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Improving Fairness in the Tax System by Closing Loopholes and Addressing Tax Planning Strategies

The impact of proposed changes to those with Private Corporations, Family Trusts

On July 18, 2017, the federal Liberal government released a consultation paper on proposed tax measures designed to close tax advantages used by certain high-income Canadians. This consultation paper follows their commitment in the March 2017 federal budget “to crack down on tax avoidance and evasion.”

Specifically, the proposed measures are targeted at high-income Canadians who use private corporations for income sprinkling, accumulating passive investment income and converting income into capital gains.

Who could be affected?
• Individuals and families who own private corporations and are using advanced tax-planning strategies to reduce income tax.
• Investors who have specific questions about the potential impact should seek advice and contact us.

What is the government focusing on?

1. Income-splitting using private corporations

Perceived benefit: Shifting income that would otherwise be realized by a high-income individual to family members who are subject to lower personal tax rates (e.g., via dividends or multiplication of the life-time capital gains exemption (LCGE)).

Proposed measure: Extend the existing “tax on split income” rules that previously applied to minors to certain adult individuals. In addition, the measures would expand the types of income that are considered to be split income to include income from debts of private corporations, gains from dispositions of split-income properties and income from compounding of previous split income.

In addition, an individual would no longer qualify for the LCGE in respect of capital gains that are realized, or that accrue, before the taxation year in which the individual attains the age of 18 years. Also, there will be restrictions on using the LCGE for gains accruing through family trusts.

2. Holding a passive investment portfolio inside a private corporation

Perceived benefit: Corporate income tax rates, which are generally much lower than personal rates, may facilitate the accumulation of earnings that can be invested in a passive portfolio, providing the owner with a significant tax deferral advantage.

Proposed measure: The government is considering changes such that investments held within corporations are taxed at the same effective rate as investments held directly. According to the government, the tax advantage conferred on private corporations – the lower rate of tax –was never intended to be used to realize higher personal savings.

3. Converting a private corporation’s regular income into capital gain

Perceived benefit: Shareholders of private corporations with higher incomes can obtain a significant tax benefit if they successfully convert corporate surplus that should be taxable as dividends, or as salary, into lower-taxed capital gains (such conversions are commonly referred to as “surplus stripping”). Through certain complex tax planning strategies, some shareholders have been able to circumvent the anti-avoidance rules that are in place to disallow surplus stripping.

Proposed measure: The government has proposed complex changes to extend and add new anti-avoidance rules to further disallow surplus stripping of this kind. Generally, these new rules are intended to prevent individual taxpayers from using non-arm’s length transactions that “step up” the cost base of shares of a corporation, or from stripping surplus through transactions involving non-share consideration.

What are the next steps?

No decision, consultation only: Over the next 72 days, until October 2, 2017, the government will accept submissions and comments from Canadians. Those interested in having their say should submit their comments to fin.consultation.fin@canada.ca

Arbutus Financial along with our consulting partners will continue to closely monitor this situation and share developments as they occur.

If you’d like to discuss this topic in greater detail or have any questions, please reach out to a member of your Arbutus Financial Team.

Reference sources: CPA association, Fidelity tax and retirement group, Manulife Financial tax and estate group, Globe and Mail