As most readers are aware, the federal government’s small business July 18 tax proposals created an enormous backlash, with many groups and individuals, including yours truly making submissions to voice their concern. It appears the government heard the outcry as it has softened its stance to varying degrees on its new proposals. Here is a summary of how things now stand:
The original proposals would extend the Tax on Split Income (“TOSI”) to dividends received by adults, unless they can show that the dividends are reasonable in light of their labour and/or capital contributions to the business.
The response by the tax and business communities focused mainly on the uncertainty of what might be considered “reasonable” and how this might translate into an acceptable dividend.
The finance minister has announced that it intends to move forward with the income sprinkling proposals. It intends to ensure that the rules will not impact businesses to the extent there are clear and meaningful contributions by family members. It will introduce reasonableness tests for adults in two categories – those aged 18-24 and those aged 25 and older. Adults will be asked to demonstrate their contribution to the business based on four basic principles:
- Labour contributions
- Capital or equity contributions
- Financial risk, such as co-signing a loan, and/or
- Past contributions of labour, capital or risks
While no new draft legislation has been released, the government states that the concerns surrounding uncertainty have been heard and they will simplify the proposed measures and reduce the compliance burden. Stay tuned to see what the specific legislation will contain.
Multiplication of the Capital Gains Exemption (“CGE”)
The original proposals would have disallowed the lifetime capital gains exemption on the sale of Qualified Small Business Shares and Qualified Farming Property as follows:
- Elimination of CGE for minor children
- Imposing TOSI reasonableness tests on availability of the CGE
- Elimination of CGE for property held in a trust
After review, the government has backed off on all of the above proposals and will not be going forward with any of them.
Converting Income into Capital Gains
These proposals were designed to curtail what the government perceived as abusive “surplus stripping”. It would have extended the rules in section 84.1, to any non-arm’s length sale of shares to a corporation. It would also have applied dividend treatment to any such sale, even where tax had already been paid on a previous capital gain on the same shares.
These proposals would have eliminated the “pipeline” strategy, widely used to limit the incidence of taxes on the death of an individual shareholder to a single capital gain in the hands of the deceased. It would have greatly increased the chances of gains on private company shares being taxed twice.
Thanks to the concerns expressed by the tax and business communities, the government has backed off completely on these proposals and will not be going forward with them.
This is great news for those who still have reservations about the legitimacy of implementing the Pipeline strategy on the death of a private company shareholder as the government specifically mentioned that it was responding to concerns about taxation on death.
Holding Passive Investments
The initial proposals addressed concerns that shareholders of private corporations are able to defer the ultimate taxation on their savings, thereby creating a larger pool of capital to be invested for retirement. This is an advantage that a shareholder of a private corporation enjoys compared to a person without a company and is to be eliminated.
After consulting with the public, the government, while not abandoning the proposals, has agreed to relax them.
First, any capital already in existence will not be affected by the new rules. They will not apply retroactively to existing retained earnings.
Second, there will be a base amount of $50,000 of passive income that a corporation may earn each year while still not having the rules apply. This is the equivalent of $1 million of capital invested at a 5% rate of return. Any income above that amount will not benefit from the tax deferral.
There is still no draft legislation to indicate exactly which mechanism will put in place. The new year should bring new announcements and more details in this important area.