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Changes to the Federal Tax Proposals Announced

Prime Minister Justin Trudeau and Finance Minister Bill Morneau announced that the small business tax rate would decrease to 9% (from 10.5%) by 2019 as part of new changes to the private company tax proposals.

The government has planned additional announcements in the upcoming week to provide further details of changes that it intends to make in response to Finance’s recent public consultation on these controversial proposals.

The small business tax rate will decrease to 10% effective January 1, 2018 and to 9% effective January 1, 2019.

While the government stated that it is committed to its proposed private company tax measures to address tax planning involving income sprinkling effective January 1, 2018, it is cancelling changes to limit access to the Lifetime Capital Gains Exemption (LCGE).

They also indicated that it will address certain issues in its passive income proposals.

The government is considering the recommendations of FBC and other concerned taxpayers before finalizing any planned changes to private company taxation.

Draft legislation has not yet been released to implement the small business tax rate changes, and Finance stated that, later this fall, the government will release revised draft legislative proposals on its private company tax measures. It is expected that these measures could be released as part of Finance’s upcoming fall economic update.

Small Business Tax Rate Drops To 9%

The federal small business income tax rate that applies to the first $500,000 of qualifying active business income of a Canadian Controlled Private Corporation will decrease to 9% (from 10.5%), to be phased in as follows:

  • 10% effective January 1, 2018
  • 9% effective January 1, 2019.

Finance states that the taxation of non-eligible dividends will be adjusted to reflect the lower small business tax rate to maintain integration of corporate and personal taxes. 

The government has not yet specified how it will make this adjustment.

Income Sprinkling Proposals

Finance looking at simplifying reasonableness tests

In a press release, Finance reiterates that it intends to proceed with its proposals to address income sprinkling using private corporations, but that it will make amendments to “simplify” these planned changes.  

Finance says that businesses with family members who “meaningfully contribute” to the business will not be affected.

Specifically, Finance confirms that it will introduce “reasonableness” tests for adult family members aged 18-24, as well as those 25 and older. The tests will consider whether these individuals made contributions to the business through any combination of the following:

  • Labour contributions
  • Capital or equity contributions
  • Financial risks, such as co-signing a loan or other debt
  • Past contributions in respect to previous labour, capital or risks

Finance also states that it plans to reduce the compliance burden for establishing these contributions and address double tax concerns.  

Although it is not yet clear how Finance intends to achieve this, Finance is expected to provide more details on its income sprinkling proposals soon.

Finance Will Not Proceed with LCGE Measures

Finance is cancelling proposed measures to address income sprinkling by multiplying the LCGE across multiple family members.

Specifically, the feedback from its consultation paper has identified unintended consequences of these measures, including the potential impact on intergenerational transfers of family businesses.

As a result, the government says it “will not be moving forward with measures that limit access to the LCGE”.

More Announcements Coming

The government also indicated that more changes to the proposals would be forthcoming. In particular, the government noted the following:

There are other unintended tax consequences which could impair estate planning and intergenerational transfers of farms and family businesses as a result of the proposed measures on the conversion of income to capital gains.

There are situations where passive investments inside of a private corporation are used by business owners, particularly small and medium-sized businesses, to manage personal income risk in the case of a downturn, sick leave, or maternity or parental leave.

In addition, there are many cases where passive investments are used as a retirement tool for small business owners as other savings vehicles such as RRSPs are not sufficiently flexible and adaptable to address business volatility.

The government indicated that it is committed to addressing unintended consequences, while targeting unfair advantages that largely benefit the wealthiest of Canadians.