News Alert: Oct 18 and 19 updates on the taxation of owner-managed businesses

On October 3rd, 2017, we reported on Part 4: The Conversion of Income into Capital Gains, providing two examples of how double taxation could arise, should this proposed legislation be passed into law.  On October 19th, Finance Minister Bill Morneau announced that the Department of Finance will not be moving forward with the foregoing legislation.  The reason cited for the abandonment of these proposals was that during the consultation period, the government heard from business owners, including many farmers and fishers, that the measures could result in several unintended consequences, such as in respect of taxation upon death and potential challenges with inter-generational transfers of businesses.

On October 18th, more announcements were made by Finance Minister Bill Morneau in regards to Part 1: Passive Investment. They were:

  1. All past investments and the income earned from those investments will not be subject to the new taxation regime, and
  2. a $50,000 per annum threshold on passive income earned by a CCPC (“Canadian Controlled Private Corporation”) in a year will not be subject to the new taxation regime.

There has still been no clarity given by the Department of Finance as yet, as to how the new taxation regime applicable to the taxation of passive investment income will apply.

You may be wondering how the government determined that the threshold amount should be $50,000.  The Department of Finance news release indicates that it is equivalent to $1 million in savings, based on a nominal 5% rate of return.  The news release indicates that based on the government’s statistics, roughly only 3% of corporations exceed that level of annual investment income. In effect, the government has admitted to Canadians:

  1. If you are fortunate enough to own a corporation that will accumulate $1 million or more of future passive investments, then you are part of the top 3% of Canadians who deserves to be penalized for your success, and
  2. even if your corporation hasn’t accumulated $1 million of future savings, but your corporation’s investments yield a greater than 5% rate of return giving rise to more than $50,000 of annual investment income in a year – then guess what – once again, you should be penalized for your investing success.

At any rate, one thing that the announcements from Finance Minister Bill Morneau demonstrates, is the power Canadian citizens can exercise when they voice their opinion to Ottawa.  But for that, it is doubtful that the government would have back peddled so drastically from their original positions announced on July 18th, 2017.  So, kudos to all of you who contacted your MPs, made submissions to Ottawa, and otherwise made your voice heard.  You should give yourself and your colleagues a big pat on the back.

That said, the October 18th announcement isn’t completely a good news story.  In Part 1: Passive Investment, we had predicted that if the proposed new taxation regime comes into existence, as originally announced on July 18th, it will lead to more professional costs and more disputes with the Canada Revenue Agency (“CRA”).  One can observe from this latest announcement how these situations will arise.  For example:

  • Assume the income from the new investments is comingled with the income from the old investments in a single bank account. When the future expenses of the corporation are paid, how does one allocate the non-specific expenses between the income from the old investments and the income from the new investments?
  • Assume the corporation makes the same investment (for example, units of the same mutual fund class) held with a particular broker, both before and after the new taxation regime comes into existence. The corporation then partially sells some of that investment, in order to make a different investment.  In that event, how is the future income from the particular investment supposed to be segregated, in order to determine if it is subject to the existing taxation regime versus the new taxation regime?
  • If a past investment is sold when the new taxation regime is in effect, and the proceeds of sale are used to make a new investment, will the income from that new investment still be subject to the old taxation regime? Assuming it qualifies under the old taxation regime, which logically it should, it will be necessary to maintain clear evidence of the foregoing, in the case of a future CRA audit.  This may be easier said than done.

In light of the October 18th announcement, once the new taxation regime does eventually come into effect, it may be prudent at that time to open up new investment accounts and bank accounts for investment holding companies to hold their new investments and future investment income – in order to minimize the potential disputes which could arise from a future CRA audit.

We sincerely hope that whatever the government ultimately decides to do in this taxation area, after having considered the submissions it has received, that it provides clear and unambiguous rules for business owners and their professional advisors to deal with.  In the absence of doing so, we foresee many years of acrimony ahead between owners of CCPCs and the CRA.

 

For more information or to discuss your current tax situation, contact your Zeifmans advisor today, or reach out to us at 416.256.4000 or info@zeifmans.ca.

 

Related news:

Part 1: Passive Investments
Part 2: Income splitting
Part 3: The enhanced capital gains deduction (“ECGD”)
Part 4: The conversion of income into capital gains
Federal Government tax changes announced Oct 16

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