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Understanding the New Tax Rules: Effective Tax Strategies for

Business Ownersby Jim Molyneux and David Thompson, MNP

New rules around income sprinkling and so-called passive income can translate into increased tax burdens

and fewer deductions for many busi-ness owners. The rules are complex and there is uncertainty and confusion as to how the rules will be applied by the Canada Revenue Agency (CRA) in various situations. Understanding the rules and adjusting tax strategies can help reduce the negative impact of the new rules and avoid pitfalls with CRA.

Tax on Split Income (Income Sprinkling)

Income sprinkling is a common practice

for incorporated small businesses where family members are granted shares of the company, including indirect own-ership that can occur through the use of a family trust. The corporation pays dividends to family members, “split-ting” the income and reducing the overall tax bite, allowing other family members to be taxed at a lower tax rate.

Under the new tax on split income (TOSI) rules, dividends paid from a private corporation to a family member can easily be ‘caught’ by the new rules. As a result, the dividends would be taxed at the top tax rate instead of a lower marginal tax rate.

However, exceptions to TOSI might

apply. The exceptions include:

a) Capital gains arising from the dis-position of shares of a qualified small business corporation (QSBC).

b) Income received by a spouse, if the spouse is 65 or older and they are not subject to TOSI themselves.

c) Income that is derived from an “excluded business” of the individual.A business qualifies as an excluded busi-ness of an individual if that individual is actively engaged on a regular, continuous and substantial basis in the activities of the business in either the current taxa-tion year, or, any five prior taxation years.

d) For shares inherited from a deceased individual by will, any income or gain on the shares would not be TOSI to the decedent.

As well, certain shares can qualify as “excluded shares” – and dividends paid on excluded shares are exempt from TOSI. Excluded shares include those owned by individuals aged 25 years or older who directly own at least 10 percent of the business (both votes and value). However, the company must meet certain conditions, includ-ing earning less than 90 percent of its income from providing services and not being shares of a professional corpora-tion (doctors, lawyers, dentists, etc.).

Can Family Trusts Still Provide Shelter?

Under the new TOSI rules, family trusts have come into question since shares have to be directly owned by a family member to meet the 10 per-cent ownership test and avoid TOSI.

If your family members did not meet the 10 percent votes and value test at the end of 2018, consider restructuring so that they can meet this test in the future. It may be a valuable exercise to undertake an estate freeze and to issue common shares directly to family members. This will allow all future growth of the corporation to attribute to shares owned by family members so they could eventually meet the 10 percent votes and value test and receive income in the future. Issuing shares to other family members should be considered only after reviewing poten-tial business issues that could arise.

Wherever Business Takes You

Business is a journey filled with twists and turns, risks and opportunities. When you’re wondering if you should stay the course or take a detour, we can help you plan the best route now and for wherever business takes you.

To find an advisor near you, contact Jim Molyneux, Regional Managing Partner for Peel Region, at 416.626.6000 or jim.molyneux@mnp.ca or visit MNP.ca

consumer feature

Jim Molyneux, CPA, CA is the

Regional Managing Partner for Peel

Region and David � ompson, CPA,

CA is a Partner, Taxation with MNP,

a leading Canadian accounting, tax

and consulting � rm. � ey can be

reached at 416.626.6000 or

jim.molyneux@mnp.ca or

dave.thompson@mnp.ca

And last, but defi nitely not least, an estate freeze with a family trust can continue to decrease estate tax of the ‘fi rst’ generation.

Passive Income, Tax on Business Income

Two other new rules now apply. Th e fi rst will restrict access to the low rate of tax on business income for those companies that also own investment assets and are earning investment income. Th e second relates to the treatment of refundable taxes on corporate investment income.

Th e small business deduction (SBD) is generally available on the fi rst $500,000 of active business income earned in Canada by a Canadian controlled private company. Th e resulting corpo-rate tax rate on income eligible for the SBD is 12.5 percent compared to 26.5 percent, the general corporate rate.

Business owners will see their access to the low rate of tax (SBD) reduced.

Under the new rules, the small busi-

ness limit of $500,000 is reduced by

fi ve dollars for every dollar of invest-

ment income earned above $50,000.

Th e reduction will start when passive

income in the company and its associ-

ated group reaches $50,000. Th e SBD is

eliminated once you exceed $150,000

in passive / investment income.

One way to keep the small business

deduction limit is to split up a joint

professional corporation to reduce the

passive income in each company to stay

below the $50,000 threshold. Th is can

work for practices co-owned by mar-

ried professionals (common among physicians, dentists or veterinarians).

Another strategy is to invest in assets that do not generate investment income, e.g., permanent life insur-ance. Income earned inside the policy is exempt from tax when it qualifi es as an exempt policy under the Income Tax Act. None of the income earned inside the policy counts towards the $50,000 per year threshold, which can allow you to preserve your SBD.

Next Steps

Th e recent changes to the tax rules

reduce, but do not eliminate, planning opportunities for business owners.

It is important you review your share structure with a trusted professional to determine if a corporate reorgani-zation should be considered. Poten-tial planning could include direct ownership of shares by other family members to allow for dividends to be paid to them without attract-ing high rate tax. Shares owned by a family trust could be distributed without tax to family members.

An estate freeze using a family trust is still viable. In this way, future growth can be transferred to the next generation and income (estate) tax on the growth can be deferred.

Meet with a trusted professional to determine what, if any, changes should be made to your corporate struc-ture to minimize your tax exposure and optimize tax opportunities.