On July 18, 2017, Finance Minister William F. Morneau released a series of documents and draft legislation curtailing tax planning using private corporations. In his letter, the Minister says “Addressing tax planning strategies, closing tax loopholes and making sure all Canadians pay their fair share is the next step in our plan; a plan that recognizes that Canadians deserve to feel confident that their Government is working for them.”
The proposals address three perceived “strategies and loopholes”:
- Sprinkling income using private corporations, which can reduce income taxes by causing income that would otherwise be realized by a high-income individual facing a higher personal income tax rate to instead be realized (e.g., via dividends or capital gains) by family members who are subject to lower personal tax rates or who may not be taxable at all.
- Holding a passive investment portfolio inside a private corporation, which may be financially advantageous for owners of private corporations compared to other investors. This is mainly due to the fact that corporate income tax rates, which are generally much lower than personal rates, facilitate the accumulation of earnings that can be invested in a passive portfolio.
- Converting a private corporation’s regular income into capital gains, which can reduce income taxes by taking advantage of the lower tax rates on capital gains. Income is normally paid out of a private corporation in the form of salary or dividends to the principals, who are taxed at the recipient’s personal income tax rate (subject to a tax credit for dividends reflecting the corporate tax presumed to have been paid). In contrast, only one-half of capital gains are included in income, resulting in a significantly lower tax rate on income that is converted from dividends to capital gains.
The proposals dramatically change the landscape that the Canadian tax community has been legally working in. Collectively this group of proposals represent the most significant change to the tax regime affecting private corporations since tax reform in the early 1970s. Almost certainly the proposals will result in increased income taxes for many families and corporations.
We will be monitoring the legislation carefully and adjusting our tax planning priorities to take into account the new rules as they become effective.