- Charles Rotenberg
Finance Minister Bill Morneau will present his second Budget on March 22nd, 2017. The last Budget contained tax hikes, changes to the system that are significantly adverse to middle income Canadians and especially to small and medium business owners.
Given that Prime Minister Trudeau has been spending money internationally with the wisdom of a drunken sailor, we can expect the bad news to continue.
I note that I wrote my pre-Budget thoughts exactly one year ago today, also in preparation for a Budget to be presented on March 22nd.
There are two scenarios that I want to raise. The first, is exactly the same as I raised last year.
Small Business Deduction and Family Dividend Income Splitting
We already saw tax increases that affect professional corporations and small businesses, through the limiting of the small business tax rate available to corporations in respect of their first $500,000 of net business income. Although there were, undoubtedly, abuses in the manner in which corporations were structured to get the benefit of multiple small business rates, the changes introduced last year will raise taxes by about 10% for small businesses doing any business with companies owned by family members, even if they are dealing on an arm’s length commercial basis.
There was speculation last year that Finance Minister Bill Morneau might take a page from the Quebec playbook and limit the eligibility of corporations for the low rate of corporate tax. Quebec changed its rules to allow the lower rate of corporate tax only to corporations with more than 3 employees.
More concerning is the thought that income splitting with family members through the payment of dividends may be targeted, perhaps by implementing a tax similar to the "kiddie tax" introduced by the Liberals in Paul Martin’s 1999 Budget. The kiddie tax results in minors paying the same rate of tax as a top rate taxpayer on certain sources of income, including dividends from family companies, eliminating the tax benefit of certain forms of income splitting. In the last Budget the Government implemented the rules previously introduced by the Conservatives that dramatically increase the tax and horrendously increase the complexity for corporations to pay dividends to other related corporations. These provisions are bad for business generally, but, unfortunately for my clients, they are good for my business.
There are a few possibilities in respect of these potential proposals:
The government may take no steps in these areas.
They may raise the trial balloon and indicate that they will have consultations post-Budget (this is probably the most likely scenario).
They may bring in the changes with a future date, for example, for dividends paid after December 31st, 2017. When kiddie tax was introduced, the Budget was February 16, 1999 and the tax came into effect January 1st, 2000.
They may bring in the changes either effective midnight March 21st, before the Budget or effective January 1st, 2017.
The chances are that no action needs to be taken before the Budget. In only one of the four scenarios above is there a problem with splitting income through the payment of dividends if it is done after Monday, March 21st.
However, for those who tend to be more cautious there is something you might consider. If you are planning to pay dividends to family members in 2017, including to minors who will turn 18 in calendar 2017 (since kiddie tax stops in the calendar year in which the child turns 18, not after their 18th birthday), you might consider declaring those dividends on or before March 21st. If the company does not have the cash to pay the dividends, a promissory note should be executed by the company.
If you would not normally consider paying such dividends, then you probably shouldn’t consider doing it "just in case". But if you would be paying those dividends in 2017 in any event, there is nothing to lose and everything to gain by declaring the dividends before Budget Day.
Remember that under current rules, a taxpayer in Ontario with no other income can earn approximately $30,000 of dividends with no tax, and more if the taxpayer has tax credits such as tuition and education credits.
Capital Gains and Losses
There was speculation leading up to last year’s Budget that the Government was going to increase the capital gains inclusion rate. That speculation is back, louder than ever.
As you know, only one-half of a capital gain is taxable and only one-half of a capital loss is deductible. There is speculation that the "inclusion rate" could increase to two-thirds or three-quarters.
For most of the years since capital gains were first taxed in 1972, the inclusion rate has been one-half. The rates have been as follows:
Capital gains inclusion rates:
1972 to 1987: 1/2
1988 and 1989: 2/3
1990 to February 27, 2000: 3/4
After February 27, 2000: 2/3
After October 17, 2000: 1/2
If the inclusion rate were to increase, it is unlikely that there would be any advance warning, to prevent manipulation of the markets.
Although there are different ways in which such a change could be implemented, it is likely that, if introduced, gains realized before March 22nd would be subject to the one-half inclusion rate, and those realized after March 21st would be taxed at the higher rate. It is likely that there would be some grandfathering for a transaction subject to a written agreement prior to the Budget.
If you are sitting on assets with accrued gains that you are considering selling, selling before Budget day would be the prudent thing to do. I would never suggest selling assets just because of the possible tax increase, if those assets should, for sound business and investment reasons, not be sold.
However, there are ways to structure transactions to trigger a sale between, for example, an individual and a corporation, or between two corporations, that could allow you to "keep" the asset and still avoid the possible tax increase.
If assets have accrued losses, it would make sense to wait until after the Budget to sell, in order to take advantage of any increase in the amount that would be deductible.
There are opportunities to transfer assets with accrued losses to shift those losses to a related, higher income taxpayer, using the "superficial loss" rules. The losses would be disallowed to the current owner, and the higher income taxpayer could claim the losses when, and if, the inclusion rate is increased.
I would be pleased to discuss any of these situations with you prior to the Budget.
I will, for the 41st consecutive year, review and write about the Budget on Budget Day.