Changes to income tax act come into effect in 2018

Last July, the government issued a consultation paper to make changes to the income tax act and how small businesses are taxed. I wrote about the proposed changes. Unfortunately, it appears I was right. In my last post, I predicted that changes to income sprinkling would be the first put into action, and my suspicion was accurate. On December 13th, 2017, the government announced changes to how income could be split would come into effect in 2018. You can read all the details here. If you liked complicated math problems, here’s one: if Cindy was driving at accelerated from 0 to 60 km/h over 19 seconds and covered a distance of 168 km, please feel free to read through the guidance provided by CRA. If those math problems made you squirm, read on. I will do my best to put it in layperson terms.

Proposed Changes

The July consultation paper proposed taxing dividends issued to those not involved in the business at the highest tax rate. It wouldn’t matter if that person’s only income were from dividends was equal to $20,000.00. Rather than being taxed at the rate of someone making $20,000.00 (federally, the rate in 2018 is 15%), that person would be taxed at the highest rate (federally, 33%). When you add the provincial portion, the highest rate in Manitoba climbs to over 50% – ouch! The changes announced in December 2017 contain more complications. The principle that those not participating in the business should not receive “free” money still applies, but the government added some features to soften the impact. I won’t be able to go over all the changes in detail because a) this post would be ten pages long, and b) most people lose interest in detailed explanations of the Income Tax Act. I will, however, attempt to highlight the areas with the biggest impact.

Actual Changes

The starting point is CRA will tax split income unless the income falls within an “excluded amount.” Under the changes, excluded amounts include:

• Dividends issued to shareholders who have an active involvement in the business. Actively is defined as involvement regularly, continuous and substantial basis, on average 20 hours per week a year.
• Dividends issued to adults over the age of 25 where the shareholder owns at least 10 per cent or more of the votes and value of the corporation (as long as the corporation earns 90 per cent or less of its income from the provision of services AND it is not a professional corporation)

So, suppose an 18-year-old or older member of the family who owns shares, or is the beneficiary under a discretionary trust, works 20 hours a week on average or more in the business year. In that case, that family member can receive dividends that fall within the “excluded amounts.” The new changes will not apply. If a 25-year-old or older member of the family owns at least 10 per cent of the value (usually in the form of common shares) and at least 10 per cent of the voting rights (voting common shares) AND the corporation earns LESS than 90 per cent of its income from the provision of services, than that person can also receive dividends that fall within the “excluded amounts”. The new changes will not apply.

Effect of Changes

This second part is good news for those small corporations where the two spouses own either an equal or a similar percentage of voting common shares. The spouse does not have to work in the business to receive dividends as long as they have at least 10 per cent of the value and 10 per cent of the voting rights. If they do, they can receive dividends that fall within the “excluded amounts.” These changes won’t affect you.  But there are many other changes, but they will apply to a smaller, more particular set of circumstances. Professional corporations (such as Medical Corporation, Law Corporations, and Chartered Professional Accountant Corporations) who issue dividends do not fall within the new definition of excluded amounts. Therefore, those dividends will almost always receive a taxation rate at the highest level. Adults under the age of 25 will almost always receive taxing at the highest rate. The rules have also been softer for families who sell their business. Family members who do not have involvement in the business may also benefit from previous capital gains exemptions and other similar benefits. However, because the rules are now more complex, you will need an accounting and legal advice.

Consequence of Changes

And because lawyers and accountants will now incur more risk and spend more time researching and providing advice on these matters, fees will also likely increase. While these new changes are not as bad as the ones proposed in July 2017, in my view, they complicate the system unnecessarily. I still think these changes are a bad idea. Most small business owners I deal with do not own yachts or vacation homes in the south. They work hard and manage a decent middle-class income. These people are the ones who will suffer under the new regime.

Disclaimer – Legalese

This article is presented for informational purposes only. The content does not constitute legal advice or solicitation and does not create a solicitor-client relationship (this means that I am not your lawyer until we both agree that I am). If you are seeking advice on specific matters, please contact Philippe Richer at 204.925.1900. We cannot consider any unsolicited information sent to the author as solicitor-client privileged (this means confidential).

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