In July 2017 the Department of Finance proposed measures to change several tax planning strategies that are currently available to owners of private corporations in Canada. In October 2017, the Government announced that it is going ahead with the Income Sprinkling measures and Passive Investment measures.
When family members are issued same or different classes of shares in a Canadian private corporation and receive dividends based on those shares, this is considered a type of income splitting if those family members are not directly involved in the corporation.
On October 16, 2017, the Minister of Finance announced:
“the Government will be making changes to simplify the proposal to address income sprinkling, a strategy that can be used by high-income owners of Canadian-controlled private corporations (CCPCs) to lower their personal income taxes by sprinkling their income among family members who do not contribute to the business. Only an estimated 50,000 family-owned private businesses are sprinkling income. This represents only a small fraction – around 3 per cent – of CCPC owners. Businesses with family members who meaningfully contribute to the business will not be impacted.
The Government intends to move forward with measures to limit income sprinkling using private corporations, while ensuring that the rules will not impact businesses to the extent there are clear and meaningful contributions by spouses, children and other family members.”
The Government has stated:
“Specifically, the Government will introduce reasonableness tests for adult family members aged 18-24, as well as those 25 and older. These adults will be asked to demonstrate their contribution to the business based on four basic principles – whether they have made a contribution through any combination of the following:
- Labour contributions;
- Capital or equity contributions to the business;
- Taken on financial risks of the business, such as co-signing a loan or other debt; and/or
- Past contributions in respect to previous labour, capital or risks.
Throughout the consultation period the Government received feedback on the complexity of the proposed measures and potential unintended consequences. The Government also received feedback that the measures could create uncertainty in relation to how amounts received from a family business would be taxed. To address these concerns, the Government will simplify the proposed measures with the aim of providing greater certainty for family members who contribute to a family business. Specifically, the Government will work to reduce the compliance burden with respect to establishing the contributions of spouses and family members including labour, capital, risk and past contributions, better target the proposed rules, and address double taxation concerns.”
The Department of Finance has provided some examples.
The new proposed measures are effective January 1, 2018.
What private corporations need to do now
Revised draft legislation is slated to be released this fall, so there is still some uncertainty as what the final rules will look like.
However, in the meantime, if there are family members who are shareholders, then it would be a good idea to have formal job descriptions for those family members and determine what the company would pay a third party for the same duties. It may also be a good idea for these family members to keep time log or at least a weekly/monthly description of work done, as well as a summary of when they started in the business and past labour contributions.
Given the uncertainty of the final rules, it is probably not worth the risk at this point to pay more dividends then you are planning to in 2017.
This information is of a general nature and professional advice should be obtained regarding a taxpayer’s particular tax position and circumstances.