Canada: Taxation Of Private Corporations And Their Shareholders

Last Updated: October 26 2017
Article by Joel A. Nitikman and Mark Woltersdorf

On July 18, 2017, the Department of Finance Canada introduced draft legislative proposals impacting private corporations and their shareholders. A 75-day consultation period was provided with a deadline for taxpayer submissions of October 2, 2017. The legislative proposals targeted unreasonable income sprinkling, access to the lifetime capital gain exemption, conversion of income into capital gains and the taxation of passive investment income earned by private corporations. For more detailed discussion of the legislative proposal see our article " The Federal Government takes aim at private corporations and their shareholders".

On October 3, 2017, the Department of Finance Canada issued a news release advising that the consultation period generated in excess of 21,000 taxpayer submissions and that it would be reviewing the submissions and considering revisions to the draft legislative proposals based on the following five key principles:

  1. Support small business and their contributions to communities and the economy;
  2. Keep taxes low for small business and support owners to actively invest in their growth, create jobs, strengthen entrepreneurship and grow the economy;
  3. Avoid creating unnecessary red tape for hard working small businesses;
  4. Recognize the importance of maintaining family farms and work with Canadians to ensure that the transfer of family farm businesses to the next generation is not affected; and
  5. Conduct a gender based analysis on finalized proposals, to ensure any changes to the tax system promote gender equality.

On October 16, 2017, the Department of Finance Canada issued a further news release advising of the following key changes to the proposals previously announced:

  1. A reduction to the small business corporate tax rate from 10.5 percent to 10 percent effective January 1, 2018, and to 9 percent effective January 1, 2019;
  2. Withdrawal of the proposals dealing with the lifetime capital gains exemption; and
  3. Simplification of the proposed measures intended to prevent unreasonable income sprinkling;

No further comment was made with respect to the conversion of income into capital gains or the taxation of passive income earned by a private corporation at that time. However, it was stated that "in the coming days, the Government will announce further steps towards fairness for the middle class that will take into account this feedback."

In addressing taxpayer submissions relating to income sprinkling, the Department of Finance Canada announced the Government's intention to simplify the proposal to limit the ability of owners of private corporations to lower their personal income taxes by sprinkling their income to family members who do not contribute to the business. It reiterated its plan to introduce reasonableness tests for adult family members aged 18-24, and those 25 and older, stating that these adults will be asked to demonstrate their contribution to the business based on four basic principles: 1) labour contributions; 2) capital or equity contributions; 3) financial risks, such as co-signing a loan or other debt; and/or 4) past contributions in respect of previous labour, capital or risks. It further stated that the Government will work to reduce the compliance burden with respect to establishing the contributions of spouses and family members.

It remains to be seen where the rules on income splitting will end up and what simplification of the July 18, 2017, legislative proposals will be achieved. What appears to be certain is a limitation on income sprinkling in some form will move forward.

On October 18, 2017, the Department of Finance Canada issued a further news release confirming its intention to move forward with measures to limit the tax deferral opportunities related to passive investments. Taking into consideration feedback received during the consultation process, the Department of Finance Canada expressed its understanding of the needs of business owner for more flexibility to build savings for business purposes, such as a downturn or financing a future expansion, as well as to deal with personal circumstances, such as sick leave or retirement. In so doing, the Department of Finance Canada reiterated the intent of the new rules, which is to target high-income individuals who can benefit under current rules beyond the pension, RRSP and TFSA limits available to other Canadians.

In further developing the passive income measures, the Department of Finance Canada indicated that it will ensure that all past investments and income earned from those investments will be protected; that businesses can continue to save for contingencies or future investments in growth; that a $50,000 threshold on passive income in a year (equivalent to $1 million in savings, based on a nominal 5-per-cent rate of return) will be available to provide more flexibility for business owners to hold savings for multiple purposes; and that incentives are in place so that Canada's venture capital and angel investors can continue to invest in the next generation of Canadian innovation.

The Department of Finance Canada will release the draft legislation for the proposed passive income measures as part of its 2018 federal budget. It noted that in drafting new legislation, it will consider all deferral benefits from passive investments and will continue to assess key design aspects, including for example how capital gains will be affected including those realized on the sale of shares of a corporation engaged in active business.

It is expected that revised draft legislation on measures other than the taxation of passive investments, along with measures related to private corporation taxation, will be released later this fall. We will continue to monitor these revisions and will report on them at the appropriate time.

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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. Specific Questions relating to this article should be addressed directly to the author.

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