Tax Insights: Private company tax proposals – Government’s initial response to outcry

October 16, 2017


Issue 2017-39

In brief

Today, Prime Minister Justin Trudeau and Finance Minister Bill Morneau made the following announcements concerning the private company tax proposals: 

  • income sprinkling rules refined – the intention is to simplify the proposals to provide greater certainty for family members who contribute (in the past or present) to a family business 
  • lifetime capital gains exemption (LCGE) preserved  proposals that limit access to the LCGE will not proceed
  • small business income tax rate reduced – will drop from 10.5% to 9% over two years, starting January 1, 2018
  • additional consultations welcome – although the official consultation period has ended, the Finance Minister stated that he will continue to solicit and listen to input

The announcements are a welcome start, reflecting many of the points made by PwC in its submission to the Department of Finance. Further modifications to the private company tax proposals are expected throughout this week. Revised draft legislative proposals are expected later this fall.

In detail

Background

Deep concern was created by the legislative proposals and a consultation paper (referred to as “the proposals”), released on July 18, 2017, targeting three tax planning strategies that, in the government’s view, use private corporations to gain unfair tax advantages for high-income individuals.

Over 21,000 submissions were made to the Department of Finance from interested parties, including PwC. 

PwC’s submission

Today, the government announced several changes that respond, in part, to our submission.

PwC’s October 3, 2017 press release made the following points: 

  1. Transitioning a family business to family members will have a significantly higher tax cost.
  2. The 75-day consultation period is inadequate.
  3. The proposals have retrospective application.
  4. Government communications to date suggest that these proposals close "loopholes."
  5. The impact of the proposals on the Canadian economy should be considered further. 

Income sprinkling 

The government stated today that it “intends to move forward with measures to limit income sprinkling using private corporations, while ensuring that the rules will not impact businesses to the extent there are clear and meaningful contributions by spouses, children and other family members.” 

To do this, as previously proposed, the “tax on split income” rules will be extended to spouses and all adult children, subject to reasonableness tests. 

These adults will be required to demonstrate their contribution to the business based on four basic principles: 

  • labour contributions
  • capital or equity contributions to the business
  • taking on financial risks of the business, such as co-signing a loan or other debt, and/or
  • past contributions in respect to previous labour, capital or risks 

Today’s announcement vows “to simplify the proposed measures with the aim of providing greater certainty for family members who contribute to a family business.” 

To this end, the government intends to: 

  • reduce the compliance burden with respect to establishing the contributions of spouses and family members including labour, capital, risk and past contributions
  • better target the proposed rules, and 
  • address double taxation concerns

Later this fall, the government intends to release revised draft legislative proposals reflecting these changes to the income sprinkling proposals, which will be effective beginning January 1, 2018. 

PwC observes

The government is moving in the right direction in its efforts to simplify the income sprinkling proposals. However, we await the revised draft legislation to assess whether the compliance burden will be sufficiently eased. 

It appears that our government’s focus remains on professional corporations and other service businesses because, for these businesses, it may often be difficult to demonstrate that family members have made “meaningful contributions,” under the principles outlined above. 

Lifetime capital gains exemption

The government also announced that it will not proceed with the proposals that address the multiplication of the LCGE. 

These proposals would have limited access to the LCGE in certain situations (for example, by denying the exemption in respect of shares held in a trust arrangement), but concerns had been expressed that intergenerational transfers of family businesses could be adversely affected.

PwC observes

We welcome the withdrawal of this measure. We had noted that, in many cases, the proposals would have resulted in significant additional tax in common family business ownership structures.

Small business income tax rate

The federal small business income tax rate will be reduced from 10.5% to 10% on January 1, 2018, and will further decline to 9% on January 1, 2019. 

Combined federal and provincial/territorial small business rates for 2017 to 2019 are shown in the Appendix.

Although the Liberal party’s tax platform had promised to reduce the small business rate to 9%, its 2016 federal budget cancelled reductions that would have caused the rate to fall to 9% by January 1, 2019. 

PwC observes

When fully implemented in 2019, the reduction will result in a maximum annual tax saving of only $7,500 for eligible small businesses. 

While tax reductions are always welcome, the planned reduction is modest assistance given the significant investment required for innovation, technology and people.

Consultation period

Finance Minister Morneau commented that he will continue to listen and reach out to interested parties and address their concerns.

PwC observes

PwC reaffirms its view that the private corporation tax proposals changes could have far reaching impacts on the economy.

We recommend that the Minister of Finance engage a group of independent experts, from many disciplines and stakeholders, to further study the proposals and their impact on both tax policy and the broader economy. 

This should include an assessment of the potential impact of the proposals on future investment in Canada and its ability to attract and retain top talent. 

The takeaway

We await the further announcements coming this week on other aspects of the proposed tax changes for private corporations and the resulting revised draft legislative proposals to be released later this fall. 

We continue to encourage interested parties to contact Finance to voice their concerns. As well, reach out to us with your questions.

The changes make year-end tax planning more challenging. For help, see our upcoming Year-end tax planner and contact us.

We will keep you apprised of developments as they occur.

For more information

See our Tax Insights:

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Appendix 1

Combined federal and provincial/territorial small business income tax rates (%)

Rates on active business income earned in Canada to $500,0001 (twelve-month taxation year ended December 31)2

  2017 2018 2019
Federal 10.5
10 9
Alberta 12.5 12 11
British Columbia 12.62 12 11
Manitoba 10.5 or 22.5 10 or 22      9 or 21   
New Brunswick 13.62 13 12
Newfoundland and Labrador 13.5 13 12
Northwest Territories 14.5 14 13
Nova Scotia 13.5 13 12
Nunavut 14.5 14 13
Ontario 15 14.5 13.5
Prince Edward Island 15 14.5 13.5
Quebec General 18.5 18 17
M&P 14.5 14 13
Saskatchewan 12.5 12 11
Yukon General 13 12 11
M&P 12 11.5 10.5

[1.]  The $500,000 threshold applies federally and in all provinces and territories, except in Manitoba where:

  • the lower rate applies to active business income up to the CCPC threshold of $450,000 
  • the higher rate applies to active business income from $450,000 to $500,000

If taxable capital employed in Canada (in Quebec, paid-up capital) of associated CCPCs in the preceding year exceeds $10 million, the federal and all provincial and territorial small business rates will be higher.  

[2.] The table reflects provincial and territorial rate changes and CCPC threshold changes that are implemented by draft or enacted legislation.
 

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Saul Plener
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Ken Griffin
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Angela Ross
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