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This article was previously published in the Fall issue of Grapes to Wine Magazine and has been reproduced with permission.
As part of the Liberal Government’s election platform, Justin Trudeau spoke about a plan to impose tax changes aimed at increasing taxes on Canada’s wealthier individuals while passing on the savings to the middle class. But what constitutes “wealthy” and “middle class” is a difficult question to answer.
As the campaign progressed, Trudeau sharpened his focus and aimed his sights at small businesses. He was quoted as saying: “We have to know that a large percentage of small businesses are actually just ways for wealthier Canadians to save on their taxes and we want to reward the people who are actually creating jobs.” These comments have had Canadian tax professionals nervous since the Liberals came to power in October 2015.
The nervousness increased when Finance Minister Bill Morneau tabled the new Liberal government’s first Budget in March 2016. The 2016 Budget included significant changes aimed at corporate structures which multiply access to the Small Business Deduction – a low rate of corporate tax available to corporations on their first $500,000 of active business income per year. Commentary at the time indicated that the Liberals may believe “wealthier Canadians” were benefiting unfairly from the ability to earn income in a private corporation and that further changes were expected.
The 2017 Budget came and went this Spring. Rather than what was in the Budget itself, it was what wasn’t in the Budget that was most concerning. This is because the Liberal government indicated that it would be releasing a paper concerning the taxation of private companies specifically focusing on three key issues. On July 18, the Liberal Government released proposals seeking to substantially change the taxation of private companies. The new proposals are focused on three specific areas: income splitting, earning passive income in a private corporation and capital gains planning. The focus of this article is in regard to income splitting.
The Federal government has shown it believes that small business owners such as doctors, lawyers, and yes, accountants have an unfair advantage from their ability to earn income through a corporation. Through a corporation, income can be split with other individuals who may not be active in the income earning process of the businesses but are nonetheless shareholders. By splitting the income among more than one individual, the overall personal income tax liability of a family is reduced because the progressivity of Canada’s income tax system can be managed. These new “income sprinkling” rules don’t just apply to professionals or “wealthier Canadians”, they will apply to all private corporations, including those operating vineyards and wineries.
The new income splitting rules will introduce a reasonableness test to any amounts paid to a Canadian resident from a private corporation, including dividends. Amounts would not be considered reasonable in the context of the business to the extent that the payment would exceed what an arm’s length party would have agreed to pay to an individual after considering the following factors:
These “tax on split income” (TOSI) rules are not completely new. They previously applied to related individuals under the age of 18 absent the reasonableness test. The effect of the TOSI rules is to tax split income at the top personal marginal tax rate.
What does this mean for corporations that own wineries and vineyards? It basically means that any dividends paid from a private corporation in 2018 will be subject to a reasonableness test. Falling short of reasonable, the dividend would be subject to the high rates of personal income tax.
For 2017, it is effectively “business” as usual when it comes to income splitting. Because the ability to split income in 2018 will be fact dependent rather than based on a shareholder’s legal relationship with a corporation, it may be a good idea to revisit the status quo and maximize savings available in 2017. For 2018, it will be necessary for small business owners to revisit long standing compensation practices and potentially budget for higher tax costs.
The expanded rules applicable to TOSI will also apply to income from capital gains. The sale of an estate winery business can create tax planning opportunities to utilize the owner’s lifetime capital gains exemption (“LCGE”) on the sale of qualified farm property, qualified small business corporation shares or both. Existing structures may have been established to utilize the LCGE of multiple family members.
Because there are significant changes which will constrain and in some cases, terminate the ability to access the LCGE, any tax planning previously implemented will need to be revisited in the immediate future to ensure that previous benefits of a tax structure are not lost.
Most of these new rules are expected to be implemented starting in 2018. For winery and vineyard owners, now is an opportune time to meet with your tax advisor to better understand how you may be impacted.
Geoff McIntyre, CA, is a Business Advisor and a Partner based in MNP’s Kelowna office. As the Food & Ag Processing Niche Leader for the Okanagan Region, Geoff specializes in serving the British Columbia wine industry. For more information, contact Geoff at [email protected] or 1.877.766.9735 or visit mnp.ca.
Related Topics:Wineries; Breweries; Entrepreneurs; Legislation; Estate Planning; Shareholders
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