Summary of the July 18, 2017 Tax Act Proposals
On July 18, 2017, Finance Minister Bill Morneau announced the release of a consultation paper and draft legislation to amend the Income Tax Act. The purpose of the proposals is to close perceived loopholes and deal with tax planning strategies that involve the use of private corporations. The government is concerned that some individuals are using corporate structures to avoid paying their fair share. These proposals represent a fundamental change to tax planning opportunities that have been used for a number of years.
Existing corporate structures are being used to split income with adult relatives in lower tax brackets, through the payment of interest and dividends. In many cases, there is no limit to the amount of dividends a relative could receive. The government is proposing to tax interest and dividends in excess of a reasonable amount at the top rate of tax, unless the individual is actively involved in the business. Based on the draft legislation as written, it may be difficult to determine what constitutes a reasonable amount. These proposed rules would come into effect in 2018.
Lifetime Capital Gains Exemption
The government proposes to restrict access to the capital gains exemption on qualifying shares only to those individuals who are actively involved in the business. In addition, growth on shares while held in a family trust will not be eligible for the capital gains exemption. These proposals will significantly limit the ability to multiply the capital gains exemption with family members. The draft legislation provides for a one-time election in 2018 in which taxpayers can elect to bump up their cost base via a deemed disposal and re-acquisition, which can be sheltered by the capital gains exemption. The maximum bump will be based on the fair market value of the qualifying shares on the election date.
Extracting Corporate Surplus
The consultation paper and the draft legislation include anti-avoidance rules that are effective as of July 18, 2017 to prevent taxpayers from extracting corporate surplus as capital gains. This type of strategy was effective because capital gains are taxed at a lower rate than dividends. The proposed rules will convert a capital gain into a dividend where there has been a series of transactions with related parties to generate the capital gain. These rules will also impact a post-mortem plan often referred to as a “pipeline”.
Corporate Investment Income
The Liberal government believes that there is an unfair advantage available to private corporations which invest their after-tax retained earnings obtained from active business operations in passive investments. The paper provides a number of possible proposals aimed at eliminating this perceived tax advantage. It should be noted that draft legislation was not provided for this issue. If the proposal is introduced in the future, the significantly higher corporate income tax on passive investment income resulting from active business profits may force the payout of corporate surplus much sooner, rather than later.
Most of the proposals are not effective until after 2017. The only exception is the anti-avoidance provision aimed at capital gains surplus stripping. As a result, the government is accepting submissions on the proposals up until October 2, 2017. We will keep you posted as to how these new rules may impact you as we review and analyze them further, and as more information becomes available.
In the meantime, please feel free to contact your DJB professional if you have any questions that you would like to discuss.