Income sprinkling and passive investments held inside a private corporation
The Liberal government released the new proposals on income sprinkling and passive investments held inside a private corporation. Based on our analysis, income splitting with your spouse is going to be seriously impacted by these changes.
With these new changes, we are now recommending that if you were planning on paying dividends to a non-active spouse or adult child, you should do that before December 31, 2017.
The $50,000 annual investment income threshold previously announced remains unchanged. However, investment income in excess of this limit will be subject to much higher taxes.
The following is a more detailed summary. Please do not hesitate to contact us if you have any questions.
Guidance on the application of the split income rules for adults
The Department of Finance consultation paper, Tax Planning Using Private Corporations, released on July 18, 2017, included proposed amendments to expand the existing tax on split income to restrict income sprinkling involving adult individuals. The consultation period for public comments on the paper ended on October 2, 2017. Based on the comments received during that period, revised draft legislative proposals were released on December 13, 2017 (the “Proposals”). These new rules are proposed to be applicable to the 2018 and subsequent taxation years.
The Proposals will expand the tax on split income to amounts received by an adult individual. In this context, “split income” will generally include dividends or interest, but not salary, paid by a private corporation directly or indirectly to an individual from a related business (“Related Business”) in respect of the individual and certain capital gains unless the amount falls within a specific exclusion (the “Excluded Amount” or “Excluded Amounts”).
Under the Proposals, the following will be Excluded Amounts from split income:
- For adult individuals – amounts received from an excluded business (“Excluded Business”):
- Excluded Business: amounts derived from a Related Business where the individual was actively engaged on a regular, continuous and substantial basis (“Actively Engaged”) in the activities of the business in the taxation year or in any five prior taxation years of the individual.
- An individual will be deemed to be Actively Engaged if the individual works in the business at least an average of 20 hours per week during the portion of the taxation year of the individual that the business operates, or meets that requirement for any five prior years. The five taxation years need not be consecutive. In any other case, whether an individual is Actively Engaged will depend on the facts and circumstances of that case.
- For individuals age 25 or over – income from or taxable capital gain from the disposition of excluded shares (“Excluded Shares”) or a payment that qualifies as a reasonable return (“Reasonable Return”):
- Excluded Shares: shares of a corporation owned by an individual are excluded shares where:
- less than 90% of the corporation’s business income was from the provision of services and the corporation is not a professional corporation;
- the shares represent 10% or more of the votes and value of the corporation; and
- all or substantially all of the income of the corporation is not derived from another Related Business in respect of the individual, and
- Reasonable Return: payments that represent a reasonable return based on the following criteria (the “Reasonableness Criteria”):
- the work performed in support of the Related Business;
- the property contributed directly or indirectly in support of the Related Business;
- the risks assumed in respect of the Related Business;
- the total amounts paid or payable by any person or partnership to or for the benefit of the individual in respect of the Related Business; and
- such other factors that may be relevant.
- For more information, see the Reasonableness Criteria section.
- For individuals between the age of 18 and 24 – return on property contributed in support of a Related Business that is a safe harbour capital return (“Safe Harbour Capital Return”) or a Reasonable Return having regard only to contributions of arm’s length capital to the business (“Arm’s Length Capital”):
- Safe Harbour Capital Return: return on property contributed by the individual in support of the Related Business provided that such return does not exceed a prescribed capital return determined by formula, and
- Arm’s Length Capital: property of an individual, other than property that is derived from property income in respect of a Related Business, that is borrowed under a loan, or that is transferred from a related person (other than inherited property).
- For any individual – taxable capital gains realized on death or from the disposition of qualified farm or fishing property and qualified small business corporation shares.
Where the individual acquired a property as a consequence of the death of another individual, special rules will apply for determining whether a payment from property is derived from an Excluded Business in respect of an individual, is a Reasonable Return on contributions made to a Related Business or is income from, or a taxable capital gain from the disposition of, Excluded Shares.
Please contact any one of the partners if you have any questions.