Tax Alert - Passive Investment Income: Striking a Balance

October 2017

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In response to considerable public opposition, the government revealed more changes to their controversial July 18 proposals on private company tax planning. On October 18, Finance Minister Bill Morneau issued an announcement outlining how he intends to proceed with changes to how passive income earned in private companies is taxed. This was seen by many as the most controversial feature of the original proposals and this announcement includes significant relief from these proposals that will benefit many private businesses.

October 18 Developments

The government intends to move forward with measures proposed on July 18 to limit the tax deferral benefits of passive investments in private corporations. However, the government reinforced that it intends to balance this intention with its commitment to provide flexibility for small business owners.

Most significantly, they have announced a maximum threshold of $50,000 of investment income per year that can be earned in a corporation that will not be subject to the new regime as it will continue to be subject to the current refundable tax system. The government estimates that this threshold represents approximately $1,000,000 in invested assets, using an assumed 5 percent rate of return. However, there is no indication of how the $50,000 will be determined – for example, will the full capital gain on sale of securities be included, or 50 percent of such a gain?

This threshold is meant to provide flexibility for small business owners to hold savings for multiple purposes such as sick leave, parental leave, an economic downturn or retirement.

The government gave reassurances to business owners who have significant investments in passive assets in corporations that the new rules will be prospective and will apply to new investments only. That is, income earned on existing assets will not be affected.

The government will release draft legislation as part of its 2018 federal budget. However, there is no indication of an effective date of the new proposals.

The government also wants to ensure that incentives are maintained for Canada’s venture capitalists and angel investors. The government will consult with the venture capital and angel investment sectors to identify how this might be best achieved. As well, it is also considering the appropriate scope of measures as they relate to capital gains, specifically whether capital gains realized on the sale of shares of a corporation engaged in an active business might be excluded from the new rules.

The government stated that it will ensure that the proposed changes to passive investments will not apply to income from AgriInvest.

Why the Government is Making This Change

As discussed in our Tax Alert, A detailed review: The government’s private company consultation paper, the current system allows for a tax deferral of the individual tax payable if the shareholder leaves funds in the corporation. The government believes that this tax deferral results in a significant tax advantage to owners of private corporations. For example, assuming a small business tax rate of 15 percent applies, an individual earning active business income of $100 in their private corporation would have $85 after-tax to invest passively if those funds are retained in the corporation. In contrast, if an individual earned the same $100 as salary, assuming they are subject to a high personal tax rate of 50 percent, they would have $50 after-tax to invest personally. The government believes that the additional $35 of capital available to corporate owners to invest in passive investments when using a corporation results in a significant advantage that grows over time.

Summary

Small business owners can be assured of a safe-harbour amount of investment income. Corporations with investments in passive assets that generate no more than $50,000 per year of investment income will continue to be taxed under the existing tax regime and will not be subject to the proposed new regime. We will need to wait until the 2018 federal budget for further details on how income over that threshold will be taxed.

We are committed to keeping you updated on issues around the private corporation tax changes. Once the final legislation is announced we will host a webinar to outline the impact of the changes and provide planning opportunities.

View all of BDO's related content in our Private Corporation Tax Changes Round-up resource.

BDO Can Help

Please contact one of our trusted Tax advisors at BDO Canada to gain more information on the July proposals and the October revisions and to help you with your private company tax planning.

Dave Walsh
Partner, Tax Service Line Leader

Rachel Gervais
Partner, GTA Group Tax Service Line Leader

Peter Routly
Partner, Central Group Tax Service Line Leader

Daryl Maduke
Partner, West Group Tax Service Line Leader

Shelley Smith
Partner, East Group Tax Service Line Leader

Learn more about BDO's Canadian Tax Services today.


The information in this publication is current as of October 18, 2017.

This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.