Canada: Strategies For Dealing With The New SBD Rules

Some taxpayers utilize corporate groups, which have been structured to multiply their access to the small business deduction (SBD). The SBD allows a company to pay a lower tax rate on the first $500,000 of income each year. Access to the SBD is sometimes limited as it must be shared by associated corporations and corporate partners. To avoid having to share the SBD, some businesses that naturally work in groups, have structured their affairs in a way that allows more than one $500,000 small business deduction. In reaction to this multiplication strategy, the government introduced legislation in the 2016 federal budget to end the effectiveness of such structures and, in effect, increase tax rates for companies in such groups.

Rate increases vary from one province to the next, but in British Columbia, this will increase the tax rate from 13 per cent to 26 per cent. Some provinces will go even higher, but the general result is that these groups of companies are facing a significant tax increase, for corporate year ends starting after March 21, 2016.

Generally, you should be concerned about these new rules if your company invoices other companies or partnerships and an ownership interest or other non-arm's length relationship exists. The new rules are far reaching so, if in doubt, talk to a tax professional.

Rather than reviewing the technical details of the new rules, let's discuss possible strategies for dealing with them.

Do nothing

While many companies involved in corporate groups will be affected by these changes, some companies will experience little impact. For example, real estate agents can be incorporated in various jurisdictions. They are unlikely to be affected by these changes because they usually invoice clients — people selling and buying houses — rather than a partnership or company they hold shares in.

Adjust setup

As a result of these changes, there's a good chance groups will have to abandon their multiple access to the SBD or restructure to fall outside the application of the new rules. However, every situation is different. Costs and benefits will have to be analyzed. Business relationships particular to a business group will have a major impact on the evaluation. For example, doctors tend to be lone practitioners. Many of them hold shares in a common billing corporation for the convenience of the health authority they're dealing with. As a result, they may fall within the new rules, even if they aren't in a partnership arrangement with other doctors or specialists. In cases like this, it may be easier to restructure, to operate through a joint venture or an arm's-length central business entity.

Joint venture/Cost-sharing arrangements

For simplicity, it may be tempting to restructure a partnership to operate as a joint venture or cost-sharing arrangement. One problem with this process is that it may be difficult to show that a change has actually occurred when the same businesses are involved, especially if there is no major alteration to operational methods.

Central business entities

The structure that seems to be moving to the forefront of current discussions is what is often called a "central business entity." In this situation, one company is owned by one or two persons. None of the others in "the operation group" are shareholders indirectly or directly in the central business entity. As long as the owner is not a shareholder and deals at arm's length with the shareholders of the central business entity, the company should be entitled to its own small business deduction.

Don't ignore the changes

Those who fail to act on these changes to the SBD could find themselves paying a great deal more tax than expected when it comes time to prepare their corporate tax returns. If the additional taxes are not expected and the money is already spent, this can be hard to recover from. Anyone using the small business deduction and invoicing a partnership or company they have a relationship with — whether it's a shareholding relationship or related to someone who's a shareholder — should be talking to their accountant about the ways these changes to the SBD may affect them.

Keep corporate earnings at a corporate level

The people that are most affected by these rules are people that keep their corporate earnings at a corporate level, deferring the personal level of tax. For instance, in B.C., you'll pay 26 per cent tax on money you retain at the corporate level, rather than the usual 13 per cent. Those who take out all earnings to pay for things like their personal mortgage or their kids' education bills are less likely to be adversely affected by this inability to multiply the small business deduction. With that in mind, you may not have reason to worry.

Income splitting

Those who income split by paying dividends to lower taxed family members may also be affected by the new rules. These dividends will now be paid out of earnings taxed at 26% rather than 13%. The effects of the new rules should be considered by those using income splitting dividends.

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.

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