Exactly one year ago today, the Trudeau Government launched its attack on small business, all while claiming to be acting to support the middle class.
In the middle of the summer, when Parliament was not sitting and everyone was in vacation mode, they introduced the most massive tax changes to our system of corporate taxation in 45 years. They allowed only 75 days for “consultation”. The result was unprecedented opposition by small business, professionals and, virtually, every tax professional across the country. The provisions were ill-conceived, badly drafted and would add untold complexity to an already overly-complex tax system. I wrote extensively about these proposals and the postings can be found at this link.
The Standing Senate Committee on National Finance reviewed the proposals and made three key recommendations, as I outlined in my newsletter of July 13th, 2018. In that newsletter I discussed the current version of the Tax on Split Income (TOSI), which will make it much more expensive for small business and professionals.
Probably the most controversial, and onerous, provisions introduced were the provisions dealing with the taxation of passive investment income in a Canadian-controlled private corporation (CCPC). Aside from the cost to taxpayers, one experienced tax professional estimated that these rules would require at least 100 pages of legislation.
As many professionals pointed out, the rules as introduced could have resulted in taxes of up to 73% in respect of investment income earned in a CCPC. I have discussed these rules numerous time, including my posting of November 3rd, 2017.
The Minister of Finance introduced a threshold of $50,000 of investment income that would continue to be taxed under the existing rules.
In addition, he promised to “grandfather” all capital existing as at December 31st, 2017, and to only apply the new rules in respect of investment income on “new” capital.
The current version of the passive investment income rules were introduced in the 2018 Federal Budget and will take effect as of January 1st, 2019. The rules included in the Budget are a huge departure from the rules originally proposed and are certainly better for taxpayers. As Dan Kelly, President of the Canadian Federation of Independent Business, has said, the new rules included in the Budget are “less bad” for small business than the previous proposals. The new provisions included no grandfathering.
Liberal Members of Parliament, in their canned, scripted, responses to concerns expressed to them, argued that they honoured their promise to grandfather pre-2018 capital because the income generated was not being taxed at a higher rate than before. This is, at best, disingenuous, and at worst, an outright lie.
As a matter of fact, with the exception of changing the way that refundable taxes will be applied, the actual tax on investment income is not being increased, whether from pre-2018 capital or post-2017 capital.
For those CCPC’s that only have investment income, this is good news.
However, for CCPC’s that have both investment income and business income, whether in one company or in associated companies, the tax on their active business income could increase by up to $65,000 annually.
Under the rules introduced in the Budget, if a CCPC and its associated corporations earn more than $50,000 of passive investment income in a given year, the amount of income eligible for the small business deduction would be gradually reduced.
The Small Business Deduction (SBD) is really a tax credit, rather than a deduction. It reduces the corporate income tax rate applying to the first $500,000 per year of qualifying active business income of a CCPC. A group of associated corporations must share the Small Business Limit (SBL) of $500,000. The difference in the tax rate is approximately 13.5%. In Ontario, paying the low rate of tax rather than the full rate on $500,000 of net income represents a tax saving of approximately $65,000.
The SBL will be reduced by $5 for every $1 of investment income above the $50,000 threshold (equivalent to $1 million in passive investment assets at a 5% return), such that the business limit will be reduced to zero at $150,000 of investment income (equivalent to $3 million in passive investment assets at 5%).
The Minister used the example of a CCPC generating a 5% return on its investment assets. Using that example, a CCPC with passive investment assets of less than $1 million will continue earn up to $500,000 in active business income and be taxed at the small business tax rate.
A CCPC with passive investment assets of $1.4 million at the same rate of return can earn up to $400,000 in business income per year and be taxed at the small business rate. This represents a tax increase of $13,500 in respect of the $100,000 that is now taxed at the higher rate.
A CCPC with passive investment assets of $3 million or more pays the higher corporate tax rate on all its business income.
The tax paid by a CCPC on its investment income, in Ontario, is 50.2%.
As I stated above, if a CCPC earns $50,000 of investment income, there is no change to the tax paid on the active business income.
However, if the CCPC earns $150,000 of investment income, assuming a full $500,000 of active business income, the tax cost in respect of the additional $100,000 is $115,200. This is the actual investment income tax of $50,200 PLUS the $65,000 of additional tax on its active business income.
This is the government that continually claims that they are trying to benefit the middle class.
Is it any wonder that capital is fleeing?
A portion of the tax paid by a CCPC in respect of investment income is refundable when dividends are paid to the company’s shareholders. There are additional, more technical, provisions in the passive investment income rules that will govern how these refunds will be determined and paid, but they are for a separate newsletter.
The takeaway from my comments today is that steps need to be taken before the end of 2018 to shelter, as much as possible, the investment income earned in a CCPC that also carries on an active business.
When I studied tax in law school in 1975, my teacher, and later partner, Arthur Drache, told us that tax is like a chess game – every year the government changes the rules and then the game starts again. He also told us that the tax community can react much faster than the government. The game is on!
Already tax professionals are devising planning ideas to minimize the impact of the passive investment income rules and the Tax on Split Income (TOSI) rules, of which I wrote last week.
There are a number of things that can be done with respect to both of these new sets of rules and I would be happy to discuss them with you at your convenience.