2018 Federal Budget: What Private Companies Need to Know
On February 27, 2018 the Department of Finance (“Finance”) released its 2018 federal budget (the “Budget”). Given the climate surrounding private companies, this Budget in particular was eagerly awaited by owner managers and tax advisors. While the Budget contains many items of interest for large private companies and high net-worth individuals with corporate-held investments, it is not as punitive as some have feared.
Specifically, Finance proposed rules affecting private corporations that hold investments generating passive income. These rules appear to be less harmful and are narrower than the approaches that were outlined in Finance’s controversial July 18, 2017 proposals relating to Tax Planning Using Private Corporations (the “July Proposals”). In particular, the punitive and draconian 73% tax rate has been taken off the table.
Passive Income for Private Corporations
We have extensively written about the July Proposals and subsequent fallout. Since then, Finance had backed off its initial proposals relating to the multiplication of the lifetime capital gains exemption and the conversation of dividends into capital gains, and has released revised legislation for income splitting.
Absent from the July Proposals, however, was legislation relating to the taxation of passive income for a private corporation. As discussed below, the Budget provides some certainty in regards to Finance’s policy on passive income.
Small Business Limit Reduction
Generally, a Canadian Controlled Private Corporation (“CCPC”) is entitled to a favourable tax rate (discussed below) on its first $500,000 of active business income. Budget 2018 proposes to reduce the small business limit for a CCPCs where such corporation earns investment income exceeding $50,000. Assuming a 5% return on such investments, the $500,000 small business limit would be reduced on a straight-line basis for CCPCs having between $1 million and $3 million of passive assets.
The business limit reduction under this measure will operate in conjunction with the current business limit reduction (i.e., taxable capital in excess of $10 million). The reduction in a CCPCs business limit will be the greater of the two.
Interestingly, in the fall Finance stated their intention to protect all past investments and the income earned from those investments. Budget, however, contains no grandfathering provision. Given than the approach to passive income for private corporations in the Budget is more simplistic than the previously proposed regime, perhaps Finance did not consider it necessary to grandfather pre-existing investments.
Limitations on Refundable Tax
Under existing tax rules, refundable dividend tax on hand (“RDTOH”) can be recovered by a CCPC on the payment of any type of dividend. Beginning in 2019, private companies will have to keep track of two RDTOH accounts:
- Eligible RDTOH; and
- Non-eligible RDTOH.
This proposal is intended to ensure that RDTOH can only be recovered when non-eligible dividends are paid to shareholders.
Income Sprinkling Legislation
On December 13, 2017, Finance released revised draft legislation in respect of the income-sprinkling measures in the July Proposals (the “Revised Income Sprinkling Legislation”). The Revised Income Sprinkling Legislation was welcome in that it somewhat simplified the July Proposals, reducing the feared compliance burden on private companies. However, there is some complexity that remains and we believe that uncertainty in respect of some of the bright-line tests will result in increased tax disputes for those who do not fit within the proposed “safe harbour” exceptions.
Leading to the Budget, there was some discussion that Finance may elect to expand the Revised Income Sprinkling Legislation. Fortunately, this was not the case. The Revised Income Sprinkling Legislation took effect as of January 1, 2018 and we do not expect any change from the December 13, 2017 draft legislation.
Small Business Tax Rate Reduced
Finance announced in December that the small business rate would be reduced over the next two years from 11% to 9%.
Increased Reporting by Trusts
Budget proposes enhanced annual reporting requirements on certain types of trusts. These enhanced transparency measures could lead to more disputes over provincial trust residency (see, for example, “Trust Residence Post-Fundy”. Canadian Tax Highlights, vol. 26 no. 2 (Canadian Tax Foundation), February 2018 - subscription required).
Where applicable, the trust will be required to disclose the names of all trustees and beneficiaries of the trust and settlors of the trust, as well as the identity of each person who has the ability to exert control over trustee decisions regarding the appointment of income or capital of the trust (e.g., a protector).
It is important to note that these are only reporting requirements, and do not result in any additional tax liability to trusts.
Tax Dispute Measures
Finance introduced various measures in relation to audits, enforcement, and reassessments. Specifically, a “stop the clock” rule is proposed which will extend the normal reassessment period in situations where a requirement or compliance order is contested. This proposal is similar to the existing rule that applies for purposes of requirements for foreign-based information in subsection 231.6(7) of the Income Tax Act.
Budget does not contain any response to recent U.S. federal tax reform. The top marginal tax rate in some provinces in excess of 50%. Leaving personal tax rates stagnant will put Canada at a distinct disadvantage. Over the coming months, it will be interesting to see how Finance responds. If you have any questions regarding recent U.S. tax reform, please contact one of Shea Nerland’s US tax advisors.
Budget did not propose any changes to the capital gains inclusion rate.
Finally, Finance’s commitment to propose incentives so that venture capital and angel investors can continue to invest in Canadian innovation appear to be absent.
As we continue to dissect the Budget our Tax & Estate Planning group will continue to release insightful material related to the Budget.
Invitation for Discussion:
If you would like to discuss this article in greater detail, or any other aspect of the 2018 Federal Budget, please do not hesitate to contact one of the lawyers in the Tax & Estate Planning group at Shea Nerland LLP.
Note that the foregoing is for general discussion purposes only and should not be construed as legal advice to any one person or company. If the issues discussed herein affect you or your company, you are encouraged to seek proper legal advice.