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With the Federal Budget released in March, it is important that professionals be fully informed as to how corporate or personal tax measures could affect their businesses. Here is an insightful look into the recent tax changes, how they affect your business and potential structuring opportunities which can help you grow your bottom line.
In the Federal Budget released March 2016, the government increased the personal tax rate on income over $200,000 by 4%. As a result, the highest personal federal tax rate increased from 29% to 33%. When these changes are combined with the personal tax rates increases in Alberta for instance, the highest combined federal and provincial tax rate increased from 39% in 2015 to 48% in 2016. The previously enacted reductions to the small business tax rate were cancelled for the years of 2017 through 2019. As a result, the federal small business tax rate for 2016 was lowered from 11% to 10.5% as scheduled but further rate reductions will not be implemented. Please see Appendix A for a summary of the personal and corporate tax rates for 2016.
In the 2016 Federal Budget, there were a number of proposed measures designed to limit the ability of corporations involved in a business structure with some degree of common “interest” from accessing multiple separate small business deductions. The new rules will apply where corporations or their individual owners operate a partnership and the corporations receive less than 90% of their income from arm’s length parties that do have a common interest in the business structure. The new rules will also apply to structures involving corporations which receive income from other corporations but the corporations have a common interest in a business structure. In these situations, there will be the ability to allocate one small business deduction between multiple corporations but each of the corporations will no longer be able to access their own separate small business deductions for income generated from a corporation or partnership with a common interest.
This is a significant change to the current rules that may impact professionals who operate in a business structure with any degree of common interest. Prior to the proposed changes, sharing of the small business deduction generally required a close relationship between corporations with a resulting “association” of the companies for tax purposes. Importantly, under the new proposed rules, the owners of each corporation can be entirely arm’s length of one another and the degree of common interest can be very limited as there is no threshold test. Any degree of common interest in a business structure between arm’s length parties can now potentially result in the sharing of one small business deduction for all income generated from this business structure. We recommend professionals review their business structures and operating agreements with their tax advisor to determine whether these new rules will apply to them.
Eligible Capital Property (ECP) refers to intangible assets with an indefinite life. The most common example of ECP is goodwill. The 2016 Federal Budget proposed to repeal the current ECP regime and instead apply the Capital Cost Allowance (CCA) system to ECP starting in 2017. There are proposed transitional rules for existing ECP pools.
Under the existing rules, when ECP is sold for a gain, 50% of the gain is taxable as active business income. Under the proposed rules, beginning in 2017 a gain on the sale of ECP will be treated as a capital gain and 50% will be taxed as investment income. One of the results of this change is that it will eliminate a significant tax deferral that was previously available on the sale of ECP.
For example, a professional corporation sells its dental practise for $1 million. $500,000 of the purchase price is attributed to goodwill. Assuming the goodwill had no cost base, there is a gain on the sale of goodwill of $500,000. Under the current rules, $250,000 ($500,000 x 50%) would be taxed as active business income at either the small business tax rate of 13.5% or the general tax rate of 27% for income over $500,000. Under the new rules, the $250,000 would be taxed as investment income and subject to refundable tax at a combined tax rate of 50.67%. As a result, there is no longer any deferral advantage to keeping the income from the sale of goodwill in the corporation. This change significantly impacts the after tax position of a vendor and is likely to make vendors less inclined to agree to an asset sale and to prefer a share sale on the disposition of their business.
The significant increase to personal tax rates on income over $200,000 highlights the benefits of income splitting opportunities with spouses and in some cases, adult children. For example, a professional who receives a mix of wages and dividends from a professional corporation totalling $300,000 and has a spouse with no personal income. If the professional involved their spouse in the corporation and paid their spouse dividends to effectively split their income, as a couple they would save approximately $20,000 in tax every year.
As you will notice in Appendix A, the personal tax rate on capital gains is significantly less than the tax rates on other forms of personal income. At the highest tax bracket, the capital gains tax rate is 16% less than the rate on non-eligible dividends, and 24% less than wages.
If you are planning for large withdrawals from your professional corporation this year, it makes sense to consider tax planning that results in a capital gain rather than increased dividends or wages. For example, a professional who is in the highest tax bracket plans to take out an additional $300,000 this year to fund the purchase of a vacation property. The tax savings on having this additional amount taxed as a capital gain rather than as a dividend would be approximately $48,000 ($300,000 x 16%).
If you are planning to sell your professional business in the near future, it may make sense to sell your goodwill in 2016 to a related corporation while the current ECP rules are still in effect. The benefit would be that the gain on the sale of ECP will be taxed as active business income and may allow for a significant deferral of personal tax that will not be available under the new ECP rules starting in 2017. This planning opportunity will only be available until the end of the year. If you are thinking of selling your business, please speak with your advisor about the possible benefits of this type of planning.
For more information contact Mark Bernard, CPA, CA at 780.453.5388 or
Related Topics:Dentists; Doctors; Lawyers; Optometrists
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