Sweeping changes proposed to the taxation of small businesses and their shareholders
On July 18, 2017, the Ministry of Finance released a Consultation Paper and draft legislation to curtail certain private company tax planning structures that are widely used by closely-held corporations and their shareholders.
The changes are aimed at (1) preventing income splitting amongst a family (through a trust, or dividend bearing shares held by family members) where the family members are not active in the business; (2) prevent the multiplication of the capital gains exemption, including by holding shares of a corporation through a family trust; and (3) deferring tax by using a corporation to hold passive investments.
Generally speaking, the proposed changes would severely curtail a business owner’s ability to split income with related persons who do not participate in the business (regardless of age), as dividends paid to or gains realized by those family members will be taxed at the highest marginal rate if the amount they receive is in excess of what a third party would receive with regard to the services provided or capital invested in the business. For the purposes of these amendments, “related persons” would include aunts, uncles, nieces and nephews.
In addition, changes were announced to prevent multiplying the capital gains exemption by holding shares in a family trust (planning to use this strategy was discussed in a previous blog post here.) Again, the aim is to restrict use of the exemption to those who are active in the business. After 2017, the rules propose to make all capital gains realized by a trust (with a few exceptions) ineligible for exemption.
While not included in the draft legislation, the consultation paper has also provided suggestions for dealing with corporations earning passive income (dividends, interest, etc.). The “problem” as seen by the government is that a business owner can invest corporate funds (which would generally be taxed at a lower rate than an individual earning a salary), and therefore reap the benefits of earning returns on a higher initial investment. No draft legislation has been proposed for this at this time, but one suggestion is to eliminate refundable tax that is currently refunded to corporations when they pay out profits from those investments as dividends.
If passed, the majority of the proposed legislation would take affect January 1, 2018, but some changes would be effective as of July 18, 2017 (the date the legislation was released). The proposals also include transitional provisions so that some actions, if taken in 2018, can rely on the existing rules.
As we work our way through the proposals, we will keep you posted, but be prepared for a dramatic change in private company tax planning.
By LaBarge Weinstein’s Taxation, Tax Planning, and Tax Litigation team.