The Liberal Government’s Federal Budget was delivered by Finance Minister, Bill Morneau, on February 27, 2018. There had been much concern and speculation about the direction the budget would take with respect to the taxation of private corporations. This was due to a release of the Department of Finance in July 2017 which contained private corporation tax proposals which addressed areas of concern to the government involving, among other things, business owners holding passive investments inside of their corporation. There was speculation that if these proposals were implemented the effective tax rate on investment income earned by a private corporation and distributed to its shareholders could increase astronomically. Thankfully, the concerns voiced by business and professional groups following the July proposals were effective in moderating the government’s actions.
This article will primarily focus on exactly what effect the Federal Budget will have on private corporations. There were of course other notable measures, and these included:
- An increased effort to achieve gender equality;
- Continued concern and focus on aggressive tax planning strategies both at home and abroad;
- The implementation of a national Pharmacare strategy;
- Continued and improved support of the indigenous people of Canada.
Of great significance in the Budget were the items that were not mentioned. These included:
- A change to the tax treatment of Capital Gains. There was some speculation that the inclusion rate of Capital Gains for tax purposes would increase from its current 50%. This did not happen;
- There was no change to the tax treatment of exempt life insurance policies. There was some speculation that the benefits of a life insurance policy owned by a corporation would be negatively affected. This turned out to be not the case;
- The rules governing the Capital Dividend Account. The CDA will continue to operate without change allowing for tax-free distributions of the non-taxable portion of capital gains and the death benefit of corporately owned life insurance;
- There has been no additional change in the income tax rate paid by corporations or individuals. The reduction of the corporate federal income tax rate previously announced will continue.
In July of 2017 the government expressed their concern that private corporations taxed at the low corporate tax rate on active business income created an unfair advantage for business owners in growing passive investments within the corporation. The Federal Budget addressed these concerns with the following introduced measures:
Corporate passive income could reduce the small business tax rate
The intention of the government was to limit corporations with large amounts of passive investment income from enjoying the small business income tax rate.
The current small business rate limit allows for up to $500,000 of active business income to be taxed at the lower tax rate. The federal small business tax rate for 2018 is 10% whereas the tax rate for active business income in excess of $500,000 is 15%. The applicable provincial corporate tax increases these rates to (in BC for example), 12% small business rate and 27% general rate.
Under the measures introduced in the Federal Budget there will be a limit of the amount of passive investment income that can be earned in any one corporate year. This amount has been set at $50,000. This was established by assuming a 5% rate of return on $1,000,000 of invested capital. For every $1 of investment income earned over this threshold amount the small business income limit will be reduced by $5. This means that once a corporation reaches a passive investment income of $150,000 they will no longer be entitled to the small business tax rate.
This measure will apply to taxation years beginning after 2018.
Limiting the Refunding of Corporate Taxes Paid on Investment Income
This measure is introduced to limit the tax advantages that large Canadian Controlled Private Corporations (CCPC) might enjoy with respect to obtaining refundable taxes on the payment of certain dividends. Usually, passive investment income earned by a CCPC must be paid out as a non-eligible dividend which carries a higher personal income tax rate than eligible dividends which are paid from a pool created by active business income. In practice, however, any dividend paid by a CCPC can generate a refund of the refundable tax. This can provide a tax advantage by being able to claim a refund of taxes paid on their passive investment income even though the dividends paid were lower-taxed eligible dividends from their pool of active business income.
This Budget proposes that a refund of the refundable tax is only available where the CCPC pays non-eligible dividends. This ensures that the refundable tax is available only if the dividends paid originated from the passive investment income of the CCPC.
As with the provisions regarding the reduction of the small business income limit, this measure will be effective starting in 2019.
The 2018 Budget certainly came as a relief to those who were of the opinion that more drastic measures were at hand. Some business owners, especially those with professional corporations can certainly take pause to consider the bullet they just dodged. This underscores the need for effective on-going planning as there will always be Federal Budgets and many of them will bring changes that often will not be welcomed.
Strategies are available to help you plan ahead
There is now an investigation into effective tax strategies to bypass the $50,000 annual passive investment income limit. Some of these may be riskier than others. One strategy that was certainly beneficial before has now become even more so.
Business owners of private corporations should consider the use of corporately-owned cash value life insurance. The opportunity to have corporate surplus grow in a permanent life insurance policy without generating passive investment income should not be overlooked. Combined with the Capital Dividend Account not being limited, nor any changes in the taxation of exempt life insurance products, permanent cash value life insurance should be viewed as a preferred investment vehicle for Canadian Private Corporations.
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