By Trevor Parry

Special to the Financial Independence Hub

While Bill Morneau’ s second federal budget can be described as a punt, this third foray can best be described as a “fart in the wind;” however,  given that this is a Justin Trudeau government, the term “pixie dust” seems far more appropriate.

The Budget included two major tax measures, one relatively substantial and the other curative.  The latter was a tweaking of the rules surrounding Refundable Dividend Tax on Hand (RDTOH) , dividing the pools into eligible and ineligible pools, thus corresponding with their according dividend. The more substantive measure was to introduce a measure that reduces the ability of a corporation (or its related entities) to claim the Small Business Deduction where “substantial” income has been earned of invested after tax profits.

The new rule would see a company’s SBD eroded by 5 dollars for each 1 dollar of passive income earned in excess of $50,000 each year.  If the company earns $150,000 per year in passive income it loses the entire SBD and is subject to General Rate taxation, effectively 26%.  The government claims that this will affect about 3% of businesses.  In the cases where the full SBD is lost the company will end up paying about $55,000 in additional corporate tax.  The same company would also be paying out eligible dividends, which will be taxed at lower personal rates by the shareholder.

Finance’s pragmatic policy wonks prevailed with the Small Business Deduction

I actually think that the more pragmatic policy wonks in the Department of Finance prevailed with regard to this measure.  The SBD was introduced to provide a tax incentive for small businesses to save and invest and by this process graduate to a medium sized or growing business.  The problem of course is that tax planners have for decades sought to freeze the status of a small business in place.  This can still be achieved by paying out shareholder bonuses, but given confiscatory personal rates in most of the provinces it is likely that trusted advisors will still the ability of a corporation to defer taxation and recommend that earnings continue to be retained.   The approach the government has taken is a more comprehensive approach to total corporate earnings.  It explicitly says to business owners and incorporated professionals that you can use your corporation as a retirement vehicle, or rainy day fund but you will be taxed as a more mature business.

There are of course planning measures that can be taken to avoid this new measure.  Permanent life insurance remains the last game in town with regard to significant tax deferral possibilities.  Given that the Department of Finance engaged in meaningful consultation in fashioning the substantive update of the “exempt test” rules in 2016 that no wholesale assault on life insurance is in the offing.

Instead, I think the Department will continue to observe the golden rule — “Pigs get fat and hogs get slaughtered” — in deciding what action is necessary.  Like the 10/8 strategy before, there are strategies being implemented today that clearly drift into the aggressive category.   The diversion of loan proceeds to a shareholder in an Immediate Finance Arrangement, or the rebating of commissions without their appropriate declaration of status as taxable income come to mind.

Individual Pension Plans only temporary remedy for new rules

Some might also trumpet the use of Individual Pension Plans.  IPP’s in the right instance are wonderful planning tools.  They are particularly useful for incorporated physicians who cannot plan retirement on the basis of an eventual sale of their professional corporations and who too often suffer from a lack of savings discipline.  Continue Reading…