Private Company Tax Proposals Now What? November 22, PDF Free Download

Private Company Tax Proposals Now What? November 22, 2017

Welcome Introduction STEVEN CARREIRO Tax Partner KPMG LLP Private Company Consultation Paper How Potential Tax Policy Changes May Impact You and Your Business Q&A 2

Introduction Private Company Proposals Now What? 3

Agenda 1. Income Sprinkling: Tax on Split Income ( TOSI ) 2. Lifetime Capital Gains Exemption ( LCGE ) 3. Conversion of Income into Capital Gains (Surplus Stripping) 4. Holding Passive Investments in Private Corporations 4

Income Sprinkling: Tax on Split Income ( TOSI )

Typical income sprinkling structure FOUNDER FAMILY TRUST Beneficiaries: Founder Spouse Children Other? Fixed value preferred shares Common shares Dividends OPCO 6

TOSI rules are coming Current Rules Current rules limit the ability to split income with minor children (known as kiddie tax ), but allow some income splitting among adult family members For example, dividends paid to family trusts allocated to minors are subject to tax at the top marginal rate on split income Dividends can be paid on shares, through family trusts, to adult family members who are in a lower tax bracket Rules Proposed on July 18, 2017 The proposals extend the rules to adults any Canadian resident with a connection to a private company (regardless of age) can be subject to the TOSI rules More types of income will be subject to tax at the top rate (e.g., interest on loans and reinvested income ( compound income )) For adults, any split income that exceeds what an arm s length party would pay, will be considered unreasonable, and taxed at the top rate Where We Are Now On October 16, 2017, Finance confirmed that it will move forward with measures to limit income sprinkling, effective January 1, 2018 Finance said it will simplify the proposals and businesses with family members who meaningfully contribute to the business will not be impacted 8

Next steps In advance of December 31, 2017, taxpayers should: 1. Consider paying dividends in 2017 the last chance to sprinkle income with family members not active in the business, who may not meet new reasonableness tests in the future. 2. Calculate safe income for any inter-corporate dividends 3. Review prescribed rate loan arrangements and relationships with lenders 4. Gather facts, information and support for family members who contribute to the family business to satisfy the reasonableness test a portion of income may be reasonable (and a portion not reasonable) 5. Review compensation plans and pay a reasonable salary to family members who are employed by the family business 9

Lifetime Capital Gains Exemption ( LCGE )

LCGE opportunities remain Current Rules Individuals have an LCGE of $835,716 (2017), indexed annually for qualified small business corporation ( QSBC ) shares, and $1,000,000 for qualified farming/fishing property ( QFP ) If multiple family members own shares of a QSBC or QFP so that when shares are sold, each family member who owns qualified property can use their LCGE to shelter taxes otherwise payable on the gain Where We Are Now On October 16, 2017, Finance confirmed that it will not move forward with measures that limit access to the LCGE Rules Proposed on July 18, 2017 The government proposed several measures to restrict LCGE claims for dispositions made after December 31, 2017 The measures included denial of LCGE for minors, for gains that accrued prior to the year in which the shareholder turns 18, for gains that accrued while held by a trust, among others No LCGE for amount included in the individual s split income under the proposed TOSI rules if the individual is 18 or older Transitional provisions were introduced to provide relief, such as a new 2018 election 11

Next steps Taxpayers should: 1. Consider taking steps to access the LCGE, to take advantage of the current crystallization opportunity Watch out for alternative minimum tax 2. This means reviewing ownership structures, trust deed, share registers, fair market value of the assets of the business, accrued gains on the shares, and family members tax attributes, among others 12

Conversion of Income into Capital Gains (Surplus Stripping)

Dividends or Capital Gains? Individuals and family trusts owning private companies 2017 marginal tax rate on capital gains is lower than dividends Capital gains Eligible dividends Difference Non eligible dividends Difference British Columbia 23.85% 31.30% 7.45% 40.95% 17.10% Alberta 24.00% 31.71% 7.71% 41.29% 17.29% Saskatchewan 23.88% 30.33% 6.45% 39.62% 15.74% Manitoba 25.20% 37.79% 12.59% 45.74% 20.54% Ontario 26.76% 39.34% 12.58% 45.30% 18.54% Quebec 26.65% 39.83% 13.18% 43.84% 17.19% New Brunswick 26.65% 33.51% 6.86% 46.25% 19.60% Nova Scotia 27.00% 41.58% 14.58% 46.97% 19.97% Prince Edward Island 25.69% 34.23% 8.54% 43.87% 18.18% Newfoundland and Labrador 25.65% 42.62% 16.97% 43.62% 17.97% 14

Non-arm s length property transfers Current Rules Where current anti-surplus stripping rules apply, the tax cost of shares on a non-arm s length transfer is reduced Current rules apply to specific situations, but if the transferor realizes a taxable capital gain on the transfer and did not claim their LCGE, the transferee will generally have a high tax cost on the assets transferred Rules Proposed on July 18, 2017 Broadens the rules for the tax cost reduction where there is a non-arm s length transfer of property Many events and transactions (including in the case of death) can result in double tax a taxable capital gain for the transferor and a deemed dividend for the transferee on future non-arm s length transfers Where We Are Now On October 19, 2017, Finance confirmed that it will not move forward with measures relating to the conversion of income into capital gains Pipeline planning is still available Finance is still considering rules 15

Intergenerational transfer of family business 1. On October 19, 2017, cancelled its July 18 proposals 2. In the coming year, it will continue its outreach to farmers, fishers and other business owners to develop proposals to better accommodate intergenerational transfers of businesses 16

What about paying capital dividends? Current Rules Specific anti-avoidance rule can apply to deny tax benefits on capital dividend distributions if the share, on which the capital dividend is paid, was acquired and one of the main purposes of the acquisition was to receive the capital dividend If the anti-avoidance rule applies, the tax rate on the dividends would increase from 0% to as high as 47% (depending on the residence of the dividend recipient) Rules Proposed on July 18, 2017 Proposed a new anti-avoidance provision whereby an individual may be deemed to receive a taxable dividend instead of a taxfree capital dividend The draft legislation was very broadreaching and could apply to the existing capital dividend account balance, raising a significant uncertainty on capital dividend distributions The capital dividend account balance of the payer corporation would not be reinstated, resulting in double tax Where We Are Now On October 19, 2017, Finance confirmed that it will not move forward with measures relating to the conversion of income into capital gains 17

Next steps Taxpayers should: 1. Consider paying out capital dividends this requires filing an election with a director s resolution and calculation of capital dividend account balance 2. Review post-mortem planning options available and revisit estate plans, divestiture plans, retirement plans and succession plans 18

Holding Passive Investments in Private Corporations

What we know so far Rules Proposed on July 18, 2017 The government proposed numerous measures to significantly increase effective tax rates for investment income earned by private corporations For example, the effective tax rates for Ontario residents on capital gains earned by a corporation would increase from 28% to 59%, and on investment income from 56% to 73% Capital gains realized by private corporations may not increase the corporation s capital dividend account balance Need to track tax balances and compare results under several methods, which will also increase complexities and compliance burdens Where We Are Now On October 18, 2017, Finance confirmed that it will move forward with measures to limit the tax benefits of earning passive income within private corporations According to Finance, the rules will apply on a go-forward basis and income from existing investments will not be impacted Finance introduced a threshold for passive income of $50,000 per year no tax increase on investment income below this threshold Commitment to work with venture capital and angel investment sectors, and proposed rules will not apply to AgriInvest Insufficient detail provided draft legislation will be released as part of Budget 2018 20

Proposed methods Active Income Passive Income Dividend Distributions Current SBD eligible Refundable tax (refunded when taxable dividends are paid) Apportionment SBD eligible No refundable tax Elective default SBD eligible No refundable tax Generally as non-eligible dividends A portion eligible and a portion non-eligible Generally as non-eligible dividends Elective elected No SBD No refundable tax As eligible dividends Passive investment company election All income is taxed as passive income Refundable tax (refunded when taxable dividends are paid) Generally as non-eligible dividends 21

Many unknowns There are many unanswered questions, for example: How will unrealized accrued gains on passive and active investments be taxed? How will grandfathering work and when will the new rules begin to apply? How to save for contingencies? How will the $50,000 threshold be applied to related or associated corporations? How much administration will be required in managing and complying with the proposed regime? Stay tuned for budget 2018! 22

Next steps Be prepared and ready to make decisions when more information becomes available. We suggest taxpayers: 1. Gather relevant tax information (e.g. tax balances, safe income, etc.) and ensure it is accurate and up-to-date 2. Review corporate structure and location of passive investments 3. Don t rush into anything need to review rules once released 23

Thank you

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