What Canada’s new tax-planning proposals mean for private Companies

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Do you have a small, medium or large private company in Canada? New tax-planning proposals will impact your passive investments.

On July 18, federal Finance Minister Bill Morneau introduced draft legislation, explanatory notes and a consultation paper proposing to overhaul the system of taxation for private companies, their shareholders and relatives. These suggestions are broad-based and mostly target Canadian-controlled private corporations (CCPC), no matter business, industry or economic group. The proposals are far reaching and will undoubtedly affect all Canadian private companies — not only incorporated professionals.

The launch of this proposal documents follow statements made from the Liberal Party election platform and the Trudeau government’s 2017 federal funding that it needs to make sure that CCPC status isn’t utilised to reduce private income-tax duties for high-income earners, instead of supporting small businesses. The draft laws identified the reinvestment of aftertax company earnings from passive investments as a priority tax-planning measure requiring substantial change.

The recently proposed tax-planning steps will fundamentally change how corporate aftertax income reinvested in passive investments will be handled. Here’s an overview of the suggested changes:

Review of passive income in corporations

Presently, corporate business income is taxed at a lower rate than personal income, which leaves businesses more cash to invest in their company. If a private corporation does not need to reinvest all its earnings to expand the company and isn’t prepared to reinvest — maybe waiting for new machines to come out or waiting for a new chance to purchase a building — they may invest those earnings from passive investments. These could consist of numerous distinct choices, such as savings accounts, GICs and stock portfolios held inside the corporation or a related company. These investments allow small companies to make a return on their investment when holding the capital for future business requirements.

What is the perceived concern?

The government perceives an unfair tax advantage when earnings are held within a corporation to not expand the company, but to make a return in the private company. Businesses will still pay the same sum, roughly 50-per-cent tax, on the passive investment income they make with these aftertax funds. The government perceives there’s an unfair tax benefit, as private businesses have more money to invest given the tax rate on their business income is less than that of a person.

What are the proposed changes?

Several proposals have been issued to discourage the holding of passive investments in private businesses by neutralizing tax-assisted monetary gains. The government is proposing to remove this perceived tax benefit by effectively raising the tax rate substantially on earnings from corporate aftertax income reinvested in passive investments which aren’t linked to the corporation’s active business. By way of instance, aftertax earnings reinvested in a portfolio of dividend-paying stocks could be impacted.

From the new proposals, the government outlined potential strategies for increasing the tax on earnings from these passive investments. Even though the proposal documents say that the rules would only apply on a go-forward foundation, no details were provided on how passive assets possessed by corporations are grandfathered under the present rules.

What variables are the draft proposals not contemplating?

The private companies I know do not set up companies to obtain an unfair tax advantage. Nearly all private companies in Canada have been working as corporations for their entire business life cycle. The present tax system helps supports tens of thousands of private companies that employ millions of people and add substantial value to the market. Private companies take risks — from loans to accountability and outside.

It is not “fair” to compare a personal company with an individual worker and attempt to equate their overall returns on earned investment income. Private businesses risk all their wealth to reap the benefits, and sometimes they fail. Employees have access to retirement plans and do not risk losing all their riches every day they go to work.

What happens now?

If you currently earn passive income via a private company, the proposed changes to legislation may lead to a higher rate of taxation on future distributions of the income. It’s important that you understand the financial consequences of the suggestions on your bottom line — now, and in the future.

The government has given professionals and citizens 75 days (until Oct. 2, 2017) to provide submissions on the proposals. Given the breadth and complexity of the proposals, it’s hoped that the government considers extending the deadline for submissions. Every private company could potentially be affected in some way by the changes contained in the proposal documents.

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