The Canadian government announced new tax legislation for small business. With new rules on income splitting and for holding passive investments in a corporation, as well as a new lower corporate tax rate, Kim Parlee discusses what the changes could mean for small businesses with Pierre Letourneau, High Net Worth Planner, at TD Wealth.
Welcome to the show. I'm Kim Parlee. It's great to have you with us. Well, the small business tax reform proposals from the government have taken another turn, the latest coming from the finance minister today. Here to sum it all up is Pierre Létourneau. He's a high net worth planner with TD Wealth. And you were here just last week.
And this tells us how fast things are changing. So you might be here next week again, too. We don't know. I wanted just to run through all the changes as they stand up to date and compare them to, again, what businesses would have been facing from, let's say, a year ago, so people understand the big changes. But first in the news today was passive income.
So what did the minister announce today?
So what they announced-- well, first off, they announced that any passive investments in a corporation right now, in a small business corporation, wouldn't be affected by the these new rules. And that includes any income generated by these investments.
So if you're a small business and you had mutual funds, stocks, bonds as an investment, you're fine for what has happened up until this point.
Yes. For those investments, the new rules won't impact that.
Right. But going forward--
Going forward, there's going to be a threshold of $50,000 of investment income per year that a small corporation can earn without being taxed at a higher rate. Anything beyond that would be taxed at a higher rate.
And the reason how they got to $50,000 of income, the government used a rate of return of 5%. So they assumed on a million dollars, you would earn $50,000 at 5%. So a million dollars is enough capital of passive investments that a corporation can use. Then for any personal needs that the business owner might have, whether it's for sick leave, parental leave, or even for retirement--
--that would be their nest egg that they'd be able to build within the corporation.
And the other thing too, just so people understand, although I'm sure small business owners know this very well, but the reason people kept those passive investments inside that structure was because it was more tax efficient than it would have been in their own personal hands.
Right. There was a tax deferral, really, because corporate tax rates are lower than the highest marginal personal tax rate. So there was an advantage that allowed business owners to accumulate more capital in the corporation, therefore have more investment assets.
Was there timing on this one today?
So there's no legislation on this yet. So what they mentioned was that for the budget of next year, so in March of next year presumably, they'll have proposed legislation for these new measures.
OK. So wait and see on the details on that one, too. Income sprinkling, splitting-- are sprinkling and splitting the same thing?
Sprinkling is new.
Brought by the government.
Sprinkling terminology is new, yes.
So what is the latest on that?
OK. So the government announced on Monday that they're going to move forward with those proposals. And the only other thing they said was that they'll look to simplify the rules. We don't really know what that means, but they're going to-- because one of the things is, these rules could be pretty complicated to work through just because they add a reasonableness test on dividends paid to family members, which are based on the contributions that these individuals make to the corporation.
So if you're working for the company or corporation--
Then you might be entitled to a certain amount of dividends based on the amount of work that you're putting into the company.
But if you're not, they're saying you won't be.
Yeah, you won't be, and so you'll be taxed at a very high rate on those dividends. Right. So they're going to move forward with that, simplify the income sprinkling, and they did announce that new legislation will come in later this fall and that the rules will be effective starting January 1, 2018.
So again, comparing this to last year, people would have been allowed to do this. I know it was under 18, they weren't allowed to do that.
Under 18, they'd still be taxed at the highest rate, if the family member is under 18. But for other family members, they could pay dividends out to those individuals.
And that's changing.
That's changing. Got it. OK. Long-term capital gains exemption--
They had come out and said, we're looking at doing this. And it had the ability to multiply, I know, with family members. And they got a lot of pushback on that one.
Right. They did. So I think the proposals led to unintended consequences, especially when you were looking at an intergenerational transfer of a business. So because of that, they decided to not move forward with those rules. And they were just rules to limit the ability to access the capital gains exemption in certain situations, multiplying it with other family members.
So they're not going to move forward with that.
And that's been scrapped. I think those unintended consequences might have been political, but I'll just leave it at that. The small business tax rate-- now, they have said they want to lower that down to 9% by January 1, 2019.
Didn't they say that before?
They did. They did. It was a campaign promise by all the parties actually. And this was actually planned before the election as well. So there was a plan to reduce the small business tax rate. In 2016, the liberal government decided to put that on hold until they dealt with these other issues that they wanted to deal with. And so now, they say they're ready to implement that reduction.
What are you still listening for at this point? I mean, I know the devil's in the details in a lot of this stuff.
Is there another shoe to drop? Is there more coming?
Well, certainly, the passive investment income taxation, they haven't proposed any legislation. We're not sure what the mechanism is going to look like for that taxation, so we're waiting to see more on that. There's also another element of the measures that they presented in July that deal with structures that turn dividend income into capital gains income on the transfer of a business. So that could have-- the proposed rules that they presented could have an impact on estate planning and on just transfers from family members, between family members of a business. So they haven't addressed that yet. There was a lot of criticism of the rules because of these unintended consequences, so they'll still need to let us know if they're going to move forward with those rules.
Finally, last question for you-- I'm watching, I am a small business owner or I fall into this category of having my own private corporation, is there anything I need to do today to get ready for these impending changes?
Well, today, the only thing I would think to-- one thing to consider would be maybe wait till the proposed legislation for the income splitting rules kick in or are presented. And then maybe it would be worthwhile to look at paying dividends to family members before the end of the year and before those rules come into play. Maybe not something to think about today, but I think in the future, once we know more how the passive investment income taxation rules are going to work, there may be other alternatives for business owners. And that might be corporately owned life insurance policies or maybe individual pension plans. Those might be other alternatives available to business owners for their savings within the corporation.
And I'll say it for you, but they need to talk to their planner or adviser to figure out what works, right?
Absolutely. Yeah, absolutely.
Pierre, always a pleasure. We may have you back. We'll see what changes say.
Great to have you here.
Pierre Létourneau, he's a high net worth planner. He works with TD Wealth.