On July 18, 2017, Finance Minister Morneau announced changes to the Canadian tax system. The announced changes were marketed at being aimed at improving fairness in the tax system. The announcement targeted the following:
- Income (dividend) sprinkling and multiplying the lifetime capital gains exemption (LCGE);
- Converting dividend income into capital gains (known as “surplus stripping); and
- Passive investment income earned by a Canadian controlled private corporation (CCPC).
The government held a “consultation period” until October 2, 2017, during which it solicited feedback from the public, interested groups, and tax practitioners.
The proposed changes were not well-received and after the consultation period, the government released an update.
In mid-October 2017, the government announced that:
- It would not move forward with the measures targeted at the LCGE (http://www.fin.gc.ca/n17/17-097-eng.asp)
- It would “simplify” the measures targeted at income sprinkling (http://www.fin.gc.ca/n17/17-097-eng.asp)
- It would not move forward with the measures “relating to the conversion of income into capital” (http://www.fin.gc.ca/n17/17-100-eng.asp)
- It would proceed with measures to limit investments in private companies (http://www.fin.gc.ca/n17/17-099-eng.asp)
On December 13, 2017, the government released revised draft legislation with respect to income sprinkling. The new rules with respect to the tax on split income (TOSI) regime are proposed to be in effect as of January 1, 2018. Click here for a technical analysis of the legislation.
General Overview of the New TOSI Regime
The TOSI rules apply the highest marginal rate of personal tax on income that is “split income” received by a “specified individual” (effectively, all Canadian residents, with a few exceptions). An example of “split income” would be a dividend received from a private corporation. An amount that is an “excluded amount” is not subject to TOSI.
An “excluded amount” includes the following:
- Amounts received by individuals 18 or older from a business that is not a “related business;”
- Amounts received by an owner’s spouse, provided that the owner meaningfully contributed to the business for, at least, 5 years and is 65 or older;
- Amounts received by individuals 18 or older who are engaged on a “regular, continuous and substantial basis” in the activities of the business during the business year or the part of the year in which the business operates or during any five previous years (note that once the five-year test is met, it is met forever regardless of future involvement);
- Individuals 24 years or older and who directly own 10 percent of the votes and value of a corporation that earns less than 90 percent of its income from the provision of services. The corporation cannot be a professional corporation. Taxpayers will have until the end of 2018 to comply with the 10 percent of the votes and value condition;
- Income or taxable capital gains from the disposition of certain inherited property received by individuals under 25;
- A taxable capital gain that arises on the deemed disposition of property as a result of death;
- Taxable capital gains arising from the disposition of shares that qualify for the lifetime capital gains exemption;
- Income from property acquired as a result of a separation or divorce.
Where an amount is not an “excluded amount,” TOSI can be reduced in some cases having regard to the capital contributed by the individual to the business, and in some cases, having regard to:
- The work performed;
- The property contributed;
- The risks assumed;
- Amounts already received; and
- Other relevant factors.
New Regime for Passive Investment Income
The government has not released any draft legislation with respect to how passive income will be taxed differently. The government is considering approaches that meet the following conditions:
- “Preserving the intent of lower tax rates on active business income earned by corporations, which is to encourage growth and job creation”; and
- “Eliminating the tax-assisted financial advantages of investing passively through a private corporation and ensuring that no new avenues for avoidance are introduced.”
In its October 18, 2017 announcement, the government explained that it would proceed with the new regime for passive investment income, but “reassured” taxpayers that:
- All past investments and the income earned from those investments will be protected;
- Businesses can continue to save for contingencies or future investments in growth;
- There will be a $50,000 threshold on passive income in a year (=$1,000,000 in savings, based on a nominal 5% rate of return); and
- Incentives will be developed to ensure that Canada’s venture capital and angel investors can continue to invest.