For shareholders of Professional Corporations, the 2016 Federal Budget should have been received with mixed feelings. There were rumors that Canada may follow Quebec and significantly limit the tax deferral benefit of a typical Professional Corporation by disallowing the Small Business Deduction. This particular measure has not come to pass, but we can be sure that the government is still looking into that issue. However, they did attack certain planning with respect to the Small Business Deduction as noted below. Here are the top issues which need to be considered by a shareholder of a Professional Corporation.
Small Business Deduction
Currently, many Professional Corporations are eligible for the Small Business Deduction (“SBD”) on their first $500,000 of business income as most carry on an active business in Canada. In Ontario, the combined tax rate on income eligible for the SBD is 15%.
Certain structures have been set up with respect to partnerships where the shareholder of the Professional Corporation is a partner in the partnership, but the Professional Corporation provides services to the partnership. These structures allowed each Professional Corporation to claim their own SBD and avoided rules which required each partner to share one $500,000 small business limit amongst all the partners. Budget 2016 proposes to eliminate the tax benefits of these types of structures.
The Budget also proposes to make certain income ineligible for the SBD where the shareholder of the corporation providing the services is related to the shareholder of the corporation paying for the services.
Corporate Tax Rates
The tax rate for income eligible for the SBD was scheduled to be reduced from 15% in 2015 to 13.5% by 2019. Budget 2016 proposes to halt the scheduled decrease in the tax rate and maintain the 15% rate indefinitely. The tax rates provided above are combined for the province of Ontario.
Eligible Capital Property (Goodwill)
The entire concept of Eligible Capital Property (“ECP”) will be eliminated January 1, 2017. Currently, when ECP (e.g. Goodwill) is acquired, 75% of the purchase price is eligible for an annual 7% declining balance tax deduction. For acquisitions of ECP after January 1, 2017, the entire balance will qualify for an annual 5% declining balance deduction.
Under the current rules, when ECP is disposed of (typically in an asset sale) a portion of the proceeds are taxed as regular “business income”. Business income may be eligible for the small business income tax rate of 15% or the regular business rate of 26.5%. Under the proposed rules, a portion of the proceeds will be treated as “investment income”. Investment income is initially taxed at 50.17% with a portion of that amount being refundable when dividends are paid.
There will be transitional rules for converting existing ECP balance to the new rules.
Transfer of Life Insurance
Under the current income tax rules, when a life insurance policy is transferred to a corporation by a shareholder there is an income inclusion for the difference between the cash surrender value of the policy and the adjusted cost basis. However, the shareholder is allowed to receive fair market value consideration for the policy which may exceed the cash surrender value. This excess is not taxed as income.
The Budget proposes to close this perceived loophole by including the fair market value consideration as part of the proceeds of disposition of the life insurance. The Budget also proposes an adjustment for policies that were transferred before budget day for consideration in excess of the cash surrender value.
Other items to note in brief:
- The Canada Child Tax Benefit (“CCTB”) and Universal Child Care Benefit (“UCCB”) have been consolidated into one Canada Child Benefit starting in July 2016;
- The Family Tax Cut resulting in a maximum annual tax savings of $2,000 will be eliminated for 2016 and subsequent years;
- Education and Textbook Credits will be eliminated for 2017 and subsequent years. Tuition credits are not eliminated; and
- Child Fitness and Arts Tax Credits will be reduced in 2016 and eliminated in 2017 and subsequent years.
If you have any questions about the 2016 Federal Budget and how it may impact you, please contact one of our staff.
Article written by: Jeremy Doan, Macc, CPA, CA