On July 18th the Liberal Government introduced a consultation paper, “Tax Planning Using Private Corporations” (the “Paper”). The Paper addressed issues relating to income sprinkling, multiplication of the capital gains exemption, conversion of income to capital gains and the taxation of passive income.
In our previous post, we summarized the key points arising out of the October 16, 2017 announcements concerning the Government’s changes to the taxation of private companies. The purpose of this post is report on the Government’s direction as to the taxation of passive investment income.
The Government expressed the view in the Paper that “fairness and neutrality require that private corporations not be used a personal savings vehicle for the purpose of gaining a tax advantage.” Business income is subject to tax at the combined B.C. and federal tax rate of 13% or 26% thereby leaving more to invest. The shareholder will pay tax when the income is distributed as a dividend; however, there is a deferral advantage.
The Paper discussed the Government’s two key objectives, which are to (i) preserve the intent of the lower tax on business income to encourage growth and job creation and (ii) eliminate the advantages of investing passively through a private corporation. The Paper outlined two possible approaches.
On October 18, 2017 Finance Minister Bill Morneau announced that the Government will proceed on the proposals outlined in the Paper; however, the new measures will not apply to a $50,000 annual threshold on passive income. The $50,000 threshold is equivalent to $1 million in saving based on a 5% rate of return. The proposed changes will also not apply to income from AgriInvest , a self-managed producer-savings account. Under the current rules, AgriInvest is treated as business income and that will not change.
The Government confirmed that the proposals will apply on a go-forward basis. They will not apply to past investments and to income earned from those investments.
The Government identified the following outstanding matters for consideration:
- the application of the new regime to capital gains, including whether the new rules should exclude capital gains realized on the sale of shares of a company engaged in an active business; and,
- how the proposals will include incentives for venture capital and angel investors so that they will continue to invest.
The draft legislation enacting the changes to the taxation of passive income will be released as part of the 2018 Budget. One can anticipate that the draft legislation enacting these proposals will add complexity to a tax system that is already complex.
There is no doubt that the proposals will add a compliance burden for private companies. Investments derived from business activities will have to be tracked separately from investments derived from other sources. It will also be necessary to track past investments and the income generated from them separately from and investments governed by the new rules.
We will continue to keep you posted as developments unfold.
