By Chris Kauenhofen.
The federal government has announced several tax changes over the last year, which will have an impact on many businesses, including manufacturers.
In October, the government outlined a few changes related to the small business tax rate, income splitting, and how passive investment income earned in private companies is taxed. It also pronounced it wouldn’t move forward with proposed measures to limit access to the lifetime capital gains exemption (LCGE). Two months later, the government revealed legislation to simplify restrictions on income splitting.
Here’s an overview of the changes:
Small business taxes
At the beginning of January, the small business tax rate has decreased to 10 or 10.5 per cent, depending on classification. As of January 1, 2019, the rate will decline again to nine per cent. The rate applies to the first $500,000 of active business income earned by a Canadian-controlled private corporation.
Starting in 2018, the government started limiting income ‘sprinkling’ using private corporations, while promising the rules won’t affect businesses where there are clear and meaningful contributions by members of the family.
There will be a reasonable test for family members over the age of 18 to demonstrate their contribution to the business based on four basic principles: labour contributions; capital or equity contributions to the business; sharing financial risks; and/or past contributions in respect to previous labour, capital, or risks.
The tax on split income (TOSI) has been expanded to apply in respect of certain amounts received by adult individuals. These amounts generally include capital gains or profits from the sale of certain properties, certain split income from trusts and partnerships, and interest or dividends paid by a private corporation directly or indirectly to an individual from a related business, subject to specific exclusions.
For taxpayers who are age 25 and older, they can avoid the TOSI rules on income received from a company if they own excluded shares that represent 10 per cent or more of the votes and value of the company when the income is received. This capital contribution test only applies to shareholders who are 25 or older. Also, the business of the corporation is restricted to businesses where less than 90 per cent of the income is from services.
If the taxpayer doesn’t meet the capital contribution test, they can avoid TOSI if they meet the labour contribution test. The taxpayer must be actively engaged in the business in the taxation year or any of the five previous taxation years. The Canada Revenue Agency considers someone to be actively engaged if they work an average of 20 hours or more per week. If the business only operates for part of the year, the 1,000-hour annual requirement is prorated for a portion of the taxation year that the business is in operation.
For taxpayers who are between 18-24, the labour test or a modified capital contributions test applies. If the labour test isn’t met, the amount received must fit into one of two specific return of capital tests.
For adults who are 65 or older, the TOSI rules don’t apply to capital gains or income received from a business where the individual’s spouse or common-law partner made contributions to the business.
Starting in 2018, split income includes taxable capital gains and income from the sale of certain property after 2017. The rules apply to exclude specific taxable capital gains from a taxpayer’s split income, including those that arise from the sale of property that qualify for the LCGE.
For taxpayers who are 25 or older and don’t meet the exclusions described earlier, an amount can still be an excluded amount if it’s a reasonable return based on one or more of the following criteria: labour contribution, property contribution, risk incurred, historical payments, and other factors that may be relevant. For taxpayers between the ages of 18-24 who have contributed arm’s length capital to support a business, their reasonable return from the business is based on the contribution they made.
Passive investment income
The government has decided to move forward to limit the tax-deferral benefits of passive investments in private corporations. Policymakers, however, will balance this with flexibility for small business owners.
There will be a maximum threshold of $50,000 of investment income earned annually in a corporation that won’t be subject to a new regime. The government estimates this threshold is about $1 million in invested assets, assuming a five per cent rate of return.
The threshold is intended to help small business owners build a savings cushion to deal with a downturn, sick and parental leave, or retirement.
For business owners with significant passive asset investments in corporations, the rules will only apply to new investments, meaning income earned on existing assets won’t be impacted.
Draft legislation is expected to be released as part of the 2018 federal budget, but the government hasn’t indicated when the new proposals will come into effect.
On January 18, 2018, Canadian Manufacturers & Exporters (CME) joined forces with members of the Canadian Manufacturing Coalition and sent a letter to federal Finance Minister Bill Morneau, highlighting the priorities of the manufacturing sector for the 2018 federal budget.
The letter underscores the critical importance of manufacturing to the Canadian economy and outlines six tax reforms CME believes the government should consider going forward to boost investment and growth in the sector:
1. Reduce federal and provincial general corporate taxes to a combined 20 per cent;
2. Expand and improve the Accelerated Capital Cost Allowance (ACCA) depreciation rules to mirror the new U.S. rules;
3. Introduce an investment tax credit on purchases of new equipment and software of between 10-15 per cent to help companies, especially SMEs, improve cash flow and offset the impact of the low Canadian dollar on the cost of buying foreign machinery and equipment;
4. Introduce a ‘patent box’ innovation support that would reduce taxes on profits from new products and product mandates;
5. Lower the top marginal personal income tax rate from 33 per cent to 31 per cent; and
6. Reform the Scientific Research and Experimental Development Tax Credit program to lower the administrative burden and support a broader range of corporate innovation needs, especially product commercialization.
Once BDO’s communication outlining the federal budget has been published, you can find it at www.bdo.ca.
Chris Kauenhofen is a partner with BDO Canada LLP and is based out of the firm’s Winnipeg office.