This is the year we celebrate Canada’s 150th birthday. There is, however, another lesser-known anniversary scheduled to occur this year: the 100th anniversary of the Income Tax Act.
While there is not likely going to be a great deal of fanfare for the event, the growth of the tax system and the importance it plays on our lives cannot be understated. On March 22nd, 2017 Bill Morneau, the Minister of Finance, tabled the second budget of the Trudeau government, entitled Building a Strong Middle Class (hereafter referred to as the “Budget”).
With all of the speculation leading up to its publication the actual Budget was rather bland; it is more of a “wait and see” budget. The Budget is a furtherance of its predecessor and continues to eliminate tax measures deemed to be “inefficient”, building the overall deficit at a level originally detailed in the inaugural budget. Don’t be lulled by the blandness; this budget might be the start of a dramatic shift in planning, particularly for the culture of entrepreneurship.
This report will focus primarily on the potential changes and conclude with a high level overview of other Budget items. For a detailed review of the Budget, consider reading one of the great publications prepared by the many major accounting and law firms across Canada.
Tax Planning Using Private Corporations
The current government has consistently expressed its concern that the “wealthy” have received unfair tax advantages through the use of private corporations. The Budget takes this concern a step further by noting specific strategies and announcing the Government’s intention to release a paper in the coming months. The paper will detail the “questionable” strategies and is to include proposed policy responses.
In addressing these issues, the Government has a desire to ensure that only corporations contributing to job creation and economic growth by actively investing in their business continue to benefit from a highly competitive tax regime. The impacts of the comments are unclear and some of the descriptions leave room for interpretation. It is recommended that you seek a better understanding of what the change might mean, certainly before taking any action.
The strategies referenced in the Budget include:
- Income sprinkling. This strategy involves shifting income, typically in the form of dividends, from the private corporation to family members who are subject to lower personal tax rates. This type of tax planning has been around a long time and is commonly listed as one of the benefits to incorporating. The ability to “sprinkle” dividends is limited to spouses and adult children as changes were made many years ago to ensure minor children did not benefit from this type of planning. This type of planning is often seen in conjunction with a family trust. Eliminating the benefit could deter entrepreneurs from taking the risk of starting a business.
- Building a passive investment portfolio within a private corporation. The Budget states this may be financially advantageous for owners of private corporations compared to otherwise similar investors. This conclusion is mainly drawn from the fact that corporate income tax rates, which are generally much lower than personal rates, facilitate the accumulation of earnings that can be invested in a passive portfolio. Experience has shown business owners are interested in diversifying their portfolios and saving for their retirement. The Income Tax Act already makes it difficult for a Canadian controlled private corporation (“CCPC”) to build a passive investment portfolio as this type of income is taxed differently than active business income. The tax rate on passive income earned by a CCPC includes a refundable tax which results in an extremely high tax rate.
- Converting a private corporation’s regular income into capital gains. This strategy requires a series of complex transactions with the goal of converting income traditionally paid out in the form of dividends into capital gains. While complicated, many “wealthy” individuals have benefited from this strategy in the past. Now that it has been brought to light, it won’t likely be an option in the future. A simple solution could come in the form of increasing the capital gain inclusion rate (see below for further details).
Capital Gain Inclusion Rate
Of all of the speculation leading up to the Budget, it was the expected increase to the capital gain inclusion rate that generated the most discussion. This led to numerous conversations about how to manage this change: do you realize capital gains prior or is it better to wait and see what happens? As it turns, the Budget did not include the expected increase to the capital gain inclusion rate and therefore the wait and see approach won out. You should keep in mind that the Budget was a “wait and see” budget and changes should be expected once the outcomes of the U.S. tax initiatives are made clearer. It is quite possible that the increase in the capital gain inclusion rate will be included in the position paper.
- The anti-avoidance rules in place for TFSAs and RRSPs are to be extended to Registered Education Savings Plans (“RESP”) and Registered Disability Savings Plans (“RDSP”). This will likely have little impact on most plans that adopt conventional investments.
- Further to the restrictions placed upon mutual funds structured as corporations in the inaugural budget, the Budget proposes to allow for these funds to be reorganized into mutual fund trusts. Similar rules have also been proposed related to the merger of segregated funds. The proposal basically levels the playing field as it provides a mutual fund corporation or segregated fund the same benefits afforded to mutual fund trusts.
- The Budget proposes to repeal the ability for eligible small oil and gas companies, defined as corporations with taxable capital employed in Canada of not more than $15 million, to reclassify the first $1 million of Canadian Development Expense (“CDE”) as Canadian Exploration Expense (“CEE”) when renounced under a flow-through share agreement. Repealing this important benefit makes it harder for these corporations to obtain financing, especially given the current environment for the oil industry.
- Various “ineffective” items have been proposed for elimination. This list includes the Public Transit Tax Credit, the deduction available to employees for home relocation loans, the First-time Donor’s Super Credit for charitable donations. It is unlikely the elimination of these will impact many taxpayers due to the previous lack of claims.
- In keeping with inefficient programs, the Budget proposes to phase out the Canada Savings Bond.
- The Budget proposes to update the list of expenses eligible for medical expense tax credit to include certain reproductive procedures, including in-vitro fertilization.
- Making good on their original campaign promise, the Budget extends parental leave and benefits offered under Employment Insurance (“EI”) to 18 months. It’s important to note that the benefit rate is lowered to 33% of the taxpayer’s average weekly earnings, compared to the current rate of 55%.
- The Budget proposes to replace the infirm dependant tax credit, the caregiver tax credit and the family caregiver tax credit with a new non-refundable Canada Caregiver Credit. The maximum amounts claimable under the credit are $6,883 for the care of an infirm dependant relative and $2,150 for an infirm dependant spouse or common-law partner, an infirm dependant for whom the individual claims an eligible dependant credit, or an infirm child who is under the age of 18 at the end of the taxation year. The credit amount is reduced where the dependant’s income exceeds a specified threshold.
This article was provided courtesy of Chris Geldert, CPA, CA, CEA.
Chris Geldert is a dedicated member of the Financial Horizons Group team. As a Chartered Accountant who has been actively involved in the insurance industry since 2003, Chris brings a wealth of knowledge and experience to our advisors. From developing and presenting strategies, to providing independent recommendations on products suited to the client’s needs and risk comfort levels, Chris works to assist advisors grow their practice.
The writer can be contacted at: email@example.com
Disclaimer: This article is intended to provide general information only and should not be considered as legal, accounting or taxation advice. Before acting on any of the information contained within this article, or before recommending a course of action, make sure your clients seeks advice from a qualified professional. Any examples or illustrations used in this article have been included to help clarify the information presented in this article and should not be relied on by you or your client in any transaction