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Is your small business ready for Canada’s new tax rules? (Part One)

Changes to income splitting and passive income rules will impact small business


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January 10, 2019 by John Bleasby

Over the next couple of weeks, Canadian Contractor will examine tax changes implemented as part of the 2018 Federal Budget that directly impact small businesses like yours  — income splitting, passive income, CPP, trusts, and selling the business.           

The 2018 Federal budget roared like a lion when the proposals effecting small businesses leaked out early last spring. Small businesses roared back. Modifications were made. It’s now time for small business owners to sit down and figure out what to make of it all.

Income splitting
Income splitting has been a popular tool for small business owners to both lessen their individual tax burdens (spreading earned income among family members including children) and to save for future company expansion. Key now is the ownership of shares issued by the company — the new 10 per cent threshold. Individuals owning more can still qualify to receive the proceeds of a split income. However, less than 10 per cent and it comes down to whether the individual meets what national accounting and business advisory firm Grant Thornton terms, “the threshold of substantial employment within the business or has taken on certain financial risks.” If one plans to use these exceptions, it’s important to have solid supporting documentation.

Even so, however, there are restrictions within the restrictions. “Recipients of a dividend must be over the age of 25 to qualify for some of the exemptions,” says Grant Thornton. “So if a person under that age works to only a limited degree in the business it may be best to pay them a reasonable salary as opposed to a dividend.” Presumably that eliminates dividends to 10 year olds. Company owners approaching age 65 might find it advantageous to defer any payments to spouses in order to take advantage of income splitting rules available for seniors.

Are you using a family trust to reduce taxes?
Trusts have been another popular way to spin off income in order to reduce individual or corporate tax burdens. However, family trusts are now also covered under the new income splitting restrictions, so take a second look to see how yours might be impacted.

Understanding the terms ‘Service’ and ‘Professional ‘corporations
Usually one thinks about doctors or lawyers when these terms come up. However, all types of service and professional corporations are facing tougher rules, so the definition is worth considering if your company invoices for supervisory work. If so, Grant Thornton suggests discussing with your professional tax advisor the unbundling of material charges from pure labour.

Passive income rules
This is a potential biggie. As Grant Thornton points out, “Income earned from investments outside of the immediate business (or passive income) has been an important means of mitigating the risk of sudden downturns or cyclical pressures for many Canadian businesses.” However, there have been significant changes to how income earned from passive investment can impact the overall small business deduction.

Here’s how Grant Thornton summarizes the changes. “The most significant change to the rules on passive income is the implementation of $50,000 yearly cap, after which every investment dollar earned leads to a loss of five dollars in the small business deduction. After $150,000 in passive income, this deduction is no longer available.” Therefore, it’s critical that small business owners calculate their passive investment income based on the previous year, and begin monitoring that income now in advance of 2019 and beyond. Timing could be a useful tool. Determine whether you can defer capital gains, or offset them through capital losses. Also, look where that income comes from. Is it dividends from other corporations or capital gains? It might be worth considering investment alternatives like tax-exempt life insurance policies.

As always, the tax rules only get more complex. It’s important that you consult with a tax professional in order to understand any need to change the way your company plans or runs its operations.

Next week, we will look at ‘Income Sprinkling’ and how the new tax rules now impact estate planning.

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JBleasby@canadiancontractor.ca

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