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By Brad Smith and Tea Pupica-Terzic
Special to the Financial Independence Hub
The 2018 Federal Budget confirms that the Government will move forward with the implementation of the December 13, 2017 proposals regarding the splitting of income by private company owners and their family members. The Budget, however, proposes two additional key measures regarding the taxation of passive investment income earned by a Private Corporation, a topic that was aggressively targeted by the July 2017 consultation paper on tax planning strategies involving private corporations.
The first measure focuses on limiting the access to the small business tax rate to private corporations earning a significant amount of passive income.[1] Currently, the small business deduction limit allows for $500,000 of active business income to be taxed at a preferential small business tax rate. This $500,000 limit begins to be ground down once the taxable capital of an associated group of companies reaches $10,000,000; it is completely eliminated once the taxable capital of the group is $15,000,000.
Budget introduced new reduction mechanism on passive investment income
The Budget’s proposal introduces a new reduction mechanism, which will work in tandem with the aforementioned existing business limit reduction, based on the passive investment income earned by a private corporation and its associated group. Specifically, once a corporation and its associated members earn $50,000 of passive investment income in a given year, the small business deduction limit begins to be ground down, on a straight line basis, until the passive investment income reaches $150,000. At this point, the small business deduction limit would be ground down to nil. The new reduction will apply to taxation years that begin after 2018.
The second measure aims at correcting an unintended tax advantage currently enjoyed by some private corporations when paying out eligible dividends to their shareholders in situations where the refundable tax pool (aka refundable dividend tax on hand “RDTOH”) was generated from investment income that would need to be paid out as a non-eligible dividend. The Budget is creating a new account, called the eligible RDTOH account, which will include the tax paid on eligible portfolio dividends.
Otherwise, tax paid on investment income or on non-eligible portfolio investments will be included in the non-eligible RDTOH account. The ordering rule will dictate that a private corporation, in payment of non-eligible dividends, will first have to access the refundable tax in the non-eligible RDTOH pool before it can tap into the eligible RDTOH pool. A payment of eligible dividends will only entitle the corporation to dividend refund to the extent of its eligible RDTOH pool. These new measures will also come into play after 2018.[2]
Prudent to boost Growth investments and reduce Fixed Income
For those business owners with more than $150,000 in annual passive income inside of their corporations, changing the portfolio mix to include less fixed income producing investments and more value appreciation investments would likely be prudent. This way, the annual investment income earned, upon which the grind to the small business deduction is based, could be strategically managed and only some years would be impacted.[3]
A detailed discussion with your financial and tax advisors and a comprehensive evaluation of your corporate structure and shareholdings will help ensure that you and your private business are optimizing your tax benefits while complying with the changing rules. More in depth income and tax planning will likely be required to determine the best approach for business owners, and multiple strategies may now be required to achieve their desired goals and objectives such as tax loss harvesting and other tax deferral strategies. One such strategy may be the use of the cash value of tax exempt life insurance policies within the Private Corporation for estate planning purposes.
Private corps still make sense but may need to be part of a larger integrated strategy with a greater requirement toward active financial, investment and tax planning and management.
[1] Income sprinkling changes are in place, however, after age 65 non-contributing spouses can receive dividends without impacting the sprinkling rules.
[2] It is important to note that the budget proposals indicate no grandfathering of pre-2018 investments or sheltering of income earned on those investments. Nevertheless, the Government estimates that less than 3% of private companies will be impacted by the proposed measures and, as such, for most small businesses, the measures will mean nothing.
[3] It is not recommended that investments be moved to other corporations which are related but not associated to avoid the Budget proposals; the Government is expected to curtail such attempts via anti-avoidance measures.
Brad Smith, CFP, is a Financial Advisor with IPC Securities Corp. He has worked diligently as an Advisor for over 16 years, becoming a Qualified Kingdom Advisor in 2008. This allows him to incorporate transcendent principles into the advice he provides his clients. Brad has shared his knowledge and expertise on his radio show, Your Life Well Invested, and has been asked to speak at numerous conference across North America hosted by IPC Securities Corporation, Advisors with Purpose, FaithLife Financial, Kingdom Advisors and international delegates. Brad is passionate about helping people set financial finish lines and then works with them to devise a strategy for meeting their goals.
Tea Pupica-Terzic, CPA, CA, BBA is a senior Tax Manager with MAC LLP. Tea is a graduate of Wilfrid Laurier’s Honours Business Administration program and the 2009 Gold Medalist for the School of Business and Economics. Tea has spent her career practicing taxation in national firms, assisting a diverse base of individual and corporate clients with compliance and planning matters. She has particularly extensive expertise in the technology sector, having spent much time mentoring and working with start-up companies at the local technology incubators. Tea’s experience includes lecturing business courses at Wilfrid Laurier University. She donates her time to the Board of Directors for the Lisaard and Innisfree House, and chairs their Finance and Audit Committee. From a personal standpoint, Tea’s greatest passion is spending time with her family and two young children.
