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Canadian Tweaks Reforms To Taxation Of Passive Investment

by Mike Godfrey,, Washington

19 October 2017

The Canadian Government has said that it will press forward with measures to limit the tax deferral opportunities related to passive investments, but will seek to ensure that business owners remain able to build a "cushion of savings."

The Government believes that an increasing number of Canadians are using private corporations in ways that allow them to reduce their personal taxes. It recently concluded a consultation on proposals to crack down on three tax planning strategies: income sprinkling among family members, the retention of passive investments in private corporations, and the conversion of the surplus income of private corporations to lower-taxed capital gains.

In the case of the tax treatment of passive investment income, the Government was seeking ways to eliminate the tax-assisted financial advantages of investing passively through a private corporation.

Finance Minister Bill Morneau has now announced that the Government will move forward with the passive investment measures, with the aim of ensuring that "Canadian-controlled private corporation (CCPC) status is not used to reduce personal income tax obligations for high-income earners rather than supporting small businesses."

The Government will release draft legislation as part of Budget 2018, and any proposals will apply on a go-forward basis. The new rules are intended to target high-income individuals who can benefit under the current rules from "an unlimited, personal, tax-preferred savings account via their corporation." The Government said that this goes far beyond the pension, RRSP, and TFSA limits available to other Canadians, and is "inherently unfair."

The Finance Department did however state that during the consultation it heard from business owners that "the flexibility afforded from savings accumulated in the corporation is important to their success." It explained that such savings can be held with the intention of financing an upcoming business expansion or facing contingencies, and are sometimes also used to provide flexibility for dealing with a range of personal circumstances.

The Finance Department said that it will ensure that investments already made by the owners of private corporations – including the future income earned from such investments – are protected. The measures will only apply on a go-forward basis.

The Government will include a passive income threshold of CAD50,000 (USD40,111) per year for future, go-forward investments. It said that this is equivalent to CAD1m in savings, based on a nominal five percent rate of return. The aim is to provide more flexibility for business owners to hold savings for multiple purposes.

There will be no tax increase on investment income below this threshold.

The Government also wishes to ensure that incentives remain in place for venture capital and angel investors, and that businesses remain able to save for contingencies or future growths in investment.

The Government will examine all deferral benefits from passive investment, and will continue to assess key aspects of the design of the measures. It will consider the appropriate scope of the new tax regime with regard to capital gains, including whether the rules should exclude capital gains realized on the shares of a corporation engaged in an active business.

The changes to passive investment will not apply to income from AgriInvest, which is a self-managed, producer-government savings account that allows producers to set money aside. The investment income from an AgriInvest account is currently treated as active business income, and it is the Government's intention to maintain this approach.

The Government believes that the vast majority of businesses will remain unaffected by these changes. According to the Finance Department, more than 80 percent of passive income is earned by just two percent of CCPCs.

Morneau said: "Every small business owner knows that success often means taking risk. I've met with and listened to small business owners all across Canada and I know that their success also depends on flexibility in how they save for things like maternity leave, sick leave and their retirement. The changes we will make, including lowering taxes on small business to nine percent, are helping us take one more step towards an economy that works for the middle class."

Commenting on the proposals, Dan Kelly, President of the Canadian Federation of Independent Businesses, said: "It is good news that the Government is beginning to recognize the many important roles passive income plays in the life of a business and its owners. If administered properly, this change will be helpful in allowing many small firms to continue to use passive income to ride out challenging times, save for investments or set aside money for a leave or retirement."

However, Kelly added that the CAD50,000 annual threshold may be too low for small firms that are saving to grow their business. "Canada has a dearth of medium-sized businesses and the size of the threshold may not be enough to help businesses looking to get to the next level," he said.

TAGS: individuals | capital gains tax (CGT) | tax | investment | small business | business | retirement | tax thresholds | small and medium-sized enterprises (SME) | legislation | venture capital | tax planning | tax rates | Canada | tax reform | trade association | trade

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