In a Ways and Means Motion passed by the House of Commons on December 9, 2015, the new government introduced the changes to tax rates promised during the recent federal election campaign. Although considerable attention was directed towards increased taxes for high income earners and tax cuts for those in lower tax brackets, the changes to the Income Tax Act (Canada) (ITA) which are proposed in the Ways and Means Motion are likely to have a somewhat broader impact.
Individual Income Tax Rates
Changes to section 117(2) of the ITA will create a new tax bracket for those earning more than $200,000 of taxable income per year. Individuals in this bracket will be required to pay federal income tax at a rate of 33% for earned income over $200,000, which is a 4% increase from the current rate of 29%. On the other hand, individuals in the second-lowest federal tax bracket, those with an annual taxable income of between $45,282 and $90,563 per year, will benefit from a reduction of 1.5% in the applicable marginal federal tax rate, from 22% to 20.5%. This reduction may result in individual tax savings of up to $679 per year. There are no changes proposed to any other federal marginal tax brackets.
Income taxes on split income with non-arm's length minors (popularly referred to as the "kiddie tax"), which generally includes income from dividends on shares from private companies, capitals gains realized from the disposition of these shares from non-arm's length persons, and income from certain partnerships or trusts, will also be increased by 4%, from 29% to 33%. Since this is a flat tax, it will apply to income of any amount that is paid to a non-arm's length minor during a taxation year.
Trust Tax Rates
In keeping with the policy of having trusts taxed at the highest marginal rate, federal income tax payable by an inter vivos trust, other than a qualified disability trust, will also be subject to the 4% tax rate increase, from 29% to 33%. As a result of amendments to the ITA which will take effect on January 1, 2016, testamentary trusts which are not graduated rate estates will, with certain exceptions, also be subject to the higher 33% federal income tax rate.
Tax Rates for Privately Owned Corporations
In order to account for the increased top marginal tax rate, several changes will be made to the taxation of Canadian-controlled private corporations (CCPCs). Some taxpayers use corporations to defer tax payable in respect of investment income. To deter this practice, a CCPC is required to pay an additional 6.67% tax on investment income, as well as Part IV tax on certain inter-corporate dividends. Both these taxes are refundable once the CCPC pays dividends out to its shareholders.
As a result of amendments proposed in the Ways and Means Motion, the refundable tax on CCPC investment income will be increased by 4%, to 10-2/3% and the Part IV tax rate will be increased by 5%, to 38-1/3%. To reflect these increases, the dividend refund rate will also be increased by 5%, to 38-1/3%.
These increases could have significant consequences for certain businesses, and for taxpayers owning CCPCs which earn investment income. Affected taxpayers should therefore seek professional assistance as soon as possible.
Tax Credits for Charitable Donations
To again account for changes to the income tax rates, effective January 1, 2016, the tax credit rate for charitable donations will increase from 29% to 33% for donations over $200. This increase will apply to the lesser of the amount of donations made in excess of $200 and a taxpayer's taxable income over $200,000. The current tax credit rate of 15% for the first $200 of charitable donations made will remain the same. As such, an individual who earns $260,000 per year and makes a donation of $60,200 can claim a credit for 33% of value of the gift over $200. On the other hand an individual with the same income who makes a $70,200 donation can only claim a tax credit of 33% of $60,000 and 29% on the remaining $10,000. A rate of 15% would apply to the first $200.
Tax Free Savings Account (TFSA)
As expected, the proposed changes will bring the annual TFSA contribution limit back down to $5,500 from the current contribution limit of $10,000, which was a change implemented by the previous government as part of the measures announced in the 2015 Federal Budget. The newly reduced contribution limit will be indexed to inflation, so it should increase incrementally over time. The $10,000 contribution limit will only apply to the 2015 taxation year, which may nonetheless present a tax planning opportunity for certain taxpayers.
The proposed changes to the ITA announced in the Ways and Means Motion are likely to impact different taxpayers in different ways. Certainly, the proposed changes may have a significant impact on high income earners and on high-net-worth taxpayers, especially those who are likely to earn income which will be subject to the new tax bracket. The same taxpayers may also be impacted by the changes to the taxation of trusts, particularly testamentary trusts, which were generally mentioned in this article, and which will take effect on January 1, 2016. Taxpayers who believe that they may be particularly affected by the upcoming changes to the ITA should discuss the changes with their tax advisors, so that their tax planning may be as effective and practical as possible in 2016 and in future taxation years.
The authors wish to thank Toronto student-at-law, Benjamin Mann, for his significant contributions to this article.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.