Measures Impacting Corporations
Passive Investment Income Measures
Business Limit Reduction
In a consultation paper released in July 2017, and in subsequent announcements in October 2017, the Government proposed tax changes intended to discourage the accumulation of passive investments inside a private corporation. The initial proposals focused on the taxation of investment income and had the potential to be very complex. Budget 2018 takes a simpler approach by proposing to limit access to the small business deduction when passive income earned in a fiscal year by a Canadian Controlled Private Corporation (“CCPC”) exceeds $50,000.
The small business deduction provides a preferential rate of tax on active business income earned up to a $500,000 annual limit that is shared amongst associated corporations. Budget 2018 proposes to add a business limit reduction measure when income from passive investments exceeds $50,000. The $50,000 applies to the corporation and all associated corporations. For every $1 of investment income earned in excess of $50,000, the small business deduction limit will be reduced by $5, resulting in no small business deduction limit once investment income exceeds $150,000. The small business deduction limit reduction affects the next taxation year. As such, if investment income exceeds $150,000 in fiscal 2020, the small business deduction will not be available for fiscal 2021.
Adjusted Aggregate Investment Income
For the purposes of determining the reduction of the small business deduction limit, passive investment income will be determined by making adjustments to the current “aggregate investment income” concept. The adjustments include:
- Exclusion of taxable capital gains (and losses) when they arise from:
- A property that is used principally in an active business carried on in Canada by the CCPC or by a related CCPC; or
- A share of another CCPC that is connected with the CCPC, where all or substantially all of the fair market value of the assets of the other CCPC is attributable to assets that are used principally in an active business carried on primarily in Canada, and other certain conditions are met;
- Exclusion of net capital losses carried over from other taxation years;
- Inclusion of dividends from non-connected corporations (i.e. portfolio dividends); and
- Inclusion of income from savings in a non-exempt life insurance policy, to the extent it was not otherwise included in aggregate investment income.
The new reduction will apply alongside the existing rules that reduce the small business deduction when taxable capital employed in Canada of an associated corporate group exceeds $10 million, until it is eliminated when total taxable capital reaches $15 million, with only the greater of the two small business limit reductions applying.
ABC Ltd. is a CCPC with a December 31st fiscal year end whose taxable capital never exceeds $10 million, and it is not associated with any other corporation.
During the fiscal year ending in 2019, ABC Ltd. earned $100,000 of portfolio dividends in addition to its active business income. During fiscal 2020, ABC Ltd. earned $300,000 of active business income. As a result of the new measures, ABC Ltd. will have its small business deduction limit reduced to $250,000 for fiscal 2020. As such, $50,000 of the $300,000 of active business income earned by ABC Ltd. in fiscal 2020 will be taxed at the general corporate rate. Assuming that also during fiscal 2020, ABC Ltd. earned only $40,000 of adjusted aggregate investment income, there will be no grind to its small business deduction limit for fiscal 2021.
The measure to limit the small business deduction will apply to taxation years that begin after 2018. Despite Finance indicating otherwise in October, there appears to be no grandfathering exclusions related to these measures. Additionally, there are a few anti-avoidance provisions, one being two related corporations will be deemed to be associated if one company lends or transfers property to the other in an effort to reduce the grind to the small business deduction limit.
Limiting Access to Refundable Taxes
The Budget proposes to change how corporations can access their refundable taxes when paying dividends.
Under the current system, a private corporation’s investment income is taxed at a higher rate than its active business income, but a portion of the tax on investment income is refundable when taxable dividends are paid to a shareholder. This refund can occur no matter the source of the dividend payment. This allows a corporation to receive a refund of its refundable taxes on higher taxed investment income when the dividend is paid out of lower taxed active income.
The Budget proposes to prevent a private corporation from receiving a refund from its refundable dividend tax on hand (“RDTOH”) account when it pays eligible dividends out of active income taxed at the general rate. It does so by introducing a new RDTOH account, referred to as the eligible RDTOH account which is designed to track the refundable portion of Part IV tax that a corporation has paid on eligible portfolio dividends. The corporation’s existing RDTOH account, which will be renamed the non-eligible RDTOH account, is designed to track refundable taxes paid under Part I of the Income Tax Act and the Part IV tax paid on non-eligible portfolio dividends.
A non-eligible dividend will allow the corporation to claim a refund first from its non-eligible RDTOH account. Once the non-eligible RDTOH account is reduced to nil, a payment of non-eligible dividends can generate a refund from the corporation’s eligible RDTOH account. An eligible dividend will only trigger a refund from the eligible RDTOH account. To the extent the eligible RDTOH account is reduced to nil, eligible dividends can still be paid but they will not generate a refund from the corporation’s non-eligible RDTOH account.
This proposed measure will apply to taxation years that begin after 2018. As a transitional rule, a CCPC’s opening eligible RDTOH account will be calculated as the lesser of their existing RDTOH account and 38.33% of the CCPC’s General Rate Income Pool balance, with any remaining balance allocated to the corporation’s non-eligible RDTOH account. For all other corporations, the corporation’s existing RDTOH balance will be allocated entirely to its eligible RDTOH account.
Previously announced measures
The Budget confirms the Government’s intention to proceed with the corporate tax rate reductions previously announced in October 2017. The federal small business rate was reduced to 10% effective January 1, 2018, and will be further reduced to 9% effective January 1, 2019. In conjunction with these rate reductions, the gross-up amount and dividend tax credit for individual recipients are also adjusted.
The federal general corporate tax rate remains at 15%.
Budget 2018 also confirms the Government’s intention to proceed with the income tax measures released on December 13, 2017 to address income sprinkling with persons age 18 and older.
Measures Impacting Individuals
Employment Insurance Changes
Budget 2018 proposes a new Employment Insurance (EI) Parental Sharing Benefit. The Benefit will be available to eligible two-parent families and will provide additional weeks of EI parental benefits when both parents agree to share parental leave. The Benefit will increase the duration of EI parental leave by up to five weeks in cases where the second parent agrees to take a minimum of five weeks of the maximum combined 40 weeks available using the standard parental option of 55% of earnings for 12 months. Alternatively, where families have opted for extended parental leave at 33% of earnings for 18 months, the second parent will be able to take up to eight weeks of additional parental leave. In cases where the second parent opts not to take the additional weeks of benefits, standard leave durations of 35 weeks and 61 weeks will apply. This incentive is expected to be available starting June 2019.
Registered Disability Savings Plans (RDSPs)
When an RDSP is established for an adult beneficiary who lacks capacity, someone “legally authorized” to act for the beneficiary must be the holder of the RDSP and make financial decisions with respect to the account. If the beneficiary lacks capacity but doesn’t have someone legally authorized to act for him or her, or only appears to lack legal capacity, then establishing the account is generally stalled. The government introduced a temporary measure in 2012 that would allow the spouse, common-law partner, or parent of an adult beneficiary to be the RDSP holder, if the RDSP issuer believes the beneficiary’s capacity is “in doubt” but there is no formal order of financial guardianship in place. This measure was set to expire at the end of 2018. The Budget proposes to extend this measure to the end of 2023.
Canada Workers Benefit
The Working Income Tax Benefit is an existing refundable tax credit for low-income working Canadians. Budget 2018 proposes an enhanced and renamed “Canada Workers Benefit” effective for the 2019 taxation year. The maximum benefit will be increased in 2019 to $1,355 for individuals and $2,335 for families. The income level for which the benefit begins to be phased out will increase for individuals and families with income in excess of $12,820 and $17,025 respectively, with benefits fully eliminated for individuals and families with income in excess of $24,111 and $36,483 respectively. Individuals who are also eligible for the Disability Tax Credit may receive a Canada Workers Benefit disability supplement. The disability supplement will be increased to $700 for 2019.
Medical Expense Tax Credit
Budget 2018 proposes to expand the medical expense tax credit to include eligible expenses incurred after 2017 related to specially trained service animals who perform tasks for individuals with severe mental impairments.
Deductibility of Employee Contributions to QPP
The Government of Quebec announced in 2017 that the Quebec Pension Plan (QPP) would be enhanced in a manner similar to the Canada Pension Plan (CPP) enhancements announced in 2016. The budget proposes to provide a deduction for employee contributions (as well as the “employee” share of contributions made by self-employed individuals) to the enhanced portion of QPP in order to provide consistent tax treatment of CPP and QPP contributions. This measure will apply to 2019 and subsequent taxation years to coincide with the introduction of contributions for the enhanced portion of QPP.
Measures Impacting Trusts
Health and Welfare Trusts
Health and Welfare Trusts (HWT) have been established by some employers in to provide benefits to all or a class of employees in the event of disability, critical illness, death and especially to self-insure a medical and dental expense reimbursement plan. These HWTs are governed only by CRA administrative policy.
New HWTs can no longer be created effective Feb 27, 2018. Existing HWTs must wind-up or convert to an Employee Life and Health Trust (ELHT) by December 31, 2020. Any HWT that still exists on January 1, 2021 will be taxed in the same manner as an inter-vivos trust. The HWT and the ELHT have the potential to provide similar benefits however existing legislation establishes conditions that must be met for the ELHT to apply such as the number of insured key-employees not being greater than 25% of the members of the class. Some existing HWTs may not qualify for conversion to an ELHT. Draft legislation will follow from the Finance Department after the closure of a comment period on June 29, 2018.
We believe that insured plans under a contract between an employer and a life insurance company which is not governed by a HWT will not be affected.
Reporting Requirements for Trusts
At present, trusts are not required to report the identity of all of the beneficiaries and generally are not required to file an annual T3 trust income tax return when the trust does not earn income or make distributions in a given year. Budget 2018 proposes that for 2021 and subsequent taxation years, certain trusts must disclose the identities of all trustees, beneficiaries, settlors and all persons who can exercise control over the trust. As a result of this disclosure requirement, a T3 trust return may be required to be filed by trusts that did not previously have to file. There will be exemptions for this expanded reporting for graduated rate estates and qualified disability trusts, among others.
This report specifically written and published by Investors Group is presented as a general source of information only, and is not intended as a solicitation to buy or sell specific investments, nor is it intended to provide legal or tax advice. Clients should discuss their situation with their Consultant for advice based on their specific circumstances.