February 27th Federal Budget Update
Finance Minister Morneau tabled a consultation paper and draft legislation in July 2017 that proposed to significantly increase the tax burden on private corporations and their shareholders. The proposal was met with significant backlash from professional groups and business owners who voiced their concerns. On February 27th, the much anticipated Federal Budget was released, finally providing clarity to tax payers and business owners. More so than any new provisions that came out of the Federal Budget, what is interesting are the proposals and changes that the Federal Budget did not end up making.
WHAT THE FEDERAL BUDGET DIDN’T DO
There were several rumors leading up to the budget that were not included in the budget. These were:
- There was no change to the inclusion rate for capital gains
- There was no change to the taxation of exempt life insurance policies
- The Capital Dividend Account was not reduced or taken away
- The TOSI (tax on split income) draft legislation was not changed and is in effect for 2018
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- The proposals for taxation of passive income were dropped
- Taxation of Charitable Flow Through Strategies was not changed
- Taxation of Immediate Finance Arrangements (IFA’s) was not changed
WHAT THE FEDERAL BUDGET DID DO
- Replaced the passive income proposals with a proposal to reduce the amount of income taxed at the small business rate where there is over $50,000 of investment income
- Adjusted the refundable dividend tax system
SMALL BUSINESS DEDUCTION
The February budget proposes a reduction to the small business deduction of $5 for each dollar of investment income over $50,000 starting in 2019. This limit is for associated companies so would apply to an OPCO/HOLDCO situation. The expected combined rate of tax in 2019 on small business income in B.C. is 11%. The expected general rate of tax in BC is 27% leaving a 16% increase tax on active income subject to the adjustment subject to the adjustment for investment income. In other words, the general rate is 245% of the small business rate.
See example for how proposed new rules affect integration.
Investment Income A new term “”adjusted aggregate investment income” is used for this purpose. Ordinary investment income is subject to the following adjustments in determining aggregate investment income. Taxable capital gains are excluded if:
- The property is used in an active business or
- Property sold is shares of a subsidiary where all or substantially all of the property is used in an active business in Canada
- Net capital losses carried over from another taxation year are excluded
- Dividends from non-connected corporations are added
Refundable Dividend Tax The changes to refundable dividend tax are intended to restrict dividend refunds to situations where ineligible dividends are paid. The concept is to prevent dividend refunds resulting from investment income being paid out when lower taxed eligible dividends are paid.
OPPORTUNITIES GOING FORWARD
Companies that will have their small business deduction reduced because of investment income exceeding $50,000 will be looking for ways to reduce or shelter investment income over time. Different investments are taxed in different ways with different effects on investment income. For example interest is fully taxable while capital gains are 50% taxable and returns of capital are not taxable.
IPP’s are like corporate RRSP’s that allow for higher contribution limits and the possibility of tax deductible past service contributions. IPP’s are designed to build up pension income. The IPP work well for incorporated professionals and shareholders of incorporated small businesses. Qualifying T4 income is required to be able to contribute to an IPP. It might be useful to obtain an IPP quote which would show current and past service amounts. We would be happy to arrange for you.
IPP’s are especially helpful for professionals who can no longer split dividends and save tax.
Tax Sheltered Life Insurance policies may be an option to shelter investment income from tax (by reducing investment income and maximizing the Small Business Limit). These policies work as follows:
- deposits are made to the policy
- mortality costs and expenses are charged to the account
- the balance is invested and tax sheltered while retained in the policy
- universal life and whole life policies are suitable
- the accumulated cash value can be withdrawn later on in partial withdrawals or a stream of loans can be organized providing retirement income using the policy as security (this may provide a tax preferred method of accessing the accumulation later on)
- the tax sheltered insurance plan works best when there is an otherwise determined life insurance need
Financial planning strategies need to be revisited to minimize the effects of TOSI and the new adjustments to the Small Business Deduction. Products such as IPP’s and tax sheltered life insurance can be helpful to build up retirement assets and minimize income tax.
– Mark Zlotnik, CPA CA TEP
The purpose of this article is for informational purposes. As each individual’s circumstances differ, this update is not meant to act as an analysis of the full budget, but rather what we feel is relevant to our clients. If you would like to discuss a specific example for your situation, please call your ZLC Advisor.