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In the last issue of Canadian Grapes to Wine, we introduced you to the changes being proposed by the federal government for the taxation of private corporations and their owners (see Sweeping Changes coming to tax planning for private corporations – Fall 2017). We also warned of the possibility of significant collateral damage from the broad and vague new rules put forward by the government back in July 2017.
Some good news! Thanks in no small part to the widespread public backlash over the initial proposals, significant changes and clarifications to the initial plans were announced in December. Numerous stakeholder groups provided feedback and submissions about the possible unintended consequences of the proposed changes and the effect they would have on private business owners. And the government seems to have listened…sort of.
Canada’s tax system is primarily based on the income of the individual, not of the family, and tax rates are steeply graduated with income. Consequently, a family with one income earner receiving $100,000 will pay more tax than a family where two spouses each earn $50,000.
Income splitting is considered common practice for incorporated small businesses, including farmers and winery owners. Family members subscribe for shares in a corporation, sometimes using a trust. The corporation pays dividends to family members, “splitting” the income and reducing the overall tax. There are often business and succession advantages in such a plan as well.
The current federal Government doesn’t like the idea that a private corporation can be used to effectively reduce the tax burden that would exist if the income was earned directly by an unincorporated business owner. The problem is that such structuring has been allowed under existing legislation for years and has become firmly entrenched in Canadian tax planning. This is not complicated, exotic planning for extremely wealthy individuals – it’s Basic Tax Planning 101 for anyone who owns a family business.
The original announcement outlined a significant expansion of the application of existing rules for Tax on Split Income (TOSI). Essentially, the government proposed to evaluate the contribution of each family member to a business’ results. Any dividends or capital gains realized from that business in excess of a “reasonable” return on labour and capital would be taxed at the top marginal rate. This is called “Tax on Split Income,” or TOSI.
The revised proposal alleviates some of these concerns. The government has kept the reasonableness tests, but narrowed the scope by adding safe harbours, where TOSI would not apply:
There will be two exemptions from the labour reasonability test. The individual will be exempt from TOSI if the individual:
This is good news for many family-owned businesses, but it raises some additional questions. For instance, what sort of evidence will be required to prove the 20 hours per week threshold? Many family members have worked actively in a family business over the years without compensation or any of the record keeping that goes with it.
The individual will be exempt from TOSI if the individual:
and the corporation meets the following conditions:
Again, this appears to be a favorable change, but we need clarification. For example, would a company providing vineyard consulting and labour to multiple vineyard owners be caught under these “provision of services” rules?
In order to simplify the application of the TOSI rules, as well as to address potential unintended consequences associated with the July 2017 proposals, the federal government has proposed the following changes:
By the time your read this, the federal government will have tabled its 2018 Federal Budget which is expected to provide greater detail on these new TOSI rules, which will be effective starting in 2018. The December revisions to the original proposals are a step in the right direction, particularly for the hundreds of small private businesses that make up the majority of Canada’s winery owners. However, there are still many situations where private business owners can expect to be paying significantly higher taxes as the Government moves to curtail income sprinkling.
Based in Kelowna, Geoff McIntyre is the Food & Ag Processing Services Leader for the Okanagan Region. Geoff specializes in serving the British Columbia wine industry; working with several winery and vineyard clients to help them achieve their goals. He can be reached at 1.877.766.9735 or [email protected]
Client Groups:Private Enterprise; Food ＆ Beverage Processing
Related Topics:Wineries; Small Business; Corporate Tax; Entrepreneurs
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