What's changed, what's the same and what's to come with the Liberal small business tax proposals
Taking a page out of its 2015 playbook when the government raised taxes on the wealthiest one per cent so that it could, in its words, “introduce a middle class tax cut for nearly nine million Canadians,” Finance Minister Bill Morneau on Monday linked a cut in the small business tax rate to a planned rethink, rework and partial abandonment of the recently-announced small business tax proposals.
On Monday, the government announced that the small business rate will drop to 10 per cent on Jan. 1, 2018 and to 9 per cent on Jan. 1, 2019. The rate, which is currently at 10.5 per cent, applies to the first $500,000 of active business income. The current rate came into effect on Jan. 1, 2016, shortly after the government came to office. The rate was frozen as the government “paused on further reductions in order to better understand the use of the small business tax deduction and the potential to be used as a tax planning tool for the wealthiest of Canadians.”
On Monday, the government said, “As we reduce the small business tax rate to nine per cent … we will ensure that Canadian-controlled private corporation (CCPC) status is not used to reduce personal income tax obligations for high income earners rather than supporting small businesses.”
The proposed CCPC tax rules, originally introduced in July 2017, focused on three areas: income sprinkling among family members, including the multiplication of the lifetime capital gains exemption, passive investment income earned within corporations and converting dividends into capital gains.
While only limited details of the expected changes were revealed, the government will be releasing more information throughout the coming small business week. Here’s what we know so far.
Through its 21,000 submissions, the government heard feedback on the complexity of the proposed income sprinkling measures, their potential impact on small family businesses and the need to simplify the draft legislative proposals released in July. It received feedback that the measures, as proposed, “could create uncertainty in relation to how amounts received from a family business would be taxed.”
As a result, the government announced that it will be making changes to simplify the proposal to ensure “that the rules will not impact businesses to the extent there are clear and meaningful contributions by spouses, children and other family members.” Specifically, the government said it will work to reduce the compliance burden with respect to determining the “reasonableness” of contributions (including labour, capital, risk and past contributions) by a spouse or family member.
The government estimated that only 3 per cent of CCPC owners or 50,000 family-owned private businesses are sprinkling income and thus the vast majority of private corporations won’t be impacted by the proposed income sprinkling rules.
Lifetime Capital Gains Exemption
The government also announced that it is abandoning the draft rules that would have severely limited access to the Lifetime Capital Gains Exemption. The LCGE provides a tax exemption for capital gains realized by individuals on the sale of qualified small business shares, subject to a lifetime limit of $835,716 ($1,000,000 for farm or fishing properties).
This about-face was in response to a number of submissions received during the consultation process which “have identified potential unintended consequences associated with the proposed measures to address the multiplication of the LCGE … (including) concerns … raised on the potential impact on intergenerational transfers of family businesses.”
Similar concerns were raised on the proposed measures to convert dividend income to capital gains, which “could have impaired estate planning and the transfer of farms and small businesses to the next generation.” This statement suggests that amendments to the income conversion rules may also be forthcoming.
Passive investment income
Finally, although today’s announcement was silent on the government’s plans to tax passive income retained in a private corporation at effective rates as high as 73 per cent, it did acknowledge some of the concerns raised during the consultation process and now seems to have a better appreciation for the the way in which passive investments within a private corporation are used, particularly by small and medium-sized businesses, to manage personal income risk in the case of a downturn, sick leave or maternity or parental leave. In many cases passive investments are also used as a retirement tool for small business owners since other savings vehicles, such as RRSPs and RRIFs, are not sufficiently flexible and adaptable to address business volatility.
A further announcement on the status of this proposal is expected this week.