Canada’s Proposed Tax Changes - What Entrepreneurs Need to Know

There’s been a lot of chatter about the proposed tax changes for Canadian corporations but like most things tax-related, it isn’t exactly quick and easy to get the skinny on the impacts your business may face.

Not to worry, Avalon is here to explain the three most important things you need to know about these changes:

1. Families that split income together may pay more tax together too

Income Splitting Today: Vivian is a dentist, she operates her business through a Canadian corporation. When she incorporated, Vivian was advised that it would be good tax planning to issue some shares to her husband Phil as well as her adult children Hilary and Carlton. Each year, she could save taxes by splitting the income that the corporation earns between her family members who would then pay less tax on this income at their lower marginal tax rates. 

Income Splitting Under The New Rules: Vivian can still pay dividends to her family members out of the corporation, but Phil, Hilary and Carlton will have to prove that this income is reasonable for work that they have actually done in the business. If they can’t, they will pay tax on the dividends at the highest marginal rate.

2. Passive investments ain’t what they used to be

Passive Investments in a Corporation Today: George Michael runs a very successful chain of fruit stands.The corporation earns enough to pay all of its bills, George Michael’s hefty salary, and corporate income taxes. There’s also a large amount of cash leftover that George Michael would like to invest in passive investments such as stocks or private companies that are unrelated to his operations. By keeping the investment inside his company, George Michael avoids paying any personal tax on these funds until he wants to take the money out of the corporation at some future date.  

Passive Investments Under The New Rules: The government would tax the passive investment income of private corporations at the top personal tax rate. This completely removes the tax-deferring advantages of passive corporate investments.

3. The Dividend and the Capital Gain

Corporate Capital Gains Today: Harvey has a successful legal practice. His accountant has used tax planning strategies to distribute the after-tax earnings of his corporation as capital gains instead of as dividends. Why you ask? Capital gains are generally taxed at a lower rate than dividends paid out of a Canadian private corporation so there can be a significant tax benefit.

Corporate Capital Gains Under The New Rules: The proposed changes aim to reduce Canadian business owners’ ability to use these tax planning strategies.

So What Does it all Mean?

The Bad News: If your business currently uses any of the three strategies, it’s possible that you will see an increase in overall tax burden when the changes come into effect in 2018.

The Good News: There are other tax planning methods that can can help you reduce your taxes. Hooray!

The Really Good News: There are so many benefits to operating a business in Canada through a corporation. Stay tuned! We’ll tell you more.

Need some advice about your corporation? Thinking of incorporating? Let’s Chat!