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Canadian Forges Ahead With Income Sprinkling Changes

by Mike Godfrey,, Washington

15 December 2017

The Canadian Government has published details of its plans to restrict the use of income sprinkling by private corporations, clarifying how the "significant contribution" of a family member to a business will be determined.

Earlier this year, the Government held a consultation on proposals to reform three aspects of the tax planning rules. One of the consultation's main focuses was so-called income sprinkling, deemed to involve the diversion of income from a high-income individual to family members with lower personal tax rates, or to family members who may not be taxable at all. By this method, the owner of a private corporation can "sprinkle" their income between themselves, their spouse, and their adult children.

The Government's aim in reforming the system was to distinguish income sprinkling from reasonable compensation for family members.

Following a backlash from small business owners in particular, the Government confirmed in October that it would still press ahead with plans to overhaul the income sprinkling rules, but that its proposals would be simplified and released in revised format before the end of the year.

On December 13, the Government published its amended proposals, which it said are designed to ensure that the changes do not affect family members who make meaningful contributions to a family business. The changes are intended to clarify the process for determining whether a family member is significantly involved in a business, and is thus excluded from potentially being taxed at the highest marginal rate.

The Government will introduce "bright-line" tests – or "off ramps" – to automatically exclude individual members of a business owner's family who fall into any of the following categories:

  • The business owner's spouse – provided that the owner meaningfully contributed to the business and is aged 65 or over;
  • Adults aged 18 or over who have made a substantial labor contribution (generally an average of at least 20 hours per week) to the business during the year, or during any five previous years;
  • Adults aged 25 or over who own 10 percent or more of a corporation that earns less than 90 percent of its income from the provision of services and is not a professional corporation; and
  • Individuals who receive capital gains from qualified small business corporation shares and qualified farm or fishing property, if they would not be subject to the highest marginal rate on the gains under the existing rules.

Individuals aged 25 or over who do not meet any of these exclusions would be subject to a reasonableness test, to determine how much income, if any, would be subject to the highest marginal tax rate. In some cases, adults aged 18 to 24 who gave contributed to a family business with their own capital would be able to use the reasonableness test on the related income.

The Government believes that the vast majority of private corporations will not be impacted by the proposals. It said that the simplified measures have further reduced the number of businesses potentially affected from 50,000 to fewer than 45,000.

The changes are intended to be effective for the 2018 and subsequent tax years. The 2018 tax year begins on January 1. Owners of private corporations will have until the end of 2018 to adjust to the new exclusion for non-service businesses.

The implementation date was criticized by the Canadian Federation of Independent Business (CFIB), which called on the Government to delay the start date to January 1, 2019.

CFIB President Dan Kelly said: "It is extremely concerning to see the federal Government drop this lump of coal during the busiest season for thousands of firms and only days before all small business owners are expected to implement the new rules. This seems the very opposite of tax fairness."

"How our government expects small businesses to understand the new rules and make any needed changes to the corporate structures in two and a half weeks is beyond me."

TAGS: compliance | tax | small business | business | tax compliance | tax incentives | small and medium-sized enterprises (SME) | tax planning | tax rates | Canada | tax reform | trade association | trade | individual income tax

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