Finance announcing changes to July 18, 2017 small business rules

During the week of October 16th,the Finance Minister announced changes to the July 18, 2017 proposed legislation.

The proposal to limit the availability of the capital gains exemption to active shareholders will be scrapped.

The proposed rules for determining the “reasonableness” of dividends paid to non-active shareholders will be simplified. It appears that capital gains on the sale of private corporation shares still could be included in “split income”, by virtue of the definition of “split income”, taxed at the top rate, to the extent that the capital gain is not sheltered by the taxpayer’s available for the capital gains exemption.

The proposed changes to section 84.1 and proposed new section 246.1 which would convert in certain transactions capital gains or otherwise tax-free corporate distributions to taxable dividends will be scrapped. This means for now that the post- mortem “pipeline procedure” will remain, however still appearing to be dependent on implementation procedures as outlining in recent tax rulings.

A welcome announcement was that the federal tax rate applicable to the small business limit will be reduced from 10.5% to 10% effective January 1, 2018 and to 9% on January 1, 2019. With no Ontario changes, the combined federal and Ontario rate will be in 2019 13.5% from the present 15%. The rate on active business income in excess of the small business limit of the present 26.5% (combined federal & Ontario rate) will not change.

The suggested rules although not presently in proposed legislation, to revamp the taxation of passive income earned by private corporations as previously announced will leave the present rules intact for annual passive income of $50,000 or less, meaning the refundable tax treatment of such income will remain the same.

Refundable tax treatment is a mechanism for the corporation to obtain a dividend refund of federal tax previously paid on passive income when taxable dividends were paid. The concept of integration is that it should not be more or less costly to earn investment income directly or indirectly through a private corporation.

It appears that income in excess of this $50K limit will be effectively taxed at a higher rate, with the implication that there would no refundable tax treatment on this amount as suggested in July. This means that the absolute tax cost of earning investment income in a private corporation will increase significantly as opposed to earning it directly by the shareholder.

Revised proposed legislation will be released to amend the July 18th proposals, likely before the end of the year, however details with respect to changes to the taxation of corporate taxation may be released as part of the 2018 federal budget.