A plain language review of the proposed tax legislation

Transcription

1 A plain language review of the proposed tax legislation (and how it affects your clients) Wednesday October 11, :30-9:30am

2 Agenda 2 1 INTRO 5 TAX ON SPLIT INCOME 2 REVIEW OF POLICY CONCERNS 6 CAPITAL GAINS AND SURPLUS STRIPPING 3 PASSIVE INVESTMENTS 7 CONCLUSION 4 TRUST ACCOUNT NUMBERS 8 QUESTIONS

3 Introduction 3 In 2017 budget (March 22, 2017), the government indicated that they will identify and close tax loopholes and tax planning schemes that disproportionately favour the wealthy including tax planning strategies that involve private corporations. On July 18, 2017, the government released a consultation paper Tax Planning Using Private Corporations which generally addressed the following three concerns: Income sprinkling Surplus stripping Holding passive investments in a holding company The consultation paper included draft legislation to address income sprinkling and surplus stripping The consultation period ended October 2, 2017

4 4 Review of Policy Concerns

5 The policy concerns 5 Passive investments held in a private corporation Since corporate income is taxed at a lower rate, shareholder has more to invest (if left in corporation) than an employee Government compares employee to shareholder, and sees inequality in amount of after-tax money available to invest Income sprinkling Private corporations can pay dividends to family member shareholders in lower tax brackets Government data shows a spike of dividends paid to year olds Can lower a family s overall tax rate by using this planning Surplus stripping Shareholders of private companies are able to convert dividend income to capital gains through certain tax planning Capital gains have a lower tax rate than dividends In some circumstances, use of the lifetime capital gains exemption can result in no tax payable

6 6 Passive Investments

7 Passive Investments 7 Intention of the proposals is to eliminate any tax incentives for CCPC owners to retain earnings in a corporation to invest Eliminate the unfair advantage CCPC owners have over employees Example in the consultation paper compares and employee and a CCPC owner earning $100,000 in profit/salary The employee would pay tax of approximately 50% and have $50,000 to invest The CCPC would pay tax of approximately 15% and have $85,000 to invest Earning the same return, the CCPC owner would be better off, since they were able to invest a higher amount up front This is viewed by the government as being unfair

8 Passive Investments 8 There was no proposed legislation included to address this concern Finance described two possible approaches in the paper, and asked for comments Upfront tax: impose a tax on earnings that are used to acquire passive investments (similar to a Part V tax which existed in the 70 s but was repealed due in part to its complexity) Deferred tax: impose an additional tax on passive income earned in CCPC s to equate it to a rate earned personally Apportionment approach corporation would need to track source of income and assets being invested, and then taxed accordingly Elective approach corporation would subject to a default tax system (passive income would be subject to a higher tax rate) unless they elect otherwise

9 Passive Investments 9 This is what has been receiving a lot of press, and seems to be the focus of the publicity This is where the estimates of 73% tax (or higher) have come from Indications are that any new rules would grandfather existing investments Not sure how they would accomplish this Keep in mind that income splitting rules would still apply We will need to wait and see what the government does next This is an area that will increase the burden of compliance, reporting and tracking for CCPC s and their advisors, particularly accountants

10 10 Trust Account Numbers

11 Trust Account Numbers 11 Requirement for trusts to obtain an account number Government feels they can better track trusts this way If you have a client who is a trust, pays amounts to a trust, or receives an amount from a trust, you will need to obtain the trust s account number

12 12 Tax on Split Income

13 TOSI 13 TOSI = tax on split income Better known today as Kiddie Tax Generally, the scope of s has expanded to catch more types of income and related parties of any age (not just minors) New definitions have been added to 120.4, including: connected individual Related source Split portion If you have a client who receives distributions from a corporation, partnership or trust and a related person is involved with that corporation, partnership or trust, TOSI may apply

14 TOSI 14 There is no change to the general charging provision for TOSI, s.120.4(2): There shall be added to a specified individual s tax payable under this Part for a taxation year the highest individual percentage for the year multiplied by the individual s split income for the year What has significantly changed is the definition of specified individual and split income

15 TOSI Who is a Specified Individual 15 Canadian resident Is related to another individual who is a Canadian resident ( Joe ) If the individual is <18 years old, Joe is their parent; or If the individual is >17 years old, the individual s income includes and amount derived from a business carried on by: Joe A corporation in which Joe is a specified shareholder (owns 10% of any class of shares) or is a connected individual A partnership or trust where Joe is active in the business; or A partnership in which Joe has a direct or indirect interest

16 TOSI What is a Connected Individual 16 Joe is a connected individual of a corporation if: Joe controls the corporation (either alone or with a related group) Joe owns shares or other property the value of which is determined by reference to shares representing 10% of the value of the corporation s shares Joe is a regulated professional whose services are offered by the corporation and represent the primary source of business revenue to the corporation and Joe or a related person continues to own shares of the corporation Joe transferred assets to the corporation (directly or through another corporation) that represent 10% of the corporation s property in return for shares or debt which remain outstanding, or no consideration and Joe or a related person continues to own shares of the corporation

17 TOSI Who is a Specified 17 Individual For the purpose of this definition: aunts, uncles, nieces and nephews are related What does this mean? Anyone who receives income from a corporation, partnership or trust which involves a related family member (using the extended definition) could be caught Doesn t have to be an inactive family member (consider two siblings in business together)

18 TOSI Split Income 18 What is caught is split income split income does not include excluded amounts excluded amounts If individual <24 years old, amount received from property acquired as a consequence of death of a parent, or death of any person if the individual is in post-secondary studies or is eligible for the disability credit If individual 18 years old, is not a split portion What is caught split income (which includes a split portion )

19 TOSI Split Income 19 (a) taxable dividends or shareholder benefits (other than public company) (b) partnership income derived from related sources Provision of property/service by a person/partnership in support of a business carried on by a related person a corporation in which a related person is a specified shareholder a connected individual A business of a partnership/trust if a related person is actively engaged on a regular basis in the activities of the business or has an interest in the partnership Includes indirect provision of services (e.g. through a corporation or other partnership)

20 TOSI Split Income 20 (c) trust allocations that are derived from related sources (d) interest on debt obligations if For a debt obligation of a partnership/trust, the amount is derived from a related source or any other amount that would be split income For a debt obligation of a corporation, a related person is a specified shareholder, or is a connected individual of the corporation (e) taxable capital gain or profit from disposition of (i) private corporation shares; or (ii) an interest in a partnership or trust or debt obligation if an amount has been included in split income in the current year or previous year (or the property disposed of derives its value from shares of a private corporation)

21 TOSI Split Income 21 (f) income included as a result of s.246, and if the payment were made directly, it would be split income (g) for individuals <24 years old, income derived from split income, a benefit attributed to another person (s.56 or attribution provisions) or a capital dividend, if it would be split income if it were taxable Can apply to trusts earning income

22 TOSI Split Portion 22 Recall, if something is a split portion it is included in split income and taxed at the highest marginal rate If it is not a split portion, it is an excluded amount for those 18 years old, and therefore taxed at their normal graduated rates The definition of split portion is where the reasonableness test is factored in

23 TOSI What is a Split Portion 23 All income on income ((g) of split income definition) Gain on the sale of shares, partnership/trust interest, and would be split income if it were a taxable dividend or partnership or trust income derived from related sources ((e) of split income definition) In all other cases, if Paid by a corporation in which a related person is a connected individual or a partnership/trust if a related person is active in the business The amount exceeds what would have been paid/payable to an arm s-length recipient, having regard to: The functions performed by the individual to the extent that the individual is engaged in the activities of the business The assets contributed to support the business The risks assumed The total of all amounts paid to the individual in respect of the business

24 TOSI What is Reasonable? 24 When looking at the functions performed by the individual If the principal purpose of the business is to derive income from property, or 50% of the income of the business is derived from property, the individual is deemed not to have performed any functions If the individual 24 years old, consider functions performed only to the extent the individual is actively engaged on a regular, continuous and substantial basis When looking at the assets contributed to support the business: If the contributed assets are split income, or acquired in connection with a related person providing a guarantee or other financial assistance, the individual is deemed not to have contributed assets If the individual 24 years old, they can only realize a return equal to the prescribed rate

25 TOSI Capital Gains on Sales to Related 25 Parties Capital gains on sales of private company shares realized by an individual or trust on a sale to a non arms-length party are deemed to be taxable dividends Expanded s.120.4(4) and s.120.4(5) to all specified persons (no longer restricted to minors) For individuals 18 years old, dispositions prior to 2018 are not caught by this change Excluded amounts are not caught (so if the gain is reasonable, it would not be a split portion, and would therefore be an excluded amount

26 26 Capital Gains and Surplus Stripping

27 Income Sprinkling Capital Gains 27 Exemption In addition to TOSI, draft rules propose to limit income sprinkling through multiplication of capital gains exemption (CGE) CGE availability restricted on dispositions after 2017: Where trusts involved For minors and others subject to TOSI Transitional rules in 2018: Arm s length dispositions generally subject to existing rules One-time election available to crystallize CGE

28 CGE Qualifying Trusts 28 After 2017, only eligible LCGE trusts can allocate CGE-eligible gains to their beneficiaries There are two types of eligible LCGE trusts: Personal trusts that are spousal trusts or alter-ego trusts, where the allocation is to the particular spouse or individual Employee trusts established under subsection 7(2)

29 CGE Employee Trusts 29 A 7(2) employee trust is an eligible LCGE trust if: The trust distributes only shares of the issuing corporation or proceeds from the sale of such shares in the year All such distributions are made only to eligible employee beneficiaries of the trust (and no distributions are made to anyone who is not an eligible employee beneficiary ) Generally, employees whose interest in the trust qualifies for purposes of section 7 of the Act will be an eligible employee beneficiary, EXCEPT specified employees and those related to specified employees are not eligible employee beneficiaries connected individuals (see TOSI) and those related to connected individuals are not eligible employee beneficiaries

30 CGE After (12) lists gains that will no longer be eligible for CGE for dispositions after 2017 (a) All gains realized while a minor (b) Any gain allocated by an employees profit sharing plan (EPSP) (c) (with 110.6(12.1)(a)) Any gain accrued up to January 1 of the year in which the individual attains the age of 18 (d) Any gain that is or would be subject to TOSI, but for the fact that it is already taxed at the highest marginal rate (e) (with 110.6(12.1)(b)) If the property was held by a trust at January 1, 2018, any gain accruing while the property was held by a trust (f) (with 110.6(12.1)(c)) Any portion of the gain that is attributable to a distribution by a trust or to an exercise of discretion by a trustee

31 CGE After Notes on 110.6(12): A number of the exclusions require point-in-time value determinations January 1 of the year an individual turns 18 The date on which a trust rolls property out to a beneficiary Increases due to trust distributions or discretions The ownership of shares on January 1, 2018 is potentially significant If the owner is a trust If the owner is a minor If the owner is subject to TOSI Rules apply for dispositions after 2017, but do not appear to have application to amounts received after 2017 for dispositions that occur before 2018

32 CGE 2018 Transition (18): One-time election Available to individuals, all personal trusts and 7(2) employee trusts ( eligible taxpayer ) Available to minors but not for shares of corporations Available in respect of eligible property Election available to EPSPs (one-time alternative to existing EPSP election in section 144(4.2)) Must be made on or before due date for 2018 tax return Late-filing and amendment possible Amendment not available if elected amount exceeds fair market value by >10% Late-filing penalty amounts to 4%/a of the gain triggered, calculated monthly

33 CGE 2018 Transition 33 eligible property for the 2018 election Cannot be subject to attribution rules in 74.2, 74.3, 75, 75.1 (note: reversionary trust shares not eligible, even for settlor) Capital property of the taxpayer identified in the election Owned continuously by the taxpayer from the end of 2017 until the end of the date of deemed disposition ( disposition day ) (note: if election made in connection with arm s length sale, ensure election effective the day before) Would be qualifying property (shares, farm, fishing) if hold period and asset mix requirements were reduced from 24 months to 12 months

34 CGE 2018 Transition (18): Trusts and the election Additional requirements All taxable capital gains resulting from the election must be allocated to beneficiaries who are resident in Canada through the end of the beneficiary s taxation year Note: implications for beneficiaries who choose to emigrate during the year Beneficiaries must have been beneficiaries of the trust since the end of 2017 through the end of the disposition day Gain realized in the trust; allocation of gain must still be in accordance with the Act (paid or payable, etc.)

35 CGE 2018 Transition (18): Effect of the election Eligible property is deemed disposed of for greater of amount elected ( designated amount ) and adjusted cost base of the property and reacquired at the designated amount Note: potential grind to the extent that designated amount exceeds fair market value of the property TOSI and the new CGE limitations do not apply to the gain realized

36 CGE 2018 Transition 36 Sale by minor in 2018 Minors can claim CGE on sale of shares to arm s length party in 2018 Also applies to gains allocated by personal trust to a minor from arm s length sale in 2018 Same reduced hold and asset test period of 12 months, rather than 24

37 Surplus Stripping 37 Finance concerned with the conversion of corporate profits into capital gains by shareholders Amendments to 84.1 (existing specific anti-avoidance rule) Introduction of new (more general specific anti-avoidance rule) BOTH INTRODUCED EFFECTIVE JULY 18, 2017

38 Surplus Stripping 38 Section 84.1 Limits extraction of corporate surplus in a non-arm s length transfer to the greater of paid-up capital and hard cost base Hard cost base is any cost base other than ACB on which transferor or related party has claimed their CGE Change (effective JULY 18, 2017): no credit given for any cost base arising from gains realized by transferor or related party, whether or not CGE claimed

39 Surplus Stripping 39 Effects of changes to Section 84.1 Related party transfers more complex, less tax-effective than previously For example: Inter-generational business transfers Post-mortem pipeline planning

40 Surplus Stripping 40 New Conditions for application Canadian-resident individual Receives payment from non-arm s length party As part of a series of transactions in which property is disposed of or paid-up capital is increased or reduced One of the purposes is for a corporation to realize a significant reduction or disappearance of assets Tax otherwise payable by the individual is avoided

41 Surplus Stripping 41 New Effect of application Deemed dividend Payment received by individual is recharacterized as a taxable dividend CDA erosion If the recharacterized payment is a capital dividend received from a private corporation, the capital dividend account of the corporation is reduced by any capital gain realized by the corporation as part of the series

42 Surplus Stripping 42 New Comments Language extremely broad; could apply to: Payment of life insurance proceeds to controlling shareholder or estate of former controlling shareholder Distribution of asset sale proceeds where corporation controlled by shareholder or related group Finance has provided assurances that this is not the intention Generally, arm s length transactions should not be affected Realization of gains on investments, etc. not targeted

43 Conclusion 43

44 October 3, 2017 press release 44 Consultation period closed October 2, 2017 The government thanked the thousands of Canadians who engaged in this important discussion Canadians views are being carefully considered

45 October 3, 2017 Press release 45 Government will base its next steps on the following key principles: 1 Support small businesses and their contributions to our communities and economy. No mention of the recognition of risk. 2 Keep taxes low for small businesses, and support owners to actively invest in their growth, create jobs, strengthen entrepreneurship and grow our economy. No mention of allowing them to accumulate retirement savings in a fashion comparable to government employees. 3 Avoid creating unnecessary red tape for hard-working small businesses. Too late. 4

46 October 3, 2017 Press release 46 Government will base its next steps on the following key principles: 4 5 Recognize the importance of maintaining family farms, and work with Canadians to ensure we don t affect the transfer of a family business to the next generation. What about other businesses? Construction? Services? Why just farms? Conduct a gender-based analysis on finalized proposals, to ensure any changes to the tax system promote gender equality. About 83 percent of passive investment income is earned by Canadiancontrolled private corporation (CCPC) owners making more than $250,000. About 70 percent of these individuals are men. Equity or equality.

47 ANY QUESTIONS? 47

48 Contact LaBarge Weinstein s Tax Team 48 Suzanne Pellerin Dineen Beath Estelle Duez Paul LaBarge spellerin@lwlaw.com dbeath@lwlaw.com eduez@lwlaw.com pl@lwlaw.com Ext Ext Ext Ext. 201 /LaBarge-Weinstein /LaBargeWeinsteinLLP