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 Passive Investment and Income Sprinkling measures.
Passive Investment Income
Under the current rules, a private corporation can accumulate earnings and make passive investments. This allows for a tax deferral opportunity as the income is subject to the corporate tax return rate and not taxed to the owner-manager of the company until it is paid out of the corporation. The Government has proposed measures to limit this deferral opportunity.
On October 18, 2017, the Minister of Finance announced:
“The Government is moving forward with measures to limit the deferral benefits of passive investments within private corporations while:
- Ensuring that investments already made by private corporations’ owners, including the future income earned from such investments, are protected. The measures will only apply on a go-forward basis;
- Protecting the ability of businesses to save the funds they need for contingencies or future investments, such as the purchase of equipment, hiring and training of staff or business expansion;
- Including a passive income threshold of $50,000 per year for future, go-forward investments (equivalent to $1 million in savings based on a nominal 5 per cent rate of return) to provide more flexibility for business owners to hold savings for multiple purposes, including savings that can later be used for personal benefits such as sick leave, parental leave, or retirement. There will be no tax increase on investment income below this threshold; and
- Ensuring that as the Government moves forward with tax changes, incentives are maintained so that Canada’s venture capital and angel investors can continue to invest in the next generation of Canadian innovation. The Government will work with the venture capital and angel investment sectors to identify how this can be best achieved.”
What private corporations need to do now
Draft legislation will be released as part of Budget 2018 so there is still some uncertainty as what the final rules will look like. The measures would apply on a go forward basis.
The exclusion of passive income of up to $50,000 per year is equivalent to a $1 million in savings based on a nominal 5% rate of return. If your company has significant passive investments, then you need to prepare for an increase in record keeping in order to track the stream of investment income that is excluded and the stream that would be taxed at a higher tax rate.
Given the uncertainty of the final rules, it is likely not worth the risk at this point to try and take any steps to increase the investment portfolio or borrow to invest more.
This information is of a general nature and professional advice should be obtained regarding a taxpayer’s particular tax position and circumstances.