This summary of the revisions to the proposed tax changes was prepared with the assistance of Rotenberg Tax and Business Consulting.
On October 18th 2017 the Finance Minister introduced revisions to his July 18th tax proposals. These revisions come after the conclusion of a brief 75-day consultation period.
Morneau now claims that the Liberals have reviewed over 21,000 written submissions — some of which are over 100 pages in length — from taxpayers and advisors across the country. Jamie Golombek, Managing Director of Tax & Estate Planning for CIBC calculated, in an article in the Financial Post on October 12th, that if the Department spent just 10 minutes per submission, it would take 465 work days to review all of the submissions.
Reduction of corporate tax rate for small business corporations
The previous Stephen Harper’s government had already announced a reduction in the rate of corporate tax paid by a Canadian controlled private corporation (CCPC) on its first $500,000 of active business income. One of the Liberal’s first moves was to cancel this tax reduction.
Minister Morneau’s announcement is simply a reinstatement of the tax cut. In effect, Minister Bill Morneau is un-breaking a broken campaign promise. It will reduce the tax that a CCPC will pay on its first $500,000 of active business income, gradually, starting in January 2018. The rate will reduce from 11% to 10% in January, 2018, and to 9% in January 2019.
Lifetime Capital Gains Exemption
Minister Morneau announced that they will not proceed with provisions that would limit access to the Lifetime Capital Gains Exemption.
Hopefully, this will mean that shares owned in a family trust will still qualify for the Lifetime Capital Gains Exemption.
There has been no significant change to these provisions.
The Finance Minister says that they will simplify the administrative burden on the family to prove that a family member has made a “reasonable contribution”. But, if the taxpayer can’t satisfy that burden, they will still tax their dividends at the top personal tax rate.
The only small beneficial change is that they have now referred to contributions as including, “past contributions”.
This will do nothing to reduce the massive volume of tax objections and appeals that we will see.
It will likely be some time before the Courts are able to determine what constitutes a “reasonable contribution, so the entire tax system will be in a state of uncertainty until then.
Passive Investment Income
Reacting to the overwhelming opposition to the proposed tax changes, Finance Minister Bill Morneau, has re-affirmed that all accumulated savings, presumably up to December 31st, 2017, in a Canadian controlled private corporation (CCPC) and any earnings generated by those savings will not be subject to the new passive income rules.
In respect of any future accumulations of capital, there will be a limit of $50,000 per year of passive income that will be exempt from the new rules. Presumably, any investment income in excess of this amount will be subject to the new rules, and the tax could be as high as 73%.
The additional problem is one of complexity. The Finance Minister has been told repeatedly that his proposals are too complex. This change in the passive income rules will make the system even more complicated. There could now be multiple regimes of refundable taxes. Refundable taxes have been in place since 1972 and provide for a refund of corporate tax when a CCPC pays taxable dividends to its shareholders.
Now small businesses will have to track pre-2018 capital and the income generated on that base. Presumably the income generated on any re-investment of that capital will be subject to the new rules. Annually the business will have to track its investment income up to $50,000 and any income in excess of this amount. All of these sources of income will be taxed differently, and will likely each be subject to a different regime of refundable taxes. Presumably accountants will be able to track this, but at a potentially significant cost to small business.
The Government indicates that they will continue to examine all matters related to passive investments and will continue to assess the technical aspects. For example, consideration will be given as to the appropriate scope of the new tax regime with respect to capital gains, including whether in certain circumstances the new rules should exclude capital gains realized on the sale of shares of a corporation engaged in an active business.
The proposed changes to passive investment will not apply to income from Agri Invest, which is a self-managed producer-government savings account that allows producers to set money aside which can be used to recover from small income shortfalls, or to make investments to reduce on-farm risks – under the current system, investment income in an Agri Invest account is treated as active business income. The government's intention is to maintain this treatment.
The details of the proposed measures will be released in Budget 2018, including a technical description of how the passive investment income threshold will be applied. This will leave the entire system in turmoil for months to come.
In his Budget Speech on March 22nd, 2017, Finance Minister Morneau stated, “Canadians expect a fair tax system.” How fair can a system be when it becomes too complicated for any, except the tax professional community, to understand?
Inter-family Transfers of Family Farms and Businesses
Minister Morneau said, in his press release on October 18th, that they would work with Canadians to ensure that the tax rules won’t affect the transfer of a family business or family farm to the next generation.
To do this will require amendments to the existing Section 84.1 which makes it more tax efficient to sell your business to an outside party than to your own children. Simply saying that they won’t change the rules related to the Lifetime Capital Gains Exemption is not sufficient to accomplish this goal.
Conversion of Ordinary Income into Capital Gains
Nothing has been said about these provisions. Some of the provisions to which Morneau has referred are in place to eliminate double, and sometimes, triple taxation of the same amounts. The changes to Section 84.1 announced in July can subject a deceased taxpayer and his estate to taxes as high as 93%.
There has also been nothing announced concerning proposed Section 246.1, which has retroactive effect and could, as drafted, eliminate the ability of a CCPC to pay out the untaxed portion of capital gains in the form of tax-free capital dividends. Again, this has been part of our tax system since 1972 and is crucial to ensure integration of personal and corporate taxes without imposing double or triple taxation.