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Tax Changes and Your Family Business: What You Need to Know

05/09/2017


​​​​​​​If the federal government’s proposed tax changes come into effect next January, family businesses could be losing significant tax benefits. It’s important to know what you might be facing so you can consider restructuring your corporation to maximize your benefits and minimize taxes.

In short, your family business may have benefitted in the past by paying dividends to either family members or trusts as shareholders of their private corporations. You may also have taken advantage of deferring income taxes on excess earnings by retaining these excess earnings within the corporation. Finally, you may have had shareholders withdraw corporate surplus as capital gains. As only 50 per cent of a capital gain is subject to tax, this allowed shareholders of family businesses to realize significant tax savings when withdrawing funds from their corporation.

TaxFactSheet 
​​​ Here’s a brief look at some of the issues.

The “Reasonability Test”
The proposed changes call for a “reasonability test” for dividends paid to adult family members. This test will be subjective and will consider:

  • The labour contributions of the individual receiving the dividend
  • The individual’s capital contributions to the business
  • Whether the individual receiving the dividend is between ages 18-24 or if they are aged 25 and older

Guidelines for how the Canada Revenue Agency (CRA) plans on administering this “reasonability test” are not yet clear. You should document the duties and contributions of each shareholder so you can support your claim should the Canada Revenue Agency challenge a dividend paid to a family member.

Family Trusts
Income distributed through a family trust to the beneficiaries will be subject to the same “tax on split income” as though the dividend had been paid directly to the individual. This will render a family trust ineffective for splitting income among family members, unless it can be shown that the amounts distributed to individuals were reasonable based on the tests discussed above.

The proposed changes will no longer permit individuals to claim the lifetime capital gains exemption (LCGE) on capital gains that accrued during a period where the shares were owned by a trust. 

Real Estate Rental Income
Where the principal​ purpose of the private corporation is to earn income from property (e.g., rents), the labour contribution by the family member is disregarded and the “reasonability test” is based solely on the capital contributed. This means that the provision of labour to a corporation in respect of its rental activities may never satisfy the “reasonability test.”
 
When it comes to passive real estate investments or surplus cash from refinancing existing real estate, there is no draft legislation. The government has indicated it intends for any changes to apply on a go-forward basis, which should not impact existing passive investments.

Land held for future development should not be affected. If it’s to be sold to generate profit, it will be looked at as a business income or loss.

The Value of Incorporation
Should you incorporate a family business, given these changes? Incorporation can still be very valuable, allowing you to pay down debts and split income in certain circumstances. Talk to your advisor about your specific situation.

If you’re already incorporated, the proposed changes could affect your current share structure if they come into effect. Again, talk to your tax advisor to ensure you minimize the impact on your business. It might be time to change your share structure so you can continue to achieve your business and personal goals.​

​Proposed Tax Changes for Family Businesses: Your Questions Answered
Fact Sheet

What’s in store for privately owned companies and tax planning and what you can do to minimize the impact.

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