Proposed New Income Sprinkling Rules Go Too Far
Heads up people, the federal government has proposed some chilling private corporation tax changes that will have a profoundly negative impact if they should pass. They are looking to change some common tax planning practices used by private corporations. Many of these changes have raised the alarm because they are not good news for Canadian entrepreneurs!
How New Rules Impact Canada’s Entrepreneurs?
The government is looking to change the rules for income sprinkling. The practice of income sprinkling typically involves issuing shares and paying dividends to family members with lower or no income to reduce the family’s overall tax burden. Tax on split income currently applies, also known as “kiddie tax”. If an individual under the age of 18 receives a dividend or other specific income, it’s automatically subject to top marginal tax rates.
The proposed changes mean that the Kiddie Rule could now apply to everyone who receives split income from a family business, aside from employment income.
This new scope will apply to adults who receive split income deemed “unreasonable.” A reasonableness test will apply, based on contributions of labour and capital, and on previous returns and remuneration. As a rule of thumb, it is judged that an amount is “unreasonable” if it exceeds what an arm’s-length party would agree to pay to a person for the contribution. In order to be deemed legitimate labour contributions, those aged 18 to 24 must be “actively engaged on a regular, continuous and substantial basis in the activities of the business”. This is an even more rigid test than for those who are older.
And if this wasn’t enough to shock you, the government is also proposing if business owners earn income through their corporation on which they pay tax at the corporate rate, the additional capital they have left to invest, if it’s not invested back into the business or paid out to them personally, would be viewed as them investing for their own benefit and not that of their corporation. So people that means that the present refundable tax system, in respect to those invested retained earnings, would no longer exist as an option.
Under the current refundable tax system, the option exists to pay a lesser corporate tax rate and have more to invest in the business or capital purchases such as a commercial property. This practice has allowed business owners to use passive corporate investment portfolios as a very-much-needed nest egg that can act as the entrepreneurial benefits and pension fund. As business owners are not guaranteed income, and often forego salaries during lean times, this practice can provide a critical financial reserve for business owners to keep operations going during lean times.
The absurd hypocrisy of these proposed changes is staggering. The government is forever touting that Canada is the land where entrepreneurs are encouraged and celebrated. They applaud the moxie of our entrepreneurs because they are courageous enough to strike out on their own and take on the risks of launching and growing a business, without the usual safety nets that come with most regular employment – health benefits, paid vacations, training, pensions… the list goes on! And in their bravery, these entrepreneurs drive the economy by creating jobs, purchasing services and supplies from other businesses and paying their taxes to support the social and economic infrastructure of our country. And yet the government, in a move one can only describe as draconian, creates these misguided changes which completely undermine Canada’s small business community by exponentially increasing their financial vulnerability and threatening their future! And it is highly doubtful that there will be a line up of eager wannabe entrepreneurs willing to take the place of those businesses that don’t make it in this harsh new reality if this proposal is adopted.
What Proposed ‘Income Sprinkling’ Rules Could Mean to You
The changes contained in the government’s proposal will effectively handcuff entrepreneurs and make it incredibly difficult for many of them to keep their businesses viable. If the government implements these ruthless measures they should do only do so once they have publicly acknowledged that this proposal has the power kill off a good portion of our economy as businesses across this country are forced to lay off their employees and ultimately close their doors forever.
If you would like to share your input on this topic, I urge you to make your voice heard by using the email feedback channel provided by the government. They will be accepting comments until October 2, 2017, at email@example.com.
It also might be an idea to give your Member of Parliament and Member of Provincial Parliament a call to share your concerns as a business owner.
I will be keeping close tabs on this proposal and consultation process so that I can share updates with you. If you’d like to read the proposal, you can view it online at http://www.fin.gc.ca/activty/consult/tppc-pfsp-eng.pdf. In the interim, if you have any questions or concerns please contact our office.
Kelly Melanson Professional Corporation – Chartered Professional Accountant, CPA