Tax Insights: Income sprinkling rules announced as Senate comments on private company tax proposals

December 13, 2017


Issue 2017-49

In brief

Today, there were two important developments relating to the private company tax proposals: 

  • the Department of Finance released draft amendments – effective for the 2018 and future taxation years – that implement the proposals to limit income sprinkling using private corporations, and the Canada Revenue Agency (CRA) released guidance respecting these measures 
  • the Standing Senate Committee on National Finance made three recommendations as a result of its study of the private company tax proposals, the first of which is that the proposals should be withdrawn or deferred until at least 2019

In detail

December 13 release: income sprinkling

The December 13 amendments are intended to clarify whether a family member is significantly involved in a business, and thus potentially excluded from being taxed at the highest marginal tax rate (i.e. subject to the new income sprinkling rules, referred to as the “tax on split income” or “TOSI”) on non-salary income or gains derived from that business.

Amounts received in a year in the following situations will be excluded: 

  • amounts received by a business owner's spouse if the owner meaningfully contributed to the business and is aged 65 or over
  • amounts derived from a business by adults aged 18 or over who have made a substantial labour contribution (generally an average of at least 20 hours per week) to the business during:
    • the year (or portion of the year when the business operates), or 
    • any five previous years
  • income or gains on shares owned by adults aged 25 or over that represent 10% or more of the shares (measured by both votes and value) of a corporation that: 
    • earns less than 90% of its income from providing services 
    • is not a professional corporation, and
    • does not have income derived, directly or indirectly, from another business in which a related person is active or has a defined interest,

in which case the “ownership exclusion” applies

  • capital gains from qualified small business corporation shares and qualified farm or fishing property (except for gains of a minor from a non-arm’s length disposition)
  • capital gains arising on an individual’s death
  • income or gains from property received as a settlement upon marriage breakdown

Individuals aged 25 or over who do not meet any of the above exclusions would be subject to a reasonableness test to determine how much income, if any, would be subject to the TOSI.

In certain cases, adults aged 18 to 24 who have contributed to a family business with their own capital will be able to use the reasonableness test on the related income. Otherwise these individuals will be allowed to earn a prescribed rate of return on capital contributed in support of the business.

These measures will apply starting with the 2018 taxation year, except that for dividends on, or gains from the disposition of, shares taxpayers will have until the end of 2018 to meet the ownership exclusion test. The measures will be legislated as part of the 2018 budget process.

December 13 release: passive investments

Today’s release also confirms that the government will move forward with measures to limit tax deferral opportunities related to passive investments in a Canadian-controlled private corporation. Details will be included in the 2018 budget. When introduced, the passive investment measures will apply only on a go-forward basis.

PwC observes

The revised draft income sprinkling rules do simplify the draft rules released on July 18, 2017, and we now have the benefit of some initial CRA guidelines for their application (essentially, a series of examples). However, there will continue to be significant complexity in applying these rules to many typical business structures. This will create uncertainty for many business owners without any grandfathering for current arrangements.

Some initial observations are:

  • It is unclear how, or whether, the ownership exclusion will apply to businesses carried on through a group of corporations – for example, shares of a parent company might not meet the exclusion when its income is derived from the income of a related subsidiary corporation.
  • The ownership exclusion will not apply to a corporation that earns 90% of more of its income from providing services. A material portion of Canada’s private business economy comes from service businesses, including many with arm’s length employees engaged in the provision of those services. As a result, a significant number of private businesses may not be able to rely on this exclusion.
  • There is no longer a general exception for individuals whose income otherwise exceeds the highest marginal tax bracket for the year. This means high income earners could be subject to the TOSI and lose access to various deductions and credits that would otherwise have been available to reduce tax on this income.
  • Taxable capital gains that are not excluded from the rules will be subject to the TOSI with no grandfathering or exclusion for gains that have accrued to the end of 2017 (when the TOSI would not have applied). 

Standing Senate Committee on National Finance 

Recognizing that the proposed changes to the taxation of private corporations create deep concern for Canadians, the Senate had authorized the Standing Senate Committee on National Finance to study them. 

The study considered witness testimony and written submissions. In particular, it focused on the impact of the proposed changes on:

  • incorporated small businesses and professionals
  • economic growth and government finances, and
  • the fairness of the taxation of different types of income 

The study culminated in the release of the committee’s 43-page report “Fair, Simple and Competitive Taxation: The Way Forward for Canada,” which provides three recommendations:

  1. “That the Minister of Finance withdraw his proposed changes to the Income Tax Act respecting Canadian-controlled private corporations. 
  2. That the Government of Canada undertake an independent comprehensive review of Canada’s tax system with the goal of reducing complexity, ensuring economic competitiveness, and enhancing overall fairness.
  3. That, should the Minister of Finance proceed with his proposals to amend the Income Tax Act respecting Canadian-controlled private corporations, then he should delay their implementation until at least 1 January 2019, and: 
  • release, as early as possible, draft legislation and related guidance documents; 
  • undertake thorough, cross-Canada consultations with businesses, tax specialists, physicians, farmers, and other Canadians on draft legislation; 
  • undertake, and release publicly, an economic impact assessment of the proposals; 
  • conduct, and release publicly, a gender analysis of each of the proposals; and 
  • assess, in cooperation with provinces and territories, the potential impacts of the proposals on the accessibility of health care, and consider measures to avoid these consequences.”

The takeaway

Stay tuned. We will keep you apprised of developments as they occur. 

The changes can make tax planning for private companies more challenging. We would be pleased to discuss what they mean for you and your business. Please contact us.

For more information

To learn more about the private company tax changes, see our Tax Insights

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