My name is Mark Goodfield. Welcome to The Blunt Bean Counter ™, a blog that shares my thoughts on income taxes, finance and the psychology of money. I am a Chartered Professional Accountant and a partner with a National Accounting Firm in Toronto. This blog is meant for everyone, but in particular for high net worth individuals and owners of private corporations. The views and opinions expressed in this blog are written solely in my personal capacity and cannot be attributed to the accounting firm with which I am affiliated. My posts are blunt, opinionated and even have a twist of humor/sarcasm. You've been warned.

Monday, October 23, 2017

Tax Planning Using Private Corporations - The Liberal’s go with Piecemeal Announcements


I have pushed back my second post on tax efficient investing to next week so I can comment on the Traveling Libburys tax damage control tour (instead of Dylan, Petty, Lynne, Harrison and Orbison, we got Justin Trudeau, Bill Morneau and Bardish Chagger).

The tour this week made stops in Stouffville Ontario, Hampton New Brunswick, Montreal Quebec and Erinsville, Ontario. At each location, the government provided a new tax morsel and comment on its tax proposals. However, without any details, many people are still not quite sure what the proposals really say or look like. A friend told me this is like a Trump tweet; do you take them at face value or is there more to them?

This is what we were told last week by the Prime Minister and Finance Minister in respect of the taxation of private corporations.

Income Splitting


The government announced the following in respect of the income splitting proposals:
  • It has committed to lower the small business tax rate to 10 per cent, effective January 1, 2018, and to 9 per cent, effective January 1, 2019. To be clear, this reduction is a drop from the current 10.5% rate and the provincial tax still needs to be added on. So for example in Ontario, the rate will drop to 14.5% from 15% for 2018.
  • The proposals to limit the ability of owners of private corporations to lower their personal income taxes by sprinkling their income to family members who do not contribute to the business will remain.
  • It will simplify the proposed measures with the aim of providing greater certainty for family members who contribute to a family business. Specifically, "the Government will work to reduce the compliance burden with respect to establishing the contributions of spouses and family members including labour, capital, risk and past contributions, better target the proposed rules, and address double taxation concerns". I would suggest this will be much easier said than done and I would expect this determination to be fraught with issues.
  • It will not be moving forward with proposed measures to limit access to the Lifetime Capital Gains Exemption. I would not be surprised to see specific exclusions in the 2018 budget to this rule, such as excluding the exemption for those under 18.

Passive Income Proposals


This proposal was probably the most contentious issue to most small business owners who felt the initial proposal would impact their retirement planning and ability to fund the ups and downs of a business. The government gave a little here, but given the potential massive complexity of tracking passive income and the fact they say only 3% of the businesses will be caught by the rules, this is the one area I feel they should have left the status quo. Not one tax professional I spoke to understood how this is really going to work and could see any type of legislation that will not cause massive complexity and extra accounting costs to small businesses.

Here is what the government said:
  • The new rules will not apply to existing savings and income from those savings (thus some kind of tracking mechanism will have to be put in place. I see this as an accounting and tax nightmare, how do you track amounts contributed from this pot of funds back into the business and then taken back out, let alone track the income earned from the existing pot of funds. Are the original funds referenced going to be current investments only, at cost or fair market value, will they include cash in the business or is the initial savings the current retained earnings)?
  • The existing rules will apply on investment income earned from new savings up to a maximum of $50,000 of passive income in a year (equivalent to $1 million in savings, based on a nominal 5% rate of return). To the extent investment income from new investments exceeds $50,000 in a year, the new punitive tax rates will apply. The wording here is very simplistic and has been interpreted differently already by many commentators. The devil will be in the details.
  • Incentives are in place so that Canada’s venture capital and angel investors can continue to invest in the next generation of Canadian innovation.

Capital Gain Stripping


Finally, the government announced these proposals will not move ahead. This is a head-scratcher. As  I noted in my last blog post on this topic, many would argue some of the tactics used here while legal, were aggressive. The issue in relation to capital gains stripping was the proposals were causing business transition issues and double taxation on death by not being able to use a "pipeline" planning technique to prevent double tax.

This is what the government said:
  • They will not be moving forward with measures relating to the conversion of income into capital gains. "During the consultation period, the Government heard from business owners, including many farmers and fishers that the measures could result in several unintended consequences, such as in respect of taxation upon death and potential challenges with intergenerational transfers of businesses. The Government will work with family businesses, including farming and fishing businesses, to make it more efficient, or less difficult, to hand down their businesses to the next generation".

The National Post reported (sorry link has disappeared) that Mr. Morneau said “What I’m announcing this morning is we’re going to take a step back and reconsider that aspect of our tax reform proposal,” and "the government will instead embark on a year of consultations aimed at developing new proposals".

Thus, I think it fair to say, we may not have heard the end of these rules and the Liberal's will likely move to judiciously carve out the aggressive stripping while ensuring succession and estate planning are not side-swiped.

As noted at the outset, we are lacking clarity. We have no details, legislation, examples or FAQ, let alone confirmation or whether the effective date of these proposals has changed? We still have partial or full tax planning paralysis because of these ad hoc proposals and revisions.

In my humble opinion, the main miss here is the passive rules. The complexity of these rules will be overwhelming for such little tax gain to the government.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.

26 comments:

  1. "It will simplify the proposed measures with the aim of providing greater certainty for family members who contribute to a family business"

    Once one is in retirement (Opco closed, assets invested through Holdco) how would the reasonableness test be applied to the shareholders (spouses)?

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    1. Great question, we dont know. Today I was at the Ont Tax Conference and that question was asked and the answer was about the same as the ten prior questions - the Liberals have provided no details so we dont know- the issue here is will they backtrack to prior labour and risk or just move forward so that prior labour and capital will not matter

      This is one of my biggest issues with all this, tax pro's have no idea what is really going on and cannot advise properly.

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    2. Mark: I feel for you and all the other professionals trying to do what's best for their clients. This is a dog's breakfast. My greatest concern is similar to above. I have no idea what I need to do to ensure the work I have done in our family business is recognized after hubby and I retire, given I've done a whole whack of work over the years but have never taken a penny out. Really looking forward to those government FAQ's! :-)

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    3. Hey Cdn Small Biz Owner

      I feel for you too. This is a dogs breakfast as you say and many people in your position have huge uncertainty while the tax profession is paralyzed and the government does not seem to really care or understand the position they have left small biz owners and their advisors .

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  2. Thanks for the insights. Was quite disappointed that Libs didn't drop passive income piece.

    Any thoughts as to what "passive investment income" means with respect to capital gains and the 50K/year amount? All of their examples have used interest income. I would think they couldn't afford the political fall out of trying to slip in a more punitive policy wrt capital gains but you never know.

    Also along same lines will capital gains on current corp investments be considered "future income earned from such investments"

    Whole business is so unclear, and now they are saying no updates until Budget 2018 on this bit.

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    1. Hi Tim

      No idea and based on discussions at the Ont Tax Conference I was attending this week, no one is quite sure. You are 100% correct, this whole thing is still unclear and the Liberals are doing everyone a huge disservice not providing details, let alone making these complex passive rules.

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  3. Do you think that based on the complexities / issues they will end up deferring the passive income changes to a later date and "sweep them under the rug" after the 2018 budget and subsequent election. I have moderate holdings and the proposed requirements seem ludicrous.

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    1. Hi Anon

      I thought the passive rules would be the proposals the Liberals decided to forgo and the dividend stripping rules would remain. Shows what I know :(

      However, we got the reverse showing the government does not have any idea still what professionals and small biz owners find acceptable. I am not very hopeful they will sweep them under the rug since that would mean they not only modified the rules, but then changed their minds again, which optically is not great though practically the way to go. My hope is when they try to draft these complex rules they have so much trouble they do give in.

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  4. Thanks so much, BBB. I, for one, am relieved that they're going to take at least a year to work things out instead of reaming it through.

    For the passive income portion, your take is that, based on their nebulous comments, if we earn more than $50K passively, per year, they may tax it at "the new punitive tax rate" of up to 73%, correct?

    If so, it means we shouldn't keep more than $1M in our corporations, if we can get a lower tax rate by taking dividends or salary.

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    1. Hi Melissa

      Yes, if new earnings (post 2017) or income from those earnings exceed the thresholds, you will likely ensure you do not exceed such. However it is my understanding the 73% is a bit misleading, since while the rate is 73%, the actual flow through of say $100 earnings personally and corporately will still be somewhat equivalent and the 73% is the equalizer to make up for the lower taxed active income. So from calculations i have seen your are not paying 73% in absolute dollars but still mid fifties even if earned and flowed through from a corp.

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  5. Re passive income: I wonder if that would exclude cap gains and dividends. "income" means something specific to me. Of course RDTOH would kick in on cap gains and dividends.


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  6. Couldn't agree more. All of this confusion could and should have been trivially foreseen. I can't fathom what the government is about putting forward these half-considered tidbits. They're just creating a ton of unnecessary stress and confusion, along with negative publicity.

    I don't mind the basic goal of removing some tax advantages for CCPC owners, even though I'll end up paying more. IMO some of them are indeed inequitable. Certainly it's something reasonable people could consider. But the way it's been approached is just mind-bogglingly incompetent. Overreaches on the policies, but more importantly, just a complete lack of planning, forethought, and effective communication.

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  7. Thanks so much for the insight. don't know what I'd do without these posts!!

    I am perplexed as to what the timeline for implementation of the passive inv. rules. Could they be effective January 1 2018? Am I right that the budget doesn't come out until a few months later??
    Thanks so much!!

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    1. Hi Anon

      No one is quite sure of the implementation date and when they will issue legislation and if it will be backdated to Dec 31, 2017. part of the frustration, we have no idea of any details

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  8. Tks for commentary, very helpful. Talk about bad timing, but 2018 is the first year I will leave retained earning in my company (I am a prof and not entitled to small bus rate). My plan is to invest using Horizons ETFs which do not pay interest/dividends so only issue will be capital gains tax rates when I sell (or wind down the co). Any thoughts on this approach including downsides, apart of course from Govt going after these types of ETF products or hiking capital gains rates.

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    1. Hi Anon

      I cannot provide advice on verbal comments made by the Liberals. From what we heard, your approach is likely ok, but I would need to see some legislation.

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  9. Great post. For clarity do the changes the Liberals announced apply to all Private Corporations or only those that qualify for the Small Business Deduction.

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    1. Hi Anon

      It is my understanding they will apply to all corps, but I am still unclear exactly how they will affect passive corps not claiming the SBD and already paying high rate tax - there is talk of some kind of election mechanism. Sorry, I cannot really provide much clarity here.

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  10. In my small company we have a good amount of funds in our CDA acct .Im debating if it would be prudent to pay these funds out to shareholder tax free and loan back to my company if we need them!

    Or has existing CDA rules changed already...

    Thank You.

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    1. Hi Andres:

      Great question. As of last week, my firm and others had suggested the proposals had inadvertently prevented the payment of CDA dividends for typical arms length transactions. The Liberals announcement last week that they would not move ahead with the dividend stripping rules seems to remove that obstacle. However, you should first speak to your accountant to get their opinion, as you are relying on the Liberals verbal pronouncement they will not proceed. Not great when tax planning is based on verbal pronouncements.

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  11. Ok thanks for sharing that.
    Perhaps another approach would be by doing a "Ajusted Journal Entry" AJE..rather that paying actual dividend.This would create a Tax Free loan owing from my company to the shareholder.Probably wise to also to exchange a promisary note and a resolution be done...showing a dividend paid and receive.

    Would this be a better approach at this time!

    Thank You

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    1. Andres, speak to your accountant. An AJE does not change the issue and creates some documentation issues. Be careful and again speak to your accountant

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  12. In another small comp. we have a good amount of RDTOH that was created around 10 years ago.
    As of this date has this been affected or are we ok to keep receiving these when we pay ourself dividend.

    Thank You

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    1. It is our understanding, again verbally, that RDTOH in existence to Dec 31, 2017 will remain. After that, you will need to see the new legislation to know where it will exist and where it wont

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