Tax Planning Using Private Corporations

August 25, 2017 Published by
Post Categories: Tax AccountingHSS BlogAdvice For You

On July 18, 2017 Finance Minister Bill Morneau released his much anticipated consultation paper
proposing changes to how private corporations are used to gain tax advantages. The proposals
outlined in the consultation paper are significant and will affect everyone who owns a private
corporation.

The following three items are targeted in the consultation paper:
· Income splitting
· Holding passive investments inside a private corporation
· Converting income into a capital gain
These proposals quickly follow other changes such as the limitation of the small business
deduction which are troublesome for small business owners. Are these new proposals a continued
attack on entrepreneurs?

INCOME SPLITTING
The proposed changes are targeting those individuals who do not actively contribute to a
corporation either in terms of labour or capital. Therefore, these individuals may be subject to tax
at the highest marginal rates on any income received from the business.
Also, the proposals aim to restrict the availability of claiming the lifetime capital gains exemption,
currently at $835,716, on those individuals not active in the business.

HOLDING PASSIVE INVESTMENTS INSIDE A PRIVATE CORPORATION
The Department of Finance perceives that there is an unfair benefit to private corporations that
invest after-tax retained earnings in passive investments. These proposals intend on raising taxes
paid by private corporations in these instances, so that any benefit in retaining funds in a
corporation is reduced or eliminated.

Passive investment income earned by a Canadian-controlled private corporation is taxed at a rate
approximately the same as the highest personal tax rates. However, active business income earned
by a corporation, whether or not subject to the small business deduction, is taxed at less than the
highest personal tax rates. Corporations have the ability to invest excess funds not required for
their ongoing operations. Therefore, corporations can invest larger amounts in passive investments
than individuals who have paid more tax on similar amounts of income. The Department of
Finance finds this offensive.

CAPITAL GAINS STRIPPING
Section 84.1 of the Income Tax Act currently applies to ensure that a majority of corporate
distributions are treated as dividends. There are limited situations where the distribution of
corporate surpluses, that would otherwise be treated as dividends, are converted to capital gains.
These proposals plan to eliminate this type of planning.

LIFETIME CAPITAL GAINS EXEMPTION (“LCGE”)
The proposals plan to eliminate the multiplication of the LCGE available on the disposition of
qualified small business corporation shares. After 2017, the LCGE will not be available to
qualifying shares held through a family trust. Also, there are proposed restrictions on qualifying
shares held by adults that are not active in the corporation.
CAPITAL DIVIDEND ACCOUNT (“CDA”)

Capital gains will continue to be eligible for the 50% inclusion rate. However, these proposals
plan to eliminate the addition of the non-taxable portion of the capital gain to the CDA.

The above highlights the significant changes outlined in the Department of Finance’s 63 page
report. Needless to say, these proposals represent the most significant overhaul to the taxation of
private corporations since 1971. Many of the planning opportunities have been in place since that
time to provide for an effective integration of personal and corporate tax. The level of complexity,
compliance costs and general business distraction will increase.

The present Income Tax Act allows for CRA to determine whether expenses are incurred to
generate income and are reasonable in the circumstances.

The wording used in the Department of Finance document is troublesome. It appears to accuse
private corporations of not contributing to the economy or not paying their fair share of taxes.
There is no mention of the risks involved in owning a private corporation.

The Department of Finance is consulting with the public concerning these proposals. The deadline
for submissions is October 2, 2017.

We will continue to monitor and advise our clients as developments occur.