The 2018 Federal Budget was announced on Tuesday, February 27th. Much to the relief of most private business owners, some of the anticipated (dreaded) changes that had been suggested last July were not present in this Budget.
One change in particular, however, will affect a number of Canadian Controlled Private Companies (“CCPCs”). That is the change to how passive income will be taxed in a CCPC, discussed in detail below in our business measures section. Companies who are currently earning, or are projected to earn, $50,000 or more in investment income in their companies are encouraged to discuss a strategy with their tax advisor to mitigate these changes which will come into effect for taxation years beginning after 2018.
The budget also confirmed that the draft proposals to Tax on Split Income (TOSI) released on December 13, 2017 will become effective as of January 1, 2018. See below in our personal measures section for further detail.
- Passive Income
- Currently, a corporation earning active business income is taxed at corporate income tax rates which are generally lower than personal income tax rates.
- This provides these corporations with more “after-tax” dollars to invest within their business.
- The CRA’s intention is for this to leave small CCPCs with more retained earnings to reinvest in their active businesses.
- This income retained in the corporation can also be used to invest in passive investments (ie. an investment portfolio with a financial advisor with funds not required for the business).
- Any income earned on these passive investments is taxed at a higher rate than the active business income, to make the taxes paid on investment income in the corporation similar to what would have been paid personally on that income.
- When the corporation pays out a taxable dividend to a shareholder, a portion of that “extra” investment tax is refundable to the company by way of the “Refundable Dividend Tax On Hand” account (“RDTOH”).
- The amount of passive income within a corporation has never affected the small business income limit of $500,000, until now. Why is this important? Because CCPC active income earned up to $500,000 is subject to very preferential tax rates in Canada.
- A corporation can earn $50,000 in passive income without affecting the $500,000 small business limit.
- For every $1 earned above $50,000, the small business limit will be ground down by $5. For example, if a corporation earns $51,000 in passive income, their small business limit will be reduced from $500,000 to $495,000.
- Once a corporation reaches $150,000 in passive income, there will be no small business deduction available.
- This measure will apply to taxation years beginning after 2018.
- Refundability of Taxes on Investment Income
- As alluded to above, currently, investment income on passive investments is taxed at an amount approximately equal to the top personal income tax rate while the investment income is retained in a corporation.
- Some or all of these taxes are then added to the Refundable Taxes account (“RDTOH”) and are refundable at a rate of $38.33 for every $100 of taxable dividends paid to shareholders.
- As set out in the government budget documents, these dividends paid by corporations are either “eligible” or “non-eligible”
- Non-eligible dividends are presumed to have been paid from the corporation’s active business income, which was subject to the small business rate, or passive investment income but not capital gains or eligible portfolio dividends. A shareholder who receives non-eligible dividends is entitled to an ordinary dividend tax credit of 10%.
- Eligible dividends are presumed to have been paid from a corporation’s active business income that has been subject to the general corporate income tax rate – which is higher than the small business rate. A shareholder who receives eligible dividends is entitled to an ordinary dividend tax credit of 15%.
- There is a possibility within this system for a refund of taxes to be obtained by a corporation on investment income through a payment of an eligible dividend, thereby allowing for further tax deferral within the corporation which was not the intention.
- As set out in the budget documents, to better align the refund of taxes paid on passive income with the payment of dividends sourced from passive income, Budget 2018 proposes that a refund of RDTOH be available only in cases where a private corporation pays non-eligible dividends. An exception will be provided in respect of RDTOH that arises from eligible portfolio dividends received by a corporation, in which case the corporation will still be able to obtain a refund of that RDTOH upon the payment of eligible dividends.
- This change in treatment will result in the addition of a new RDTOH account:
- The new account (eligible RDTOH) will track refundable Part IV taxes paid on eligible portfolio dividends. Any taxable dividend paid will entitle the corporation to a refund from the eligible RDTOH (for RDTOH paid on non-eligible dividends, the non-eligible RDTOH must be paid out first)
- The current RDTOH account (now referred to as non-eligible RDTOH) will track refundable Part I taxes on investment income as well as under Part IV on non-eligible portfolio dividends. Refunds from this account will be payable only on the payment of non-eligible dividends.
- Tax on Split Income (TOSI)
- Previously, TOSI only applied to minors, taxing certain types of income they earned at the highest marginal tax rates, including taxable dividends.
- The TOSI rules will now apply to any Canadian resident, regardless of age. Many types of income can be caught under these rules, including taxable dividends, interest on debt obligations etc. This means that income paid to a spouse via taxable dividends will now be taxed at the highest marginal tax rate unless one of the exclusions below applies.
- Fortunately, it has been clarified that TOSI will not apply to the arms length sale of QSBC shares that qualify for the Lifetime Capital Gains Exemption.
- So the big question is, when does TOSI not apply?
- According to the CPA Canada Federal Budget Commentary, TOSI will not apply to payments made to an individual who is actively engaged in the company on a “regular, continuous and substantial basis” in the taxation year in which the income is received, or in any of five previous taxation years that don’t need to be consecutive.
- TOSI also will not apply on “excluded shares”. To meet this definition, several conditions must be met:
- The individual must own at least 10% of votes and value of the company.
- The corporation must earn less than 90% of its income from services.
- The corporation cannot be a professional corporation.
- All or substantially all of the corporation’s income cannot be derived from a related business in respect of the individual.
- According to the CPA Canada Federal Budget Commentary, if taxpayers restructure their companies in 2018 to meet the excluded share definition by the end of 2018, the exception will be available to them for the entire year.
- Parental Leave Changes – Effective in 2019
In the battle towards greater gender equality in the workplace and at home, the federal government has increased the parental leave benefit for two-parent families, where the second parent agrees to stay at home with the child for at least 5 weeks, up to an 5 additional weeks. This applies in the case of standard parental leave options of 12 months. For families who have opted for extended leave (18 months), the second parent can take up to 8 weeks of parental leave.
With the changes proposed above, the aim is to have more equitable parental leave and challenge hiring practice biases.
- Canada Workers’ Benefit – Effective in 2019
The Canada workers’ benefit is a refundable tax credit for low-income earners. You may have already heard about the Working Income Tax Benefit which is now renamed to be Canada Workers’ Benefit.
Starting in 2019, a 1% increase in the benefit rate will be added to any income earned in excess of $3,000 to a maximum of $1,355 for single individuals and a maximum of $2,335 for families (including single parents). In addition, they have increased the adjusted net income threshold up to $12,820 (single individuals) and $17,025 (families). Any amounts earned in excess of these amounts will be reduced by 12% versus 14%.
- If you are a single individual who earned $10,000 net income for the year, you’ll receive the maximum refundable credit of $1,355.
- If you and your spouse each earned $10,000 (family net income of $20,000), your maximum refundable tax credit of $2,335 will be reduced by $357 ((20,000-17,025)*0.12).
Requirements for Information and Compliance Orders
- Currently, the CRA is required to perform an assessment of taxes payable within three years of the date that the Notice of Assessment was sent for CCPCs, and four years for non-CCPCs.
- When the reassessment requires foreign-based information, a “stop-the-clock” rule is in place to extend the period for the length of time in which the compliance order is opposed (it will start when the taxpayer disputes the compliance order and will end when an arrangement is made, which would include any appeals).
- The “stop the clock” rules have now been proposed for all other taxpayers that do not involve foreign-based information, meaning that an extension will now be made for the length of time that the compliance order is contested.
- This proposed change would apply after the measure receives Royal Assent.
Non-Resident Non-Arm’s Length
- The normal reassessment period stated above can also be extended for an additional three years for situations where losses are being carried back and involve non-arm’s length transactions with a non-resident.
- For example, if a corporation incurs a loss in 2017 and carries it back to 2014 to use against taxable income, CRA has until 2020 to reassess the 2014 taxation year.
- As set out in the government budget documents, this loss carry-back reassessment period is intended to ensure that where a loss arises in a taxation year and is carried back to be used in a prior taxation year, the loss carried back to the prior taxation year cannot become statute-barred before the end of the reassessment period for the taxation year in which the loss arose.
- It is now proposed to allow an additional three years to reassess a prior taxation year to the extent of the reassessment that relates to the loss carryback adjustment that involves a non-arm’s length transaction with a non-resident.
- For example, if a loss is incurred in 2017 and it gets carried back to 2014, CRA can now assess 2014 up until 2023 to the extent that the reassessment is related to the loss carryback adjustment.
- This change will apply where there is a loss carryback claimed that was incurred from a taxation year that ended on or after February 27th, 2018.