On July 18, 2017, the Department of Finance proposed changes to the following three areas of tax planning using private corporations:
- Income sprinkling (Splitting) with family members
- Holding passive investments inside a private corporation
- Converting income into capital gains (Surplus stripping)
Income sprinkling with family members
Many owners of private corporations benefit from tax saving by splitting their salaries or dividends to family members (Spouse and/or child) with lower personal tax rates.
The Department of Finance proposed that effective for 2018 and later any split salaries or dividends to family members with lower personal tax rates would be subject to a reasonableness test. Any split remuneration in excess of the reasonable amount will be tax at the high income earning individual tax rate.
Reasonableness proposals include: 1) labour contribution; 2) capital contribution; 3) financial risk; and 4) past contribution.
Holding passive investments inside a private corporation
The use of the corporate tax deferral to hold passive investments inside a corporation. Currently in Alberta, corporate business earns less than $500,000 pays tax rate at 12.5%, which is at a lower rate than personal income. This results in a tax deferral of up to 35.5%. This deferral leaves corporations more money to grow and invest. The government perceives is unfair that the retained money is not used to grow the company but to fund passive investments such as stocks, rental properties, etc. compare to unincorporated salaried person. The government is proposing to tax this deferral.
Converting income into capital gains
The proposals include various provisions to prevent tax plans that convert high-taxed dividend income into low-taxed capital gains.
After 75 days of consultation period, on October 16, October 18, and October 19, 2017, the Department of Finance issued news released of the following changes to the proposals of July 18, 2017 announced:
- The government will move forward the proposed income sprinkling with family members. The government will be tabling more clear guidelines on reasonableness test and compliance burden with respect to establishing the contributions of spouses and family members.
- The government will move forward the proposed measures to limit the tax deferral opportunities related to passive investments with a few tweaks, which will release the draft legislation as part of the 2018 federal budget.
- The government is withdrawn the proposed measures to limit access to the Lifetime Capital Gains Exemption.
- The government is withdrawn the proposed measures relating to the conversion of income into capital gains.