Implications of the Government’s Consultation Paper on Professionals Using Private Corporations

September 2017

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Changes proposed in the federal government’s recent consultation paper, “Tax Planning Using Private Corporations”, could have significant implications for the use of private corporations by professionals. The proposed changes are designed to close loopholes and address perceived issues of fairness in three main areas:

  1. Income splitting with family members to reduce the total family tax burden.
  2. Passive investment portfolios owned by private corporations.
  3. Strategies that convert regular or dividend income into capital gains.

Each of these areas may potentially impact the many Canadian professionals who use private corporations as a legitimate way to manage their income while deferring and reducing their total tax burden.

Changes to private corporation investments

Under the current system, many professionals use private corporations as a form of tax deferral. The reasons for this are clear: corporate tax rates have been falling, while personal tax rates have been trending upward. For many professionals, especially those in the higher tax brackets, use of a private corporation to help defer the total tax burden has been an obvious solution.

When income is earned through a corporation and taxed at the appropriate corporate tax rate—generally between 10.5 and 15 percent for the small business rate and 26 to 31 percent for the top corporate rate, depending on the province or territory, rather than a 50 percent personal marginal tax rate—the amount that the shareholder retains in the corporation can be used for investment purposes. This allows professionals to use after-tax corporate dollars rather than after-tax personal dollars for passive investment purposes. Under the existing rules, refundable taxes apply to passive income earned in a corporation such that the tax paid by the corporation is roughly the same as would be paid personally. The refundable taxes are then refunded to the corporation on payment of shareholder dividends.

The government’s position is that this corporate investment strategy is unfair to Canadian taxpayers, as it allows professionals with private corporations to retain and invest more than individuals who are employees, due to the difference in after-tax profits at the corporate level that is available for investment as compared to the after-tax profits available if the income had been taxed at the top personal marginal tax rates. This disparity could also grow over time due to the returns from company-held passive investments, compounding the perceived advantage. The proposed changes attempt to mitigate these advantages to ensure that a professional working through a private corporation has the same economic advantages as an employee earning the same income, regardless of sweat equity, risks, or key differences in circumstances that make business owners and employees distinct groups.

Impact of elimination of tax deferral strategies

With the reduction or elimination of the described tax deferral strategy, use of a private corporation will become much less useful or tax-efficient for many professionals. One result could be that professional corporations may become a thing of the past, or used only in very specific situations.

Tax deferral and planning considerations

Within the scope of what is currently proposed, there may still be ways to achieve a tax deferral using a private corporation. One such method is the use of individual pension plans, held by the corporation for the employee. An individual pension plan is similar to an RRSP, but in certain circumstances could allow a greater deferral of tax relating to the amounts contributed to the plan.

Addressing income splitting

Income splitting is a commonly used method of transferring income by way of paying corporate dividends to lower-income family shareholders in order to reduce the total family tax burden. While there are already rules in place to limit the ability to split income with minor children, the government is now taking steps to further limit the usefulness of this approach by taxing these funds at the top marginal personal tax rates.

Income splitting is not available to professional accountants or lawyers in all provinces, but this proposed change would affect other professionals who use private corporations, such as doctors. It is important to note that eligibility of who can have shares in a professional corporation depends on provincial rules. According to the current rules, for example, a doctor could pay corporate tax (ranging between 10.5 and 31 percent), then be able to pay dividends out to low-income family members. In some situations, this could result in paying no more tax at all, whereas if the doctor themselves received that money they would likely pay tax at the top personal tax rates on this income.

The government proposals are designed to stop income splitting with all low income adult family members, such as a spouse, or an adult child who is attending university.

Navigating the changes

There are a number of recommendations that professionals using private corporations may want to consider in advance of potential changes in 2018. Professionals should look to employ the tools available to them right now. Planning recommendations to consider include:

  1. Adjust cash flow and investment strategies in the short term. Professionals should reconsider their short-term compensation strategies related to their private corporation in light of the government proposals.
  2. Use income splitting while you can. Professionals who already use income splitting or for whom income splitting is an option are encouraged to take full advantage of the lower personal tax rates of family members for 2017 that are allowed within the current tax landscape.
  3. Reconsider incorporation. Depending on personal and business objectives, incorporation may no longer offer the most tax efficient structure. For professionals currently considering incorporating, it may be wise to hold off until greater clarity on the potential changes is made available.

Due the complexity involved in the proposed tax changes, there is no “one size fits all” strategy for all professionals that use private corporations. Incorporated professionals are strongly encouraged to reach out to their advisors to fully understand the potential impacts to their business, financial and tax planning.

Recommendations on how to provide feedback on the changes

As many of the proposals in the Department of Finance’s consultation paper came with detailed draft legislation, we can assume that many of these changes are likely to be enacted as is or with only minor modifications. The government solicited feedback, particularly regarding the treatment of passive income portfolios held within a private corporation. Interested and affected parties are strongly recommended to review all proposed changes. 

You can provide feedback by speaking to your advisors, professional organizations, and members of parliament.

The proposed changes will have far-reaching consequences for many professionals using private corporations, in 2018 and beyond. To better understand the impact to your personal financial planning and tax strategies, speak to your BDO advisor.

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

Contributors

Christina Arnold
Partner, Canadian Tax

Rachel Gervais
Partner, GTA Group Tax Service Line Leader & Transaction Tax Practice Leader


The information in this publication is current as of September 8, 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.