Year-end tax planning is always important – perhaps never more than this year. The usual planning steps still need to be considered:
Selling assets with accrued losses to trigger the deduction in the current year. Note that for 2017, publicly traded securities must be sold before December 27th to be effective this year
Accelerating the recognition of deductible expenses
Postponing the receipt of taxable income
Note that if your tax rate will be higher next year, the usual acceleration of expenses and postponement of income might not be efficient – get professional advice
Make charitable donations before the end of the year to get the charitable tax credit in 2017
Not to minimize the importance of the items listed above, this year I want to focus on two things. After the uproar about the CRA going after employees who receive discounts or other benefits from their employers, a discussion about employee bonuses, gifts, etc. is timely.
And, after the summer and fall that we have had, a discussion about the new tax proposals for small business and what they mean for year end is particularly important.
Gifts to Employees – T’is the Season
As we approach the Christmas season, it is important to note the Canada Revenue Agency (CRA) administrative policy regarding non-cash gifts to employees. Years ago, the CRA policy was that one non-cash gift per year could be given to an employee on a non-taxable basis, as long as the gift had a value of less than $100.00 and the employer could not deduct the value of the gift. This changed effective 2001.
Employers can give their employees up to two non-cash gifts per year, on a tax-free basis, for special occasions such as Christmas, Hanukkah, birthdays, and marriages. As long as the total cost of the gifts to the employer, including taxes, is not be more than $500 per year, the employer can deduct the cost of the gifts, even though the employee is not taxable on the value of the gift.
This does not apply to cash or near-cash gifts and awards. The value of such gifts and awards will be considered a taxable employment benefit. Near-cash gifts and awards may include such things as gift certificates, gift cards, or any items that can easily be converted to cash.
Where the cost of the gift or gifts (maximum of two) exceeds $500, the total fair-market value of the gift(s) will be included in the employee's income. There is no exemption for the first $500. If the cost of the gift exceeds the $500 limit, the gifts are deemed to form part of the employee's remuneration package.
For employers who want to give employees gifts at this time of year, as opposed to cash bonuses, the benefit of being able to deduct the value of the gifts while allowing the employees to receive the gifts tax free can be significant.
Proposed Tax Changes for Small Business
Unless you have been stranded on a desert island, you know that Finance Minister Morneau has launched an all-out attack on small business corporations and their shareholders. In the largest overhaul of the tax system in 45 years, he has proposed dramatically increasing taxes on investment income earned in a private corporation (where it is already approximately double what a public company pays), and has proposed extending the Tax on Split Income (TOSI) rules to all non-active family shareholders. I have written extensively about the various proposals and changes to those proposals, and you can find my commentaries on my blog page.
On October 16th, the Finance Minister announced some changes and announced that he was backing off on a couple of the original proposals.
The two proposals that we are left with are the TOSI rules, which we have not yet seen but which will come into force on January 1st, 2018, and the investment income proposals which we will not see until Budget 2018, some time next March or April.
Based upon the proposals for the taxation of passive investment income and TOSI, it would appear that any accumulated capital in a private corporation will be taxed under the existing tax rules. However, capital gains realized in respect of that capital may not qualify for capital dividends. And, even for capital gains accrued before 2018, it may be that any dividend paid out of the capital dividend account after January 1st, 2018 will not qualify as a tax-free capital dividend in the hands of a “non active” shareholder. Accordingly, thought should be given to clearing out the capital dividend account prior to the end of the year.
It has always been my recommendation, in any event, to pay out any CDA balances on a regular basis, since any future capital losses would reduce the available CDA balances.
In addition, since any future dividends paid to non-active shareholders will likely be taxed at top personal rates, a dividend sufficient to clear out any RDTOH balance paid after December 31st, 2018 might involve a double taxation element, so this should also be considered prior to December 31st, 2017.
The Department of Finance has stated that they will not be proceeding with the implementation of Section 246.1. Accordingly, the payment of capital dividends, or the repayment of shareholder loans should not be impacted, subject to my comment above.
Because it is not clear if capital gains realized after 2017 will still allow for the payment of a capital dividend, some thought should be given to triggering capital gains before the end of the year in order to preserve the capital dividend amount. Since Morneau has stated that the passive investment income rules will not apply to capital accumulated as at December 31st, 2017, we can assume that the capital dividend account up to that time will be preserved – but only if you believe the Finance Minister.
Without exception I would recommend paying a capital dividend to clear out the entire balance of the CDA. This can be done by way of promissory note. Although there is a process to have the CRA confirm the CDA balance, this will take 6 months or more, so there is some exposure in proceeding, but it can’t be helped.
In the case of companies owned, in whole or in part, by non-active shareholders, or family trusts, there is merit in allocating the capital dividends to “non-active” shareholders. The payment of a capital dividend to a non-active shareholder by way of promissory note should (subject to the final rules) constitute a capital contribution under the TOSI rules for the purposes of future dividends.
Even when a capital dividend is paid to an active shareholder, in order to clear out the CDA balance, paying it back to the company, or paying it with a promissory note should still form part of a pool of pre-2018 capital which should continue to be taxed under the existing rules.
Assuming that we can take the Finance Minister at his word (a big and not guaranteed assumption), we can assume that the Refundable Dividend Tax (RDTOH) accounts in existence at the end of 2017 will not be affected, and that dividends paid to shareholders will still trigger dividend refunds. When a corporation pays tax on investment income, a portion of that tax is, currently, refundable when dividends are paid to the corporation’s shareholders. The passive investment income proposals could eliminate RDTOH in respect of any corporate taxes paid after 2017.
In any event, we must assume that dividends to non-active shareholders will, after December 31st, 2017, be taxed at top personal tax rates. On that basis, future dividends to non-active shareholders, out of taxes for years up to and including 2017, will continue to trigger dividend refunds in the company, but a dividend to a non-active shareholder might involve a double taxation element. Accordingly, in addition to possibly paying out capital dividends to non-active shareholders, you may wish to consider taxable dividends to family members, especially those with lower tax rates, in order to take advantage, one last time, of the dividend gross up and tax credit mechanism.
In 2017, for a taxpayer in Ontario with no other taxable income, the following sets out the tax cost of paying taxable dividends.
Again, paying the dividends by way of promissory note should contribute to the pool of pre-2018 capital, and should also form a “contribution” by way of capital for non-active shareholders that may support future dividend payments.
To reiterate, all of this is speculation – reasonably educated speculation, but speculation nonetheless. We won’t have definitive answers until we see legislation. As unfair and unreasonable as it is, we have to proceed without seeing the rules in order to conclude transactions before year end.
In his October 16th, 2017 announcement, Morneau said that Finance was not proceeding, at this time, with changes to the LCGE. That was a welcome relief.
However, the changes initially proposed brought to light the need to make sure that the shares of your Canadian Controlled Private Corporation (CCPC) always qualify for the LCGE.
This is particularly important because the TOSI rules will tax the non-exempt capital gain for a non-active shareholder as a dividend, taxable at top personal rates. So, if the shares of a CCPC do not qualify for the LCGE, a non-active shareholder, instead of being taxed on the basis of a capital gain (top rate in Ontario is 26.76%), he or she will be taxed on the basis of an ordinary dividend at top personal rates (45.30%), an increase of 18.54%.
Non-Exempt Capital Gains
Although standard planning dictates that gains be postponed and losses be accelerated, if a taxpayer owns shares that will not qualify for the LCGE, either because the company is offside, or because a shareholder has a CNIL account or has used up their LCGE, thought might be given to triggering non-exempt capital gains in respect of the shares of a CCPC before the new TOSI rules come into effect.
In a normal year, this would be my last newsletter of the year. But, this has been anything but a normal year. We still anticipate seeing the new TOSI rules before the end of the year and, if the rules are tabled before the end of the year, I will post another commentary on those new rules.
In case the Department of Finance is unable to finalize the new rules before the end of the year, I will wish you all a very Merry Christmas, Happy Hanukkah, Happy Kwanzaa and a happy and healthy New Year.