New tax reform for private companies – Update

Tax News

Morneau Proposals Revisited

Last week, the Government announced several changes to their July 18 proposals targeting private company tax planning . These releases address numerous issues and concerns expressed by entrepreneurs and the overall Canadian tax community throughout the consultation period.

Further to these welcome announcements, it appears that the Government is backing down on a few proposals while maintaining others with some modifications.

Lower Small Business Tax Rate

On October 16, the Government announced its intention to reduce the small business tax rate from 10.5% to 10%, effective January 1, 2018, and to 9%, effective January 1, 2019.

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

Simplification of Income Sprinkling Measures

Also announced on October 16, the Government intends to move forward with measures to limit income sprinkling using private corporations, while ensuring that the rules will not impact businesses to the extent there are clear and meaningful contributions by family members. These measures, effective January 1, 2018, will be simplified in response to concerns raised by entrepreneurs and the overall Canadian tax community.

Specifically, the government will introduce reasonableness tests for adult family members aged 18-24, as well as those 25 and older. These adults will be asked to demonstrate their contribution to the business based on four basic principles:

  • Labour contributions;
  • Capital or equity contributions to the business;
  • Taking on financial risks of the business, such as co-signing a loan or other debt; and/or
  • Past contributions in respect to previous labour, capital or risks.

The draft legislation outlining the proposed change should be released later this fall.

Multiplication of the Lifetime Capital Gains Exemption

The Government will not move forward with measures that were proposed in July to limit the multiplication of the lifetime capital gains exemption among family members. These measures were abandoned due to their potential unintended consequences on intergenerational transfers of family businesses, among others.

Flexibility to Passive Investments Measures

On October 18, the Government announced its intention to move forward with measures to limit the tax deferral opportunities related to passive investments within private corporations. Nonetheless, the Government announced that investment income earned in a year below a $50,000 threshold will not be subject to the new measures and will continue to be taxed under the current tax system in order to provide more flexibility to business owners and target more specifically high-income individuals.

In addition, Finance Minister Bill Morneau assured that the new measures should not be applicable to all past investments and income earned from those investments. As such, the new measures would apply only to new investments.

Finally, the Government will ensure that the proposed changes will not affect the incentives for Canada’s venture capitalists and angel investors. Consultation with the venture capital and angel investment sectors will be held to better identify how this might be achieved.

The Government will release these new measures as part of the 2018 federal budget. However, there is no indication as when they will be effective.

Conversion of Income into Capital Gains

On October 19, the Government announced that it will not proceed with measures relating to the conversion of income into capital gains. These measures were abandoned due to several unintended consequences, such as in respect of taxation upon death and potential challenges with intergenerational transfers of family businesses.

In the coming year, the Government intends to work jointly with business owners to develop new measures to facilitate intergenerational transfers of small businesses while protecting the fairness of the Canadian tax system.

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