Good news for business owners!
Last fall, the Federal government was proposing this some changes to how small businesses are taxed. Happily, the changes are minimal, but you may still be affected.
Passive Income
If you have passive income in a company, whether it’s interest or dividends, the first $50,000 has no impact on your taxes, with the exception being interest saved for general capital purposes.
The original suggestion was that this passive income was going to be taxed at higher rates, which isn’t fair for all industries.
For instance, EPC generates most of its income during the first four months of the year, but rent and salaries still have to be paid during the other eight months. It would be foolish for us not to put the income in an interest-generating savings account, so it doesn’t make sense to tax us on this.
As well the government hadn’t come up with a good way of figuring out how to tax this income – the proposed rules sounded complicated.
Canadian corporations have been eligible for the Small Business Deduction (SBD), which means that the first $500,000 in income was taxed at 15% as compared to the 26% tax that larger companies are taxed at.
What’s changing? For every $1 of passive income a corporation generates over $50,000, the government is clawing back $5 of income that is eligible for the SBD.
The reason the government is changing the rules of course, is to collect more taxes and it’s expected that by 2023, this will be bringing in upwards of $925M per year.
Income sprinkling
Income sprinkling is something that has been common among business owners. Effectively, a business owners transfers income to someone in their family who is taxed at a lower rate.
The rules around income sprinkling are only coming into effect for the tax year 2018, but if you’re paying dividends to your university-aged child, you’re going to want to change this practice.
The government is revising these rules so that income can only be transferred to someone who has been regularly involved in the business. The biggest challenge with income sprinkling is trying to figure out how deeply someone is involved in the business and these cases can go to court. The legislation doesn’t give a clear answer about how to prove somebody has been involved in the business and seems to have random exceptions.
We’ll have to wait and see what happens when someone with deeper pockets goes to court – perhaps the government will clear up the definitions and requirements.
The new rules are in effect as of January 1, but businesses have a year to become compliant. If you think you may be in the estimated 3% of business owners this legislation affects, or even if you’re just curious, please get in touch.