by Angela Todd, CPA, CGA
On July 18, 2017 the Department of Finance of Canada released legislative proposals to the Income Tax Act creating a whirlwind of activity in the business and professional communities. The July proposals targeted income splitting, surplus stripping and corporations with passive income and assets. The legislation is very complex and carries a heavy impact for many Canadians. Over 21,000 written submissions prompted Finance to announce significant changes in October.
The Good News
- Federal small business rate reduced from 10.5% to 10% on January 1, 2018 and to 9% on January 1, 2019 (affecting an increase in tax on non-eligible dividends)
- Not moving forward with the lifetime capital gains exemption measures
- Not moving forward with surplus stripping proposals (for now)
The Good and Bad on Tax on Split Income (TOSI)
Individuals and Income Excluded or Exempted from TOSI
- Your spouse if you contributed to your business and are over 65 years
- If you are 18 years or more and contributed labour (an average of 20 hours per week) in the year or in any 5 prior years (prorated for seasonal operations)
- If you are 25 years or more and own 10% or more of votes and value of a corporation that earns less than 90% of its income from the provision of services and is not a professional corporation, by December 31, 2018
- Secondary income earned on an amount previously subject to TOSI
- Income earned on property received due to marital breakdown
- Capital gains on qualified small business shares and qualified farm or fishing property (if not subject to TOSI under the old rules)
- If you are the surviving spouse and inherit assets transferred on death, you continue to benefit from the deceased spouse’s excluded status
- If you are under 25 years and inherit assets from a parent
- If you are a fulltime student or eligible for the disability tax credit and inherit assets from a deceased individual
Individuals and Income Subject to TOSI
- Every shareholder unless excluded above
- Income includes: direct or indirect income from one or more related businesses, debt obligations, income and gains from dispositions where income from the property would be split income
- If you are under 18 years all income is TOSI
- If you are 18-24 years all income is TOSI unless you earn a reasonable return on arm’s length capital or you have contributed labour (see above)
- If you are over 25 years the reasonability test applies unless you own excluded shares (see above)
What to Expect in 2018
The small business reduction is good news, although it increases the tax deferral on corporate income and the “fairness” gap that Finance identified. Corporations could see significant changes in the future to their capital dividend accounts, their eligible dividend pools and new or additional refundable and/or non-refundable taxes to be paid on passive investments. As these changes will apply on a go-forward basis, existing passive assets and income is grandfathered. The new regime for passive assets in a corporation could result in significant compliance costs for corporations. We expect to see draft legislation in 2018.
Finance offers assurances that the ability for small business corporations and family farms and fishers to transition assets on a tax deferred basis to the next generation will be preserved. New legislation to preserve these tax deferrals is expected.
A significant number of shareholders may be affected by the new tax on split income rules. Changes to existing corporate business structures and estate plans may be required to comply with the new exclusions.
Disclaimer: This article is for general information only. If you have specific questions regarding how these proposed changes could affect you, please contact your accountant or tax specialist.