Proposed Tax Changes – How Will You Be Affected?

In Part 1, I talked about how the message about these tax changes was being delivered. In this part, I will discuss how you will be impacted.

The government is claiming that these changes will only have an impact on the wealthy, so let’s see if that is true.

Income Splitting

As I stated in Part 1, I believe that claiming to give children money without actually giving it to them, is tax avoidance and therefore illegal. Actually giving the children money and then having it gifted back would be the same as not giving it to them at all in my mind. I am not aware of a tax case where this was proven to not be the case and short of seeing that, I would not personally be involved in this sort of strategy.

However, I have recommended many times to incorporate to split income with a stay-at-home spouse. The spouse generally is involved in the business in some way. Discussions with the business owner obviously, taking care of the household so the owner can work long hours, and often having their home and well being put at risk by the business. It is unclear with the proposed changes if the spouse would be considered reasonably involved in the business. This uncertainty makes it difficult for anyone to do any tax planning. We’ll have to wait for a court case on the subject to determine the true impact of this.

Obviously, if you are currently income splitting you will be impacted by this.

Capital Gains Exemption Changes

The Lifetime Capital Gains Exemptions (LCGE) allows an individual to avoid paying capital gains on the sale of a qualified small business or qualified farm up to a lifetime limit ($835,716 in 2017). The government is concerned with the LCGE being multiplied by family members and has proposed restrictions on trusts, minors, and adult family members.

This obviously has an impact on family businesses and farms. What if the adult child takes a post secondary course to better be prepared for the business? Are they no longer actively involved in the business and therefore not eligible for the exemption while they are away? As each child shareholder turns 18, a business evaluator should be called in to evaluate the business so the minor shareholder knows his tax base. These evaluations are going to result in higher costs for the individual and/or business. Finally, if your corporate shares are held in a trust, you will want to discuss with a CPA about possibly restructuring.

There may be some abuse of this exemption, but I haven’t heard of any concrete example, just fear. However, there will be some real-world ramifications for this change which will be much further reaching that just the wealthiest Canadians.

Passive Income

Every business owner knows that there are good times and bad times. As you grow your business as a sole proprietor every dollar you earn in the year is taxed. Eventually your business grows to a point where you don’t need every penny earned to live off of. A corporation allows you to take only what you need and leave the rest of the money in the corporation to be taken in leaner times or reinvested back into the business.

The government is concerned that this money is being used for retirement saving and not business growth as it was intended for. They claim this will not impact smaller businesses as the money can be invested in Tax Free Savings Accounts (TFSA) and Registered Retirement Plans (RRSP) instead. The problem with this type of thinking, is that it ignores why small business owners have passive investment income in the first place. While there is a tax deferral on the initial capital, the passive investment income is already taxed at a higher tax rate, and will be taxed again when the money is taken out of the corporation. The problem with using RRSPs, is that there are large penalties for withdrawing the funds when needed and TFSAs don’t have enough room for a lot of companies (especially if also used for personal savings). So yes, if by some miracle there is no economic downturn, the money will eventually fund the business owner’s retirement. However, the money needs to accessible if something does go wrong.

Indirect Impacts

The other issue is the indirect affect these changes will have on individuals and other small businesses. Increased taxes lead to less spending and hiring. If passive investing stops, investments in small start ups decrease. Doctors facing higher taxation in Canada may choose to move to countries with better taxation resulting in poorer healthcare for all Canadians. And I must admit my bias as these changes will deeply impact the advice that I can offer to my clients for tax minimization strategies.

The Langley Chamber of Commerce has a great template if you would like to write to your MLA. Only a few days left for consultation.