If you have picked up any of the major newspapers or followed any twitter feeds or other social media channels, you may have read about the uproar on the 2017 proposals to changing tax regulations that would affect private corporations. We are definitely in a changing tax landscape and have been for a couple years. Here is a reminder of some of the changes we have already experienced, as well as changes potentially to come.
Paying inter-corporate dividends between connected corporations is not as simple as it used to be. Effective for dividends paid after April 20, 2015, we will need to be completing safe income on hand calculations to support the fact that these inter-corporate dividends are being paid out of safe income and only on the allowable portion of safe income for that particular class of shares. When paying dividends you are effectively reducing the fair market value of the shares that the dividends are being paid on because you are taking retained earnings out of the company with the payment of the dividend. If subsection 55(2) applies, the otherwise tax-free inter-corporate dividend could be re-characterized as a capital gain and subject to capital gains tax. Under the old rules there were exceptions, which included (1) dividends paid out of safe income, (2) a related party exemption, and (2) dividends due to a butterfly reorganization. The new rules have now broadened the application of subsection 55(2), have narrowed the ability to utilize the exceptions under the old rules, and companies must exercise more caution when considering the payment of inter-corporate dividends.
Small Business Deduction
Under the old rules, a Canadian Controlled Private Corporation (CCPC) was able to take a reduced tax rate on the first $500,000 of active business income. In the case where one or more companies are considered associated, that group of companies needed to share that $500,000 small business deduction limit.
As a part of the 2016 federal budget, a new concept of “specified corporate income” has emerged, which are in addition to the associated company rules. These changes were passed into law on December 15, 2016 and are effective for year ends that begin after March 21, 2016.
Specified Corporate Income is income from providing goods or services to another private corporation where the company, a shareholder of the company, or a related person has a direct or indirect interest in the other private corporation. If there is specified corporate income, this income will not be eligible for the small business deduction unless the receiving corporation assigns a portion of its small business limit to the company providing the goods or services. The other exception would be if the specified corporate income represents less than 10% of the providing company’s total income.
For example, Mr. A solely owns a construction company. Mr. B solely owns another construction company and is Mr. A’s brother. Because they are brothers, their two companies are deemed not to deal with each other at arm’s length and are considered related. If Mr. B provides services to Mr. A’s company, the income earned by Mr. B for those services would be specified corporate income and will not be eligible for the small business tax rate unless the income is less than 10% of Mr. B’s company’s total income, or if Mr. A assigns a portion of its small business limit to Mr. B’s company. So even though the two companies would not be considered associated, because of the relationship there could be the requirement to share the $500,000 small business deduction limit between these related companies.
There were also changes to specified partnership income that could result in designated members sharing the small business limit of the partnership even though they are not directly a partner of the partnership, but rather just providing services to the partnership.
Budget 2017 items
We are currently in a consultation period until October 2, 2017 regarding the Budget 2017 proposals. If these proposals were to go through, we would see a significant number of changes all that would result in a significant increase in tax for private corporations and their shareholders. Some of the items that they are looking at changing include:
- Income splitting arrangements where dividends are paid to adult family members that have not contributed capital to the company, or where wages are paid to family members that have not worked in the business to justify said wages, would be penalized by being taxed at the highest personal tax rates (similar to our current “kiddie tax” or “tax on split income” rules).
- Holding a passive investment portfolio inside of a private corporation and accessing benefits such as the Refundable Dividend Tax on Hand (RDTOH) or the Capital Dividend Account (CDA). These benefits may be no more.
- Not allowing the capital gains exemption when selling your qualified small business corporation shares of your company to a family member. These new rules are to be effective starting in 2018, and under the proposals there may be a transitional rule to crystallize a capital gain and claim the capital gains exemption so as to increase the adjusted cost base of the qualified small business shares. Making such an election will reduce the individual’s capital gain on a subsequent sale of those shares. Please note that a proper business valuation from a CBV should be completed to determine the fair market value of the company.
- Restricting the ability to deduct the cost of WIP when computer income for designated professions (accountants, dentists, lawyers, medical doctors, veterinarians, and chiropractors)
- And more…
A lot of these changes are complex. They will require pro-active discussions with your legal and accounting advisors before your year end. They will also require additional questions when preparing your year end financial statements and corporate tax returns. Please contact our team at Quon and Associates in Calgary to assist you in this changing tax landscape.