Tax Insights: Private company tax proposals – More “sprinkling” of changes – Update #2

October 18, 2017


Issue 2017-40

In brief

Today, Finance Minister Bill Morneau made his second announcement of the week on the private company tax proposals. He confirmed that the government will “move forward with measures to limit the tax deferral opportunities related to passive investments” but added that $50,000 of passive income annually will be exempt.

In detail

Background

In our government’s view, the retention of after-tax business earnings to build a passive investment portfolio within a private corporation creates unfair tax advantages for corporate owners.

This is because corporate tax rates are generally lower than personal rates on business income, facilitating the accumulation of higher earnings within private corporations that can be invested to earn passive income. 

The Department of Finance consultation paper released on July 18, 2017, identified alternatives to improve fairness related to the taxation of passive investment income and requested input on the approach to be adopted.

October 18 announcements

On October 18, 2017, Finance Minister Morneau stated that the government will proceed with the previously announced proposals, except that the new measures will not apply to a $50,000 annual threshold on passive income. According to Morneau, this threshold is equivalent to $1 million in savings based on a nominal 5% rate of return. 

According to Morneau, in 2015, only 3% of Canadian-controlled private corporations had taxable passive income exceeding $50,000.

Morneau also confirmed that the measures targeting passive income will not apply to past investments and the income earned from those investments.

Further, the government has commented that incentives will be in place so that venture capital and angel investors can continue to invest.

PwC observes

We await the draft legislation to see which approach the government will adopt with respect to passive income and how the $50,000 threshold will apply. These are expected in the 2018 federal budget.

Some questions are:

  • Will the $50,000 annual income exclusion increase each year to account for the accumulation of the investment income?
  • Does the $50,000 threshold apply regardless of the source of the investment portfolio? Or, for example, does the investment portfolio have to be derived from income subject to the small business tax rate? 
  • Will withdrawals from the investment portfolio be considered to be made from past investments, which are grandfathered, or those investments that are not grandfathered?
  • Will the measures take into account investments that may produce “lumpy” annual income (such as one-time capital gains), when the annual average may not exceed $50,000?
  • Is the $50,000 threshold shared among corporations in a group (such as associated corporations)?
  • Is a notional capital amount of $1 million enough if the investments are acting as a retirement fund when compared to commuted values of pensions?

What seems clear is that the measures still will require tracking of grandfathered and non-grandfathered investments, and a host of rules to properly distinguish passive income and gains related to direct and indirect business investments (to avoid unfairly increasing the related tax); this will add much complexity to the compliance burden of private corporations. 

The Minister commented that he will continue to listen to feedback when developing the new rules, including specific mention of working with the venture capital and investment sectors to identify how best to ensure that appropriate incentives for their investments are maintained. Hopefully, our questions, as well as the broader impact on the economy, will also be taken into account.

The takeaway

We will keep you apprised as the “sprinkling” of government communications continue. 

The changes make year-end tax planning more challenging. We would be pleased to discuss what the changes mean for you and your business. 

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Saul Plener
National Leader, Private Company Services
Tel: +1 905 418 3471
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Ken Griffin
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Bruce Harris
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Angela Ross
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