The changes to Canadian Tax policy in from 2017 to 2018 are the most impactful changes made to Canadian Tax policy in a long time. These contentious changes to business tax policies have left many Canadians shaken, and unsure how to move forward. With the minimum wage in Ontario increasing from $11.60 in 2017 to $14.00 in 2018, an incredible $2.40 jump, business owners, especially small business owners, have been left wondering how they are going to keep their doors open in 2018.
Income sprinkling is one of the most contentious changes to the new tax laws. It is the practice of “sprinkling”, or sharing, income by the owner of a Canadian-controlled private corporation (CCPC) to their family members. By doing this, the owner of the business appears to make a smaller salary than he or she did, and they are then taxed at a lower rate, as is each family member receiving sprinkled income. The new Canadian Tax policy will be cracking down on this, implementing three new guidelines that must be met for income sprinkling to be allowed. For a family member to participate in income sprinkling they must be over 18, contribute to the business, and work at least 20 hours a week; and/or, the family member must be 25 years or older and own at least 10% of the business; and/or, the family member must be the owner’s spouse and the owner must be substantially contributing to their own business. The rules do have special exclusions, but they must first be investigated for their reasonableness before income sprinkling will be allowed.
Passive Investment Income
Passive investment income is the practice of holding income gains under a CCPC, where the tax rate is lower than if a person were to claim the income as personal income. The idea behind it is that income that remains in a CCPC is then actively used to expand and improve the business, which stimulates the economy and allows small businesses to grow. The idea behind this is to keep wealthy business owners from using their CCPCs to save additional income at a lower tax rate than available through Tax-free Savings Account (TFSA) and Registered Retirement Savings Plan (RRSP). Stipulations are being put in place to ensure fairness, including that in regards to passive investment income there is now a threshold of $50,000 per year that can be kept in a CCPC.
Dividend vs. Capital Gain Rates
Previously, when someone sells shares in a corporation where they bought the shares for less than the current sales rate, this income is referred to as a capital gain. This practice is converting income into capital gains. There can be exempt payment on these capital gains, depending on many factors. The new changes made to this policy in 2018 are that individuals must pay the higher dividend rates not capital gain rates, when extracting funds from their own company. Criticism of this change includes the fact that there is the potential for double taxation when a family business transfers to the next generation.
Lifetime Capital Gains
The lifetime capital gains exemption is going up in 2018. In 2017 it sat at $835,716. It has now gone up to $848,252, a total gain of $12,536. By meeting certain conditions, this is how much an individual can shelter as lifetime capital gains. For small business owners this increase an help, but it does not offset the changes to capital gain rates in regards to selling shares in a corporation being turned into dividend rates.
Many of the tax reforms being put in place in 2018 have good intentions. The idea behind them was to stop tax avoidance by wealthy business owners. The reality of the situation is that it is small business owners who are suffering under these new laws. Income sprinkling allowed business owners to properly reflect the effort being put in by every family member to keep their doors open. Passive investment income was both a way of saving slowly to invest back into the business, but also of ensuring that if there was a crisis their family would have money to handle it. Selling shares of a corporation as capital gains also meant for family businesses that they could pass the torch on to new generations without being double taxed. With all these new rules it is hard for small business owners to know how to tackle the 2018 fiscal year. We at SWCPAS provide small businesses with accounting services at very competitive rates, and can help you weather the changes made to the 2018 Canadian Tax policy, and keep your business afloat.