s income.
The Government is asking Canadians to share their views and ideas about the proposals and submit responses by October 2, 2017. Following this consultation period, the government will table a revised form of legislation to close loopholes in the tax system.
More information and related reading can be found here:
- Summary Overview: Consultations on Tax Planning Using Private Corporations
- Consultation Document: Tax Planning Using Private Corporations
- Draft Legislation and Explanatory Notes
- PowerPoint Presentation on Tax Planning Using Private Corporations [PDF 475 KB]
If you have any questions regarding the consultation paper issued by the Department of Finance, you are encouraged to get in touch with Your Trusted Financial Advisor. Our partners have researched the document thoroughly and can direct your questions and concerns appropriately.