July 24, 2017
Financial advisors should be directing their business-owner clients to book an appointment with their tax advisor soon as proposed changes to the rules affecting tax-planning strategies using private corporations, outlined by the government last week in a consultation paper, will likely be affecting them.
“Advisors should be telling their clients two things,” says Wilmot George, vice president of wealth planning, with CI Investments Inc. in Toronto. “No. 1, these are broad-based changes that are going to impact a large majority of private corporations. No. 2, they should work with their tax advisors to determine how these rules changes are going to impact them specifically, because they are detailed and complex.”
If you have a small business-owner client who has been considering incorporating to take advantage of tax strategies using private corporations, they’d be well advised to hold off.
“Let the dust settle a little and see where the tax landscape is going to be,” George says. “What they would not want to do is put particular strategies in place now, only to see those strategies change when the proposed changes become law.”
On Tuesday, the federal Department of Finance Canada released a consultation paper targeting thee common tax-planning strategies using private corporations. These include “income sprinkling,” which involves the diversion of income, via salary or dividends, from a high-income taxpayer to family members with lower personal tax rates; the retention of passive investments in personal corporations taking advantage of the fact that corporate income tax rates are lower than personal rates; and the conversion of a private corporation’s income into capital gains in such a way as to provide an “unfair opportunity” to reduce income taxes.
The Liberals indicated in the 2017 federal budget, announced in March, that it considered tax planning using private corporations to be an area of concern in terms of overall tax fairness. The consultation paper,Tax Planning Using Private Corporations, outlines potential draft legislation; offers possible solutions to address the issues; and invites comments from interested parties. The deadline for submission is Oct. 2.
There are many concerned with the complexity of the proposed new rules and their possible negative effect on Canadian small businesses, overall.
“Is it going to discourage folks who should be able to legitimately access certain tax benefits [from incorporation] from being able to access them?” says Corinne Pohlmann, senior vice president of national affairs for the Canadian Federation of Independent Business (CFIB) in Ottawa, which represents small and medium-sized business members across Canada. “Families spend a lot of time, effort and risk in building businesses.”
The complexity of the new rules — the consultation paper is more than 60 pages long — is also worrying, tax practitioners say.
“Compliance costs could be prohibitive to your average small business corporation,” says Debbie Pearl-Weinberg, executive director of tax and estate planning, wealth strategies group, with Canadian Imperial Bank of Commerce in Toronto. “These are [further] rules that are going to add to the complexity [of the existing rules], and that concerns me somewhat. What might happen on a go-forward basis is that [corporate structures] may be not be used in all the situations that people want to use them in. There are non-tax reasons for using corporations, such as asset and creditor protection. What are the implications there?”
There’s also the possibility that the new rules may give rise to as-yet-unknown, and unintended, negative consequences for certain small businesses.
“Our biggest concern is that there might be stuff here that we don’t even realize is going to happen,” says Pohlmann. “Sometimes, you don’t know [the full implications] until the legislation is passed and implemented. Businesses may get caught in the new rules that shouldn’t be.”
Although the proposed draft legislation contained in the consultation paper is not law and is subject to change by the government after the consultation period closes, tax practitioners and industry stakeholders say that government appears to have every intention of proceeding on all three areas of concerns.
“I have a hard time believing they’re not going to pass just about all of this,” says Jason Pereira, a partner and senior financial consultant with Woodgate Financial Inc., which offers investment services through IPC Securities Corp.
Says Pohlmann: “It looks more like they’re asking for feedback [on the changes], not so much on whether they should do it or not.”
Tax practitioners say they’re still busy reviewing the consultation paper. “There are a lot of new wrinkles that are going to take some time to digest,” says George, who says he was surprised at the scope and complexity of the changes.
In terms of income-sprinkling, the government has issued draft legislation that seeks to extend the existing “kiddie tax” rules that prevent income-splitting with minor children to now include children between 18 and 24 years of age, and to expand these rules to include interest paid by a corporation and not just dividends. The government is also taking aim at compound income, which had not been subject to the kiddie tax rules, and is introducing a “reasonableness test” to determine how an adult child who receives income from a business should be taxed.
Ottawa, as part of its initiative against income-splitting, is also looking at the use of certain tax strategies that allow family units to access the lifetime capital gains exemption (LCGE) multiple times. In the consultation paper, the government includes draft legislation that would largely eliminate these strategies starting in 2018.
“It’s a very common planning strategy,” Pereira says. “That is now off the table essentially.”
The government has included transitional rules to take into account that many small businesses have been structured to take advantage of the existing rules, which would allow taxpayers to claim the LCGE on eligible property under the old rules in 2018, if they file an election.
“That’s really time sensitive,” Pearl-Weinberg says. “Clients need to speak to a tax advisor about how this might impact them.”
In terms of passive investment income, the government has not released draft legislation in the consultation paper, but has instead offered a variety of possible solutions to address what it regards as the unfair advantage this strategy provides small business owners. It still wants to maintain the lower tax rate on an active business income in a corporation, however.
“They have a strong intention to go ahead,” Pearl-Weinberg says, “but I think it says something about how complicated the issue is, that they did not provide a detailed solution or draft legislation on this particular issue.”
In terms of certain tax strategies converting income into capital gains, the government wants to bolster existing anti-avoidance legislation it already has in place to prevent taxpayers from accessing them.
Tax practitioners say this third change is the least problematic of the three.
“It’s not a strategy you see on a daily basis,” says Pearl-Weinberg.
Adds Pereira: “I’m on side with this change, it’s not a problem.”