The government’s July 18th tax reform proposals could reasonably be described as unanticipated and overly complex, issued in the middle of the summer with a relatively short consultation period that caught even the government’s caucus off guard.
In response to pushback arising from the proposals, and to align with celebrating “Small Business Week”, the government responded by reducing small business rates and backing down from two significant controversial ideas that would impact many small businesses with unintended results, namely:
- limiting the availability of the lifetime capital gains exemption to family members where shares were held in trusts and where family members were subject to split income, and
- converting non- arm’s length transfers of shares and property that would otherwise give rise to capital gains into dividends.
In addition, they provided further information with respect to their intention to create an additional tax on corporate passive income that is derived from after-tax retained earnings that was subject only to the active business tax rate. (Passive income is generally considered to be income that is not generated from an active business such as income from interest, rent and royalties, unless there are more than five employees to produce such income.)
The first announcement on October 16th was reflected on the Department of Finance’s website as follows:
“Based on what it heard, the Government announced yesterday its intention to lower the small business tax rate to 10 per cent, effective January 1, 2018, and to nine per cent, effective January 1, 2019” [Harper government scheduled rate reductions repealed by the Trudeau government in its first budget]. To support this change, the Government also announced its intention to make changes to the tax system that will ensure that Canadian-controlled private corporation (CCPC) status is not used to reduce personal income tax obligations for high-income earners rather than to support small businesses to invest and grow.
Yesterday, Minister Morneau also announced the Government’s intention to simplify the proposal to limit the ability of owners of private corporations to lower their personal income taxes by sprinkling their income to family members. The vast majority of private corporations, including corporations with family members who meaningfully contribute to the business, will not be impacted by the proposed income sprinkling measures. In addition, the Government announced yesterday it will not be moving forward with proposed measures to limit access to the Lifetime Capital Gains Exemption.”
The second announcement, on October 18, 2017 was reflected on the Department of Finance’s website as follows:
“Minister Morneau outlined today the Government’s intention to move forward with measures to limit the tax deferral opportunities related to passive investments, while providing business owners with more flexibility to build a cushion of savings for business purposes – for example to deal with a possible downturn or finance a future expansion – as well as to deal with personal circumstances, such as for parental leave, sick days or retirement. The intent of the new rules will be to target high-income individuals who can benefit under current rules from an unlimited, personal, tax-preferred savings account via their corporation, far beyond the pension, RRSP and TFSA limits available to other Canadians. This is inherently unfair, and the Government is committed to fixing it, while it reflects on the feedback received from Canadians during the consultation period.
In further developing these measures, the Government will ensure that:
All past investments and the income earned from those investments will be protected;
Businesses can continue to save for contingencies or future investments in growth;
A $50,000 threshold on passive income in a year (equivalent to $1 million in savings, based on a nominal 5-per-cent rate of return) – an amount that is exceeded by only about 3 per cent of corporations – is available to provide more flexibility for business owners to hold savings for multiple purposes, including savings that can later be used for personal benefits such as sick-leave, maternity or parental leave, or retirement; and
Incentives are in place so that Canada’s venture capital and angel investors can continue to invest in the next generation of Canadian innovation. “
The pertinent part of the third announcement on October 19, 2017 was reflected on the Department of Finance’s website as follows:
“Minister Morneau announced today that the Government will not be moving forward with measures relating to the conversion of income into capital gains. During the consultation period, the Government heard from business owners, including many farmers and fishers that the measures could result in several unintended consequences, such as in respect of taxation upon death and potential challenges with intergenerational transfers of businesses. The Government will work with family businesses, including farming and fishing businesses, to make it more efficient, or less difficult, to hand down their businesses to the next generation.
In the coming year, the Government will continue its outreach to farmers, fishers and other business owners to develop proposals to better accommodate intergenerational transfers of businesses while protecting the fairness of the tax system.”
In summary, it appears the government:
- will not be proceeding with proposed measures to limit access to the Lifetime Capital Gains exemption.
- intends to proceed with, but simplify, the proposal to limit the ability of owners of private corporations to split income with family members.
- will reduce the small business corporate tax rate to 10%, effective January 1, 2018.
- will reduce the small business corporate tax rate to 9%, effective January 1, 2019.
- will not be proceeding currently with proposed measures that convert capital gains to dividends on non-arm’s length transfers of property.
- Intends to proceed with passive income proposals with appropriate transitional rules to shelter income derived from pre-existing assets, as well as to provide a threshold of $50,000 of passive income above which these provisions may apply. Further information will be known when the provisions are drafted.
The July 18, 2017 tax proposals were poorly planned, communicated and executed. Although they purportedly targeted abuse by “the wealthy”, their impact was significantly broader. Given the level of controversy generated by the proposals, more definitive communications would have been desirable. The government’s response to the groundswell of objections to their proposals appears to be politically motivated, rather than a measured response to points raised in consultations.