November 09, 2017
Combined federal and provincial/territorial personal tax rates on non-eligible dividends are going to rise. If you are subject to the top marginal tax rate, your rate will increase, on average, by one percentage point from 2017 to 2019. As a result:
Non-eligible dividends include dividends paid out of:
Most dividends paid by public corporations are eligible dividends. Eligible dividends must be designated as such by the payor.
The government’s October 16, 2017 announcement on the private company tax proposals stated that the small business income tax rate will drop from 10.5% to 10% on January 1, 2018, and to 9% on January 1, 2019.
A Notice of Ways and Means Motion (NWMM) released by the Department of Finance on October 24, 2017, implements this rate change.
Consequential to the decrease to the small business tax rate, the effective personal tax rate on non-eligible dividends will increase. To achieve this, the NWMM reduces the federal:
Appendix 1 shows the top combined federal and provincial/territorial personal tax rates on non-eligible dividends for 2017 to 2020.
The increase to the non-eligible dividend rate for distributions of small business income makes sense, to ensure that the combined corporate and personal tax paid on this income approximates the tax that would be paid by an individual who earns this income directly. This is referred to as the concept of “integration” for corporate and personal tax rates.
However, the change increases the combined corporate and personal tax rate on investment income (other than eligible dividends) earned through a CCPC. This results in greater “under integration” for that investment income because the effective federal and provincial/territorial corporate tax rate on this income exceeds the small business income tax rate.
There is already under integration on investment income (other than dividends) earned in a CCPC. For example, in Ontario, the top tax rate on interest income earned directly by an individual is 53.53%. If instead, the interest income is earned in a CCPC and distributed to the shareholder as a non-eligible dividend, the combined federal/Ontario tax liability is 55.97% in 2017.
The federal changes to the non-eligible dividend tax rate will increase this combined federal/Ontario tax liability to 56.32% in 2018 and 57.13% in 2019 – assuming the province does not make changes to its small business and non-eligible dividend rates to reflect the federal changes. (These rates are halved for capital gains.)
Appendix 2 shows the total effective tax rates on CCPC interest income distributed as a non-eligible dividend to an individual shareholder at the top combined federal and provincial/territorial tax rates for 2017 to 2020. These rates are higher than the top personal marginal rates in every province and territory, in some cases by more than 6%. (The rates in Appendix 2 are halved for capital gains.)
Of note, under integration occurs only when the investment earnings are distributed to the shareholder. Until then, the corporate tax paid on the investment earnings is generally similar to top personal marginal tax rates.
In effect, the dividend tax regime (gross up and tax credit) rules assume that total corporate tax on small business income and investment income are essentially the same. In fact, the former has been decreasing while the latter has not, while the non-eligible dividend gross up and tax credit amounts have been adjusted to reflect reductions in the small business rate.
This highlights a significant conceptual issue with the government’s proposed changes related to the taxation of passive income earned on reinvested business income. The impetus for the federal government’s July 18, 2017 tax proposals for passive investment income earned in a CCPC is the perceived advantage a CCPC owner enjoys (as compared to an individual) because of the ability to reinvest business earnings taxed at the lower corporate business rates.
There was already criticism of the proposals because of the current under integration of tax on the investment income. Clearly, the amount of under integration is increasing.
If the detailed legislation expected in the next federal budget fails to address the reality of under integration, the proposed changes could worsen the current rate disincentive to invest passively through private corporations, rather than achieving the stated objective of creating a “neutral” tax system that would neither encourage nor discourage the use of private corporations for such investment.
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To learn more about the private company tax changes, see our Tax Insights:
This Appendix reflects the changes in the NWMM as well as provincial and territorial changes that have been announced to date.
The reduction in the federal dividend gross-up rate automatically applies in all provinces and territories, except Quebec. The table assumes that Quebec will harmonize with this change.
The reduction in the federal dividend gross-up rate also causes the provincial/territorial dividend tax credit rate to fall in the eight jurisdictions (i.e. Alberta, British Columbia, Nova Scotia, Nunavut, Ontario, Prince Edward Island, Saskatchewan and the Yukon) in which the provincial/territorial dividend tax credit rate is linked to the federal dividend gross-up for non-eligible dividends. It is unclear whether these provinces will increase their dividend tax credit rates to avoid receiving a “windfall” tax increase as a result of the federal changes.
(twelve-month taxation year ended December 31)
This Appendix shows the combined effective federal and provincial/territorial income tax rate if interest income is earned in a CCPC and distributed to the individual shareholder as a non-eligible dividend. It assumes the shareholder is subject to the top marginal income tax rate.
The rates shown are halved for capital gains.
The rates in this Appendix assume no changes are made to provincial or territorial non-eligible dividend tax credit rates.
Download a PDF
Tax Insights: Private company tax changes – Taxes on non-eligible dividends to rise
Of further interest
Tax Insights: Private company tax proposals – More “sprinkling” of changes – Update #3
Tax Insights: Private company tax proposals – More “sprinkling” of changes – Update #2
Tax Insights: Private company tax proposals – Government’s initial response to outcry
Tax Insights: Private corporation tax changes – Where do things stand?
Tax Insights: Government targets tax planning using private corporations
PwC Submission to the Department of Finance: Tax Planning Using Private Corporations
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