The Federal finance budget was tabled on February 27, 2018. Tax practitioners were waiting for this budget with great anticipation to see the government’s latest proposals relating to passive income rules for Canadian-Controlled Private Corporations (CCPCs). The good news is that the government significantly backed off on its initial proposals presented last July. However, if you are a small business owner, there are two changes that could affect you:
- Reduced access to the small business rate, and
- Limited access to refundable taxes.
What does this all mean you might ask? Let’s break it down.
Small Business rate
Under the proposed changes, access to the low corporate tax rate which is scheduled to be reduced to 13.5% on the first $500,000 of active business income will gradually be eliminated as the amount of passive income increases in a group of associated corporations. The $500,000 small business limit will be reduced by $5 for every $1 of passive income over $50,000. Effectively, the availability of the small business tax rate will be eliminated completely once passive income reaches $150,000. Under this proposal, you could have approximately $3 million of investments, assuming an investment return of 5%, in your private company before you lose the small business tax rate entirely.
Limiting access to refundable taxes
You may have heard that our tax system is an integrated tax system. What this means is our tax system should be indifferent as to whether you are earning income inside a corporation and paying the after-tax income to yourself as a dividend out of the corporation, or simply earning that income personally.
Investment income earned by a private corporation is initially taxed at a high rate, approximately 50%. When your company pays you dividends, it will receive a refund of a portion of those taxes and you will personally pay taxes on the dividend at your personal marginal tax rate. In the end, the total tax paid by you and the company combined is approximately the same as if you had simply earned the investment income personally. Private corporations that also earn active business income that is taxed at the general corporate tax rate, rather than the low small business rate can use the high-rate active business income to pay dividends to the owner. This situation results in a refund of taxes on the investment income and potentially a lower overall rate of tax than was intended. The lower overall rate of tax is temporary, but it can provide for a tax deferral.
The budget has proposed a change to prevent the use of lower taxed eligible dividends to recover refundable corporate tax other than refundable corporate tax that results from receiving portfolio dividends. This will require tracking of separate pools of refundable corporate tax.
What do these changes mean to the small business owner?
In a nutshell:
- The changes may reduce the amount of active business income that can enjoy the small business tax rate in the future, and
- You will need to track two separate pools of refundable tax and plan the types of dividends that are declared starting in 2019.
Both of these measures will apply to tax years that start after 2018, so there is a little time to figure out how you are affected. As to what steps you should take to prepare for the changes, please contact us and we will work through them with you.
Our commentary on the full budget covers:
- Business Income Tax Measures
- Personal Income Tax Measures
- International
- Trusts
- Charities
- Sales and Excise Tax Measures
