Finance Minister Bill Morneau announced in July that the Federal Government would be imposing a series of new tax measures to crack down on what they view as an unfair exploitation of the system by many wealthy Canadians.This announcement holds significant impact to many of our dentist and doctor clients (not to mention our own law firm), as it will decisively alter their tax plans in 2018 and future ability to grow their business and plan for their future.
One of the primary areas these tax changes are focused on is the commonly used, but up until now perfectly legal tax avoidance loophole known as income “sprinkling”. Income sprinkling (also known as income splitting) is the process in which small business owners (in our line of work doctors or dentists), split their income amongst family members at least 18 years of age listed as shareholders of their corporation in the form of dividends. The reason this tactic is so beneficial to owners of such corporations is that these family members(usually either a spouse or adult children) belong to a lower tax bracket, and therefore are required to pay far less taxes on such income. Further to that, everyone is allowed a basic personal deduction amount of $11,635 per year. This means that if a family member is unemployed (going to school), they can receive a substantial amount of dividends free of tax or with only a small amount of tax.
However, this is not the first time this issue has been addressed by the Canadian government. In 1999 a “Kiddie” tax was implemented to prevent the splitting of income to family members under the age of 18. Prior to that, companies were able to sprinkle dividends amongst minors.This was eventually negated by the governments implementation of the Kiddie tax which placed top bracket tax rates on dividends paid to children under the age of 18.
This time around, the Federal government began to notice what they perceive as a problem in the trends of dividends being paid out by corporations at an increasingly disproportional amount to the age group 18 to 26 (the years that your children attend school with very little income of their own)
The proposed changes to be made effective in 2018 are summarized as follows:
1. Adult family members will be expected to provide what the government is calling “reasonable” contribution to the corporation, whether it be in the form of labour or capital, in relation to a number of dividends they receive, with a special focus being placed on 18-24 year old family members.
2. If the income received by family members is not deemed appropriate or reasonable to the amount of labour or capital they provide to the corporation, the highest rate of federal income tax (33%) will be applied to all dividends they receive from the business.
Another area the federal government announced it aims to crack down on is the issue of capital gains. With proper tax planning, business owners can often claim standard business income as capital gains instead of withdrawing funds from their business in the form of dividends.
Morneau announced that future legislation will be introduced to address this area of concern, but it will be applied retroactively to all proceedings following July 18th of this year (date of the announcement).
The tax agenda will also target passive investment income controlled by private corporations.This is the area of largest concern for many professionals. Currently, business owners can stand to profit from retaining money within their business, and investing it through the corporation as opposed to paying the profits out to the shareholder, paying additional taxes and then making the investments. Doing this enables them to pay lower taxes on income they receive from those investments and attain tax deferrals in the corporation for an extended period of time. At this time, the government has not yet announced how it will tackle this but is still in discussion to find a viable solution.
By implementing stricter rules and more severe penalties, these new tax proposals aim to quickly eliminate the current tax advantages present in today’s system, a prospect that may force many Canadian business owners to seek new tax strategies in 2018.
At Kutner Law, we are in the same boat as many of our clients. We are incorporated professionals running a small business. This new policy is an attack on the entrepreneurial spirit we thought was the backbone of the Canadian economy. We strongly disagree with the portrayal the Liberal Government has made of small business owners and professionals like us. We would strongly suggest that each of you send a short letter to their member of parliament setting out their views on this matter. In future blogs, we will suggest tax strategies to implement prior to the end of 2017.