The Daily Telegraph, a national British newspaper, once commented on a Federal Budget by saying that; a “budget is like going to the dentist, there has to be pain now or the future health of the economy is at risk”. While I may want to debate that assertion another time, I took their comment literally. Last Monday I started off the week with a root canal on my bottom left tooth and was supposed to have an extraction on Friday for another tooth on the top left of my mouth. Unfortunately, or fortunately, I am not sure which, the Friday appointment was re-scheduled until the middle of tax season. Thus, I was not in a good frame of mind to write my usual detailed review of the federal budget, presented last Tuesday, February 27th.
Setting aside my tooth pain, the budget contained surprisingly few new proposals (which you can read about in this excellent BDO LLP budget summary) other than the introduction of new rules relating to the taxation of passive investment income (generally made-up of interest, dividends, capital gains and rental income) in private corporations. Today I will briefly discuss these new rules.
The initial proposals set forth by the Liberal government in July and October of 2017, in relation to the passive income rules were very complicated and would have been an administrative headache for small business owners and accountants. There was also some concern that the proposals could result in a tax rate approximating 73%.
In issuing the new rules in last week's budget, the government clearly listened to the various comments made by small business owners and their advisors. The new rules are simple and clear and target those taxpayers the government seemed to be offended by in the first place, professionals and other service providers who were accessing the small business deduction.
While the aforementioned taxpayers who have accumulated significant passive assets for retirement based on the old rules will not be happy, there are many other small business owners and professionals, who let out a collective sigh of relief. Corporations (including professional corporations, typically partners in large professional firms) already subject to the general tax rate of 26.5% or so (depending upon your province) and investment companies that hold only passive investment assets, will continue under the current regime without any new restrictions.
Under the new rules, which are applicable for taxation years beginning after 2018 (so for companies with non-December year-ends, the rules may not apply until 2020) the Small Business Deduction (“SBD”) is phased out once passive income exceeds $50,000 at the rate of $5 for every $1 of passive income, or $50,000 for every $10,000 of passive income.
It is important to note that the test is for a corporation and its associated corporations. Therefore, if your operating company has no passive income, but your Holdco has $75,000 of passive income, you must combine the two and your operating company will have a reduced SBD.
The chart below illustrates how this will work.
Somewhat lost in the discussion is that the SBD is just a tax deferral, not an absolute tax savings. For example, if you flow through a $100,000 taxed at the small biz rate and a $100,000 taxed at the general rate to a shareholder, there is likely only a net after-tax difference of a $1,000-$2,000 dollars, depending upon the province. So to be clear, you are not paying more tax, just paying it earlier.
Private corporations subject to the new rules will lose a tax deferral from $1 to around $65,000 or so (depending upon your province and assuming the provinces follow suit. If not, the amount will be lower) if the full $500k SBD is clawed back. In simple terms, at the maximum reduction, you will have to pay $65k (could be less depending upon the province) in tax earlier than under the current tax rules and you lose the ability to grow your retirement assets by the return on that yearly $65k.
Part and parcel of the above changes to the SBD, the government has also proposed to create a second refundable dividend tax on hand ("RDTOH") account for eligible dividends, called, not unexpectedly, the “Eligible RDTOH”.
Under the current rules, where a private company earns investment income, the corporation is taxed at a high rate, typically 50%, of which 30% or so is refundable and 20% is a hard tax. Where the company also earns low rate small business income, the dividend refund can be caused in part from this lower rate tax and the shareholder can benefit from both a corporate dividend refund and a low rate eligible dividend designation.
To prevent this from happening in the future, the new rules essentially create two RDTOH accounts, non-eligible and eligible and upon the payment of a non-eligible dividend, the company must first access its non-eligible RDTOH before it can access its eligible RDTOH. I am sure this is clear as mud.
To further muddy the waters, there will ordering and transition rules, which are described in detail in the BDO tax memo I link to above.
As result of these new rules, which are also applicable for taxation years beginning after 2018, you will want to discuss with your accountant whether it makes sense to pay a large dividend prior to the application of the rules to clear out your current RDTOH.
Setting aside my tooth pain, the budget contained surprisingly few new proposals (which you can read about in this excellent BDO LLP budget summary) other than the introduction of new rules relating to the taxation of passive investment income (generally made-up of interest, dividends, capital gains and rental income) in private corporations. Today I will briefly discuss these new rules.
Passive Investment Income Taxation
The initial proposals set forth by the Liberal government in July and October of 2017, in relation to the passive income rules were very complicated and would have been an administrative headache for small business owners and accountants. There was also some concern that the proposals could result in a tax rate approximating 73%.
In issuing the new rules in last week's budget, the government clearly listened to the various comments made by small business owners and their advisors. The new rules are simple and clear and target those taxpayers the government seemed to be offended by in the first place, professionals and other service providers who were accessing the small business deduction.
While the aforementioned taxpayers who have accumulated significant passive assets for retirement based on the old rules will not be happy, there are many other small business owners and professionals, who let out a collective sigh of relief. Corporations (including professional corporations, typically partners in large professional firms) already subject to the general tax rate of 26.5% or so (depending upon your province) and investment companies that hold only passive investment assets, will continue under the current regime without any new restrictions.
Under the new rules, which are applicable for taxation years beginning after 2018 (so for companies with non-December year-ends, the rules may not apply until 2020) the Small Business Deduction (“SBD”) is phased out once passive income exceeds $50,000 at the rate of $5 for every $1 of passive income, or $50,000 for every $10,000 of passive income.
It is important to note that the test is for a corporation and its associated corporations. Therefore, if your operating company has no passive income, but your Holdco has $75,000 of passive income, you must combine the two and your operating company will have a reduced SBD.
The chart below illustrates how this will work.
Passive Income
Earned
|
Small Business
Deduction Available
|
$50,000
|
$500,000
|
$70,000
|
$400,000
|
$90,000
|
$300,000
|
$110,000
|
$200,000
|
$130,000
|
$100,000
|
$150,000
|
$nil
|
Somewhat lost in the discussion is that the SBD is just a tax deferral, not an absolute tax savings. For example, if you flow through a $100,000 taxed at the small biz rate and a $100,000 taxed at the general rate to a shareholder, there is likely only a net after-tax difference of a $1,000-$2,000 dollars, depending upon the province. So to be clear, you are not paying more tax, just paying it earlier.
Private corporations subject to the new rules will lose a tax deferral from $1 to around $65,000 or so (depending upon your province and assuming the provinces follow suit. If not, the amount will be lower) if the full $500k SBD is clawed back. In simple terms, at the maximum reduction, you will have to pay $65k (could be less depending upon the province) in tax earlier than under the current tax rules and you lose the ability to grow your retirement assets by the return on that yearly $65k.
Double Your RDTOH Pleasure
Part and parcel of the above changes to the SBD, the government has also proposed to create a second refundable dividend tax on hand ("RDTOH") account for eligible dividends, called, not unexpectedly, the “Eligible RDTOH”.
Under the current rules, where a private company earns investment income, the corporation is taxed at a high rate, typically 50%, of which 30% or so is refundable and 20% is a hard tax. Where the company also earns low rate small business income, the dividend refund can be caused in part from this lower rate tax and the shareholder can benefit from both a corporate dividend refund and a low rate eligible dividend designation.
To prevent this from happening in the future, the new rules essentially create two RDTOH accounts, non-eligible and eligible and upon the payment of a non-eligible dividend, the company must first access its non-eligible RDTOH before it can access its eligible RDTOH. I am sure this is clear as mud.
To further muddy the waters, there will ordering and transition rules, which are described in detail in the BDO tax memo I link to above.
As result of these new rules, which are also applicable for taxation years beginning after 2018, you will want to discuss with your accountant whether it makes sense to pay a large dividend prior to the application of the rules to clear out your current RDTOH.
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. Please note the blog post is time sensitive and subject to changes in legislation or law.
