Tax Planning for Private Corporations
A couple of weeks ago, the Minister of Finance, Bill Morneau, made a series of announcements regarding the government’s plans to reform the taxation of private corporations. For those of us in the tax community that were hoping for some clarity so that we could get back on track with some legitimate tax planning for our clients, I think it is fair to say we were disappointed. There were however some changes from the original proposals that were announced, so it is worthwhile to give a recap of where we stand on the three reforms that were under consideration.
In an announcement made on October 16th, Bill Morneau confirmed that the government intends to proceed with measures that limit the ability of owners of private corporations to lower their personal income taxes by sprinkling their income to family members, who do not make a meaningful contribution to the business. There was no further clarification on what would constitute meaningful, or how it would be measured. The government did however commit to “reducing the compliance burden with respect to establishing the contributions of spouses and family members including labour, capital, risk and past contributions, better target the proposed rules, and address double taxation concerns”.
At the same time the government also announced it will not be moving forward with proposed measures to limit access to the Lifetime Capital Gains Exemption. I expect that they determined there simply were not enough taxpayers able to take advantage of the current provisions to make it worth their while.
Holding Passive Investments Inside a Private Corporation
Although there was some backtracking from the original proposals here, the concessions may have added even more complexity to an already unworkable proposal. On October 18th, Bill Morneau made the following announcements:
- “All past investments and the income earned from those investments will be protected” How this will actually be implemented tracked is anyone’s guess. I certainly cannot envisage any practical way of doing this.
- “A $50,000 threshold on passive income in a year (equivalent to $1 million in savings, based on a nominal 5-per-cent rate of return) is available to provide more flexibility for business owners to hold savings for multiple purposes, including savings that can later be used for personal benefits such as sick-leave, maternity or parental leave, or retirement”. It is unclear whether this is on top of the exemption for past investments mentioned above, or if it would be reduced by the earnings reported on those investments.
The resulting tax on investments that are not “protected” or below the threshold will certainly be punitive assuming there are no other changes to the proposals, and I can see very few circumstances where anyone should continue to employ this strategy. That being said, the $50,000 threshold will mean that a large number of smaller investors will not have to deal with these new rules.
Converting Income into Capital Gains
On October 19th, Bill Morneau announced that the Government will not be moving forward with measures relating to the conversion of income into capital gains. This is actually one area where I felt the government had legitimate issues, as much of the tax planning surrounding these strategies has been extremely aggressive, and definitely meets the criteria of “tax breaks not available to average Canadians”. It was however one of the more poorly thought out proposals, and some of the unintended consequences to farmers and fishermen grabbed a lot of attention and resulting political heat.
Reforms in this area are not dead however. In his announcement, Bill Morneau stated “The Government will work with family businesses, including farming and fishing businesses, to make it more efficient, or less difficult, to hand down their businesses to the next generation. In the coming year, the Government will continue its outreach to farmers, fishers and other business owners to develop proposals to better accommodate intergenerational transfers of businesses while protecting the fairness of the tax system”.