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The consultation paper and draft legislation released by Finance Minister Bill Morneau last month is likely the biggest attack on perceived tax benefits available to incorporated small business owners in decades.  Aside from the content of the proposals, one of my biggest complaints is how the changes have been characterized in the popular press, and indeed by some government spokespeople when commenting on the proposals.  Words like “tax evasion” and “abuse” and the somewhat more benign “tax loophole” have been bandied around, implying that those using legal tax strategies available to reduce their taxes were doing so with criminal intent.

To be clear, while one may agree or disagree with the proposals, they represent changes to current practices that are perfectly legal and widely used by small business owners.  While the tax legislation surrounding these issues may be more complex, it would be the equivalent of proposing to eliminate RRSP’s (since most studies have shown they disproportionately benefit wealthier Canadians) and then accusing those who have contributed to RRSP’s in the past of tax abuse.

For those of you who may have missed all the hoopla, here is a brief summary of the proposals:

1. Income Splitting

The new rules will severely curtail the ability of business owners to split income among family members through techniques such as dividend sprinkling, as well using the small business capital gains exemption of multiple family members on the sale of a business.  We will need to wait until the final rules are issued to see how the government intends to differentiate between a true “family business” where several family members may be actively involved, and structures that are set up purely for income splitting (as well as every shade of grey in between).

2. Passive Investments Held in Corporations

The government is proposing to change the way in which passive investments are taxed within small business corporations.  While the current rules do a good job of ensuring that the rate of taxation of investment income is similar whether the investments are held personally or through a corporation, the government is concerned that the timing of the taxation gives an unfair advantage to those holding investments within a corporation.  New rules would likely eliminate any possible tax advantage of holding investments within a corporate structure.

3. Conversion of Income into Capital Gains

These changes impact a tax planning technique far less common than the first two.  In principal I have no objection to the changes in the rules here, however those who have done some complex estate planning to take advantage of this technique may be impacted.

 

The final legislation relating to these changes will likely be released sometime late in the year, to take effect in 2018 (other than the capital gains conversion which is already in effect).  Keep a look out for more information in my fall newsletter once more details are known.