Canada Finance Minister Proposes Major Changes to the Taxation of Private Corporations

Federal Finance Minister Bill Morneau released a paper and draft legislative proposals addressing the taxation of private corporations for consultation on July 18, 2017. The Canadian government believes these changes are necessary to close perceived tax loopholes for all private business owners. These significant proposals, if enacted, would potentially affect all incorporated Canadian business owners and their families, and reverse many long-standing tax policies that have encouraged business growth.

It is interesting that the tax expected to be raised ranges from “nominal” to a budget rounding error: $250 million. That puts these proposals into the “class warfare” or “politics of envy” bucket similar to the U.S. estate tax.

While the mainstream media outlets such as CBC and Macleans (and even international accounting firms) state that tax proposals are targeted at the wealthy, nothing could be further from the truth. There are no de minimus rules. These rules apply to all incorporated private Canadian businesses, whether it is a single carpenter earning $100,000 per year or a merchant banker earning $5,000,000 per year.

The proposals are aimed at targeting three specific areas:

Anti-Income-Splitting Rules

Proposed legislation, generally effective for 2018 and later taxation years, aims to limit income sprinkling to only family members receiving ”reasonable” compensation from a private corporation. The proposed measures cover the following three general categories: (i) extending the tax on split income (”kiddie tax”) rules to all Canadian resident individuals who receive “split income”; (ii) limiting multiplication of claims to the lifetime capital gains exemption; and (iii) broadening measures within the tax system to limit income sprinkling.

Passive Investment Income

The government is seeking input on potential approaches to “neutralize” the tax advantage of investing undistributed earnings from an active business using a private corporation. The perceived advantage is due to the fact that corporate income tax rates on active business income are significantly lower than personal income tax rates, thereby allowing a greater amount of undistributed earnings to be invested in a passive corporate portfolio.

Coverting Income into Capital Gains

Proposed legislation, effective on 18 July 2017, is intended to prevent a private corporation’s surplus income from being converted into a capital gain. Since taxable dividends and salary are taxed at a higher personal income tax rate than capital gains, a tax benefit may be obtained by converting corporate surplus income into capital gains.

Our initial reaction to the proposals is that the usefulness of holding companies for capital appreciation, family trusts for income sprinkling and multiplication of the capital gains exemption will come to an end to the extent these proposals are implemented in their current form.

Catalyst will continue to analyze the implications of the proposals and provide further comment and guidance. For more information about how these changes may impact your private business, please contact us.

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