The evolution of tax changes for the Canadian farm business
By Jesse Moore CPA CA BBA Partner Tax BDO Canada LLPFeatures Business & Policy Farm Business annex Business/Policy Canada Events Financial Planning Government Market news Producer tools
Many of you are aware that the Federal Government recently introduced tax legislation that affects farm business owners all over Canada.
Because of the rapid way in which things progressed, there is a lot of confusion as to what legislation was proposed, modified, or simply dropped altogether.
I have attempted to outline the “evolution” of these tax changes in this article, from early 2017 to where we are today.
I wish I could tell you that the tax changes create a better tax environment for business owners, but in my opinion the opposite is true – business owners now face more complexities and uncertainties then ever in managing their tax affairs and trying to comply with tax legislation.
On that positive note, let us start with a quick history lesson:
March 22, 2017 – Budget 2017
Finance signals its intention to address specific tax planning strategies employed by business owners.
July 18, 2017 – Finance releases the Proposals
Finance releases the consultation paper, and unexpected draft legislation and explanatory notes (“the Proposals”).
The Proposals target the following strategies:
- Income splitting (“Income Splitting Proposals”): Income splitting is redirecting taxable income between the family so that the family “unit” pays the least amount of income tax. This includes allowing more than one family member to access the Enhanced Capital Gains Exemption (ECGE).
- Private corporations investing in passive assets (“Passive Investment Proposals”): Canadian-controlled private corporations carrying on an active business in Canada (which includes farming) have the ability to pay a low rate of tax on the first $500,000 of corporate business profits. Corporations can invest the after-tax business profits in rental property, stocks, bonds, etc., and delay triggering personal tax until some later date.
- Surplus stripping (“Surplus Stripping Proposals”): Converting what would otherwise be a taxable dividend from a company to a capital gain, which are currently taxed at lower rates.
July 19, 2017 – October 2, 2017 – Reaction to the Proposals
Outrage within the business and tax community ensues.
The business and tax community identify a significant number of issues with the Proposals, including but not limited to:
Income Splitting Proposals:
- Too complicated for business owners, let alone professional tax advisors, to understand, increasing tax compliance costs.
- Significant concern that the Proposals will result in CRA challenges to what should be a relatively simple business decision, i.e. how much can I pay my family members and myself.
- The cost of incorrectly applying these rules is significant – income is taxed at the highest marginal tax rate for the province of residency. In Ontario, this can be as high as 54%.
- Farmers and their family members may not be able to access their ECGE.
Passive Investment Proposals:
- Business owners will pay extremely high rates of tax on investment income earned in a corporation and paid out to the owner as a dividend. In some cases, the rate of tax could be as high as 73%. The sale of land or quota within a corporation, or the rental of land owned by a corporation, is treated as investment income, which would specifically affect farmers.
Surplus Stripping Proposals:
- Estates could face significantly larger tax burdens if a business owner passes away.
- Tax costs to transition incorporated businesses to the next generation increase significantly, providing a tax incentive to sell the business “outside” the family.
October 16, 2017 – October 19, 2017 – Finance Takes a Step Back
Finance makes a number of significant announcements regarding the Proposals:
- October 16, 2017: Finance announces it intends to proceed with the Income Splitting Proposals, however
- They intend to simplify them; and
- Restrictions on the ECGE will be dropped altogether.
- October 16, 2017: Finance announces it will reduce the small business tax rate to 10% effective January 1, 2018 and to 9% effective January 1, 2019. This affects CCPC’s carrying on an active business in Canada. This announcement is a surprise, albeit a welcome one.
- October 18, 2017: Finance announces it intends to proceed with the Passive Investment Proposals, however current investments will be “protected” from the new rules, as well as corporations earning less than $50,000 of investment income in any given year.
- October 19, 2017: Finance announces it is going to drop the Surplus Stripping Proposals altogether.
December 13, 2017 – Finance releases “Version 2” of the Income Splitting Proposals
The revised Income Splitting Proposals are simplified, and a number of exclusions to the rules are introduced.
The Income Splitting Proposals are to be effective January 1, 2018.
February 27, 2018 – Budget 2018
Finance releases draft legislation regarding the Passive Investment Proposals.
These rules are simpler and less complicated compared to what Finance was originally proposing.
March 27, 2018 – Bill C74 – Budget Implementation Act, 2018, No. 1 (March 27, 2018)
“Version 3” of the Income Splitting Proposals as well as the Passive Investment Proposals are introduced in this Bill.
Where are We Now?
Income Splitting Proposals
We are in a completely different world now when it comes to income splitting.
A family business carried on through a corporation, partnership, or trust must consider the new rules when any family member is paid from that business.
Generally speaking, if you pay a family member income from a family business, that income will attract the highest marginal tax rate for your province. This concept is known as “tax on split income,” or TOSI.
Thankfully, there are exceptions to the TOSI rules. Some of the more notable ones are as follows:
- TOSI does not apply to a wage or salary – which have always been subject to a “reasonability” requirement;
- TOSI does not apply to income from an “excluded business” – this exception looks at the level of involvement of the family member in the business, both in the current year and throughout the history of the business;
- TOSI does not apply to income from “excluded shares” – this exception is only relevant for incorporated businesses, and looks at the nature of the business being carried on in the company, the source of its income, as well as the type and number of shares owned; and
- TOSI does not apply to a capital gain from the disposition of “qualified farm property,” which can include shares of a family farm corporation, however you still have to be careful if a minor shareholder is involved.
There are other exceptions to TOSI as well which might be relevant for your situation.
Passive Investment Proposals
Effective January 1, 2019, if a corporation earns in excess of $50,000 of investment income in the prior year, access to the low small business tax rate in the next year is affected.
This will apply to the corporation earning the investment income, as well as any other corporations “associated” with that corporation (essentially a group of corporations with common control/shareholders).
“Investment income” will not include the sale of assets that are used in an active business, such as farmland or quota.
Consult with your tax advisor immediately to:
- Determine the impact of the Income Splitting Proposals on the current business structure/remuneration plan for family members;
- Consider the impact of the Passive Investment Proposals and whether access to the low small business tax rate is affected, assuming your business is incorporated; and
- Determine whether any planning or restructuring is required because of these new rules.
In the meantime, we anxiously await more direction from Finance and CRA on many of the issues, uncertainties, and complexities relating to the legislation in its current form.
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