While the federal budget was anticipated by the tax advisory and legal communities with apprehension, the changes made by the Liberal government were mostly incremental in nature, and in keeping with the existing structure of the tax regime. That said, the outcome was better for owners of small and medium-sized enterprises than was expected.
Passive Income in Private Companies
Minister Morneau announced that measures would be introduced last July, and then followed up with additional guidance in December.
At that time, the government indicated that companies will be entitled to up to $50,000 in passive income before any new measures come into effect. The government tied this passive income threshold to the small business tax rate for Canadian Controlled Private Corporations (CCPC) (which in Ontario will be 13.5% this year, as compared to the general corporate rate of 26.5%). Where a company has passive income in excess of the new $50,000, for each dollar of excess income the access to the small business rate will be reduced by $5.00.
For example, a small business that is expected to have $350,000 in net income in 2019 (the new measures take effect after this tax year), and has retained earnings that are invested in the stock market, or another passive vehicle, which generate $90,000 in passive income, the new measures will have the following effect:
As passive income exceeds the $50,000 limit by $40,000, access to the small business rate (currently available on the first $500,000 of income in a CCPC) will be reduced to $300,000 ($500,000 minus 5 x $40,000).
Accordingly, the business will only have access to the small business rate on the first $300,000 of income in 2019 and will pay tax at a higher rate on the income between $300,000 and $350,000. In this case, the business would be able to manage the issue by paying a bonus of $50,000, to bring the corporate income down to the revised small business limit.
Where a company has passive income in excess of $150,000, the small business rate is entirely eliminated.
While the change will have its detractors, the policy underpinning this new approach seems sound.
Small Changes to the Refundable Dividend Tax on Hand (RDTOH) Regime
Contained in the federal budget is a change for businesses that earn income in excess of the small business limits, namely the Refundable Dividend Tax on Hand (RDTOH). The RDTOH regime is used to mirror the rates of tax that would be payable, on an integrated basis, by an individual if (i) dividends from marketable securities are received by a CCPC; and (ii) investment income is made by a CCPC. In the case of investment income, the tax rates are structured so that when the company pays a non-eligible dividend, the shareholder should be indifferent as to whether the income was made in the company or in her or his hands personally.
What the federal budget recognizes is that companies making income in excess of the small business limit can use the notional amounts, in their general rate income pool, to pay out eligible dividends and receive a refund of the RDTOH they have paid. By doing so, the total amount collected by Canada Revenue Agency (CRA), between the individual shareholder and the company, is lower than it should have been.
Accordingly, CRA has created additional administrative work for tax advisors and bookkeepers of large and medium-sized private companies. Going forward, companies will have to track the source of their RDTOH – both eligible and non-eligible RDTOH accounts. To receive a refund of non-eligible RDTOH, a company will have to pay a non-eligible dividend (i.e., a dividend that is taxed at a higher effective rate in the shareholder’s hands).
Tolling of Statutory Assessment Periods
The federal budget introduces for purely domestic companies a “stop-the-clock” provision that for some time had been in place for audits of companies that included foreign-based information.
Until this year, where CRA initiated an audit of a Canadian company through a request for information, (during the period that a taxpayer took in getting the information to CRA, and during the time CRA took to review and process the disclosed information) the “clock” kept running on the CRA’s statutory limitation period for assessing a taxpayer for prior years.
Accordingly, CRA might find itself in a position where a year became non-reviewable while a review was ongoing. The federal budget changes this so that once the audit process is underway, the CRA’s ability to bring an action against the taxpayer will stay open.
Reporting Requirements for Trusts
Starting in 2021, most family trusts will be required to file T3 returns to CRA. On such T3’s, the information that will need to be disclosed includes:
- identities of the trustees of the trust;
- identities of the beneficiaries of the trust;
- the identity of the settlor of the trust; and
- the identity of any “protector” of, or similar person who has the ability to exert control over, the trust.
The new reporting requirements apply to express trusts that are resident Canadians, and to non-resident trusts that are presently required to file a Canadian tax return.
Currently, trusts are generally not required to file a return if they do not earn income or make a distribution in a year. Nor do they have to disclose the names of beneficiaries.
The purpose of these new reporting requirements is to enhance the availability of beneficial ownership information. According to the federal budget, improved beneficial ownership information will help authorities to counter aggressive tax avoidance, tax evasion and money laundering.
The federal budget also proposes new penalties for failure to file a T3 return.
Brandon Tigchelaar focuses on private mergers and acquisitions, general commercial matters, and assisting with planning and implementation of tax efficient reorganizations of private entities.
Andrea Tratnik practises estate and trust planning and administration, acting for domestic and international companies, small businesses, and individuals.
Do you have questions about this topic? Email Brandon at email@example.com or call him at 416-306-1742. You can email Andrea at firstname.lastname@example.org or call her at 416-306-1815.