Tax changes for private companies
By Helen Burnett-Nichols, Contributing Editor
The federal government's proposed changes to rules for the taxation of private corporations have changed since they came out last summer, Toronto corporate lawyer Peter Murphy tells AdvocateDaily.com.
In July 2017, the Ministry of Finance released proposals to change the rules in four areas:
1. to extend the tax on split income rules to spouses, adult children and other family members;
2. to limit family business owners' access to the lifetime capital gains exemption (LCGE);
3. to prevent private corporations from converting amounts that would otherwise be payable to shareholders as dividends into lower-taxed capital gains; and
4. to develop ways to neutralize the tax benefits of retaining passive benefits inside a private corporation.
But after consultations and written submissions, the government has since backed down on some of the measures, including putting aside the proposals relating to the conversion of income into capital gains and those limiting access to the LCGE, says Murphy, a partner with Shibley Righton LLP.
"The income conversion to capital gains and LCGE changes would have had a big impact on the taxation of intergenerational transfers of family-held businesses and on intergenerational estate planning.
“The government came to realize that these proposals would have imposed tax burdens that are not currently present on the intergenerational transfers of family-held businesses, so they backed off on that.”
At the same time, he says, the government has indicated that it plans to continue a dialogue with business owners this year in order to develop changes that would better accommodate the intergenerational transfers of businesses while achieving the goal of “more fairness for the tax system.”
“We do expect that they will come back with new rules regarding conversion of private corporations earnings into capital gains some time in 2018,” he says.
Owners of private corporations also voiced concerns about the proposal that passive investments in a private corporation would receive different tax treatment, says Murphy.
“In many cases, holders of private corporations will retain their earnings within the corporation in the form of investments — almost like an RRSP. While in the corporation, the investments generate revenue, passive income, in a tax beneficial way. The government is proposing to increase the taxation to minimize the tax benefit to holders of private corporations generating passive investment income in the corporation.”
After some pushback, the government announced that it would be moving forward with measures to limit tax deferral opportunities related to passive investments, with details of the plan to be included in the 2018 budget.
“We don’t know exactly what those are going to be, but we know they plan to make some changes to increase the taxation on passive investments held in private corporations,” says Murphy.
"We expect the details to be released with the 2018 federal budget," he says.
In the fall, the government also clarified its proposal to further limit the tax benefits of income sprinkling — namely, the process for paying a private corporation's earnings to family members to benefit from their lower overall tax rates.
"The government issued bright lines tests to determined whether adult family members are sufficiently involved in the business and, therefore, entitled to be excluded from the tax on split income (TOSI), that would otherwise apply to tax dividends and interest they receive from the business at the highest marginal tax rate," says Murphy.
"According to the government, the adult family member must have made a 'regular, continuous and substantial' contribution to the business to be excluded from TOSI."
The government's guidance on the application of the split income rules for adults can be found here.
Murphy says owners of private corporations should consider taking steps now in order to get ahead of the changes.
“In the case of the changes to the tax on split-income, owners of private corporations should ensure their companies are set up so that if owned by family members, they own different classes of shares so that dividends can be paid to various shareholders and not to all shareholders at the same time, which might trigger TOSI,” he says.
“That’s something they should definitely consider if all of their shares are held within the same class,” he adds.
"In addition, it might be appropriate to get those family members on the payroll now so they receive a salary instead of dividends from the company."