Effective 2018, the Canada Revenue Agency is implementing new rules in three key areas that affect corporations. If you work for or handle the accounting of a private corporation, it’s important to understand and prepare for these changes.
Income sprinkling is when a corporation issues paycheques to the owner’s spouse or children, even if they don’t work for the company. This lowers the tax liability for the corporation, and for most families, it’s more advantageous than a single family member claiming all that income.
As of 2017, analysts estimate that about 50,000 Canadian-controlled private corporations use this practice, and although that number may sound high, it only represents 3 percent of the country’s CCPCs. For tax year 2018, the government plans to change the rules on income sprinkling and apply the Tax On Split Income rules (TOSI) to sprinkled income.
Usually, tax on split income applies in cases where a business owner shifts some of the income to other family members such as a spouse or a child. Theoretically, this saves money because the family members are in a lower income bracket. The split income rules eliminate the savings, and they apply the top marginal tax rate to that income. Under the new income sprinkling rules, private corporations can only issue payments to people who really work for the company. In cases where it appears that a family member is just getting a cheque to lower the business’ or family’s tax liability, the split income tax may apply.
New Thresholds for Passive Income
The government is also considering imposing new thresholds for passive income for CCPCs in tax year 2018. Under the proposed rules, CCPCs can have up to $50,000 in passive income per year with limited tax consequences. Assuming a 5 percent rate of return, this means that a business can have $1 million in savings and still not be subject to the new tax. Businesses with passive income over that threshold would face additional taxes on any excess amounts.
Luckily, most corporations don’t have to worry about this additional tax. Only 3 percent of CCPCs had more than $50,000 in passive income in 2015. In fact, 80 percent of passive income is earned by just 2 percent of CCPCs. As a result, most businesses should not be affected by the new rules, especially considering that existing passive investments will be exempt from the new threshold. But if your corporation is affected, you may face tax of up to 73 percent on those amounts. That is a combination of the corporate tax rate and the top marginal personal tax rate.
Reduction to the Federal Small Business Tax Rate
The government also plans to lower the federal small business tax rate to 10 percent in 2018 and 9 percent in 2019. If that change goes through, the average combined provincial and federal income tax rate for small corporations is going to be between 12.9 and 14.4 percent. That’s the lowest of all the G7 countries.
The government debated a lot of different changes for tax year 2018 and beyond. Some of the proposed changes such as measures related to the conversion of income to capital gains did not go through, and even the thresholds for passive income and rules on income sprinkling aren’t expected to be finalized until the spring of 2018. As an accountant, it’s critical to stay on top of proposed changes and monitor which changes take effect. The more you know about updates to tax laws, the easier it becomes for you to help and advise your clients.