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How Budget 2018 Will Affect the Small-Business Tax Rate and Passive Income

In Budget 2018, the federal government has proposed two changes to the tax rules governing the income generated by investments held in a Canadian controlled private corporation (CCPP).

Last July, the government's initial tax reform proposals were met with an uproar by the small-business sector.
After further consultation with stakeholder groups, the government has put forward a new plan that it says will target only the wealthiest 3% of private corporations.

The proposed new measures represent a balancing act in which the government continues to help small business owners invest in their firms, while not giving them a tax advantage over other tax payers.
Small-Business Tax Rate

The first proposal addresses the ability of small businesses to benefit from the small-business deduction if they earn significant income from passive investments. The basic rule is that a private corporation can generate up to $50,000 each year in passive income and still qualify for the small-business tax rate. The $50,000 threshold is equivalent to $1 million in passive investment assets at a 5% return.

If a private corporation exceeds the $50,000 threshold, the amount of income eligible for the small business tax rate is reduced and more of its active income is taxed at the general corporate rate of 15%.

Once your annual passive income reaches $150,000, you will no longer qualify for the small business tax rate.

According to Budget 2018, this change to the small business tax rate ensures small businesses “reinvest in their active business, not accumulate a large amount of passive savings.”


Refunds Through Distribution of Dividends

The second proposal limits the refundable taxes that private corporations receive on the payment of certain dividends.

As it stands now, investment income earned in a private corporation is taxed at a higher rate, a portion of which is refunded when investment income is paid out to shareholders in dividends. In practice, though, taxable dividends can allow for a refund of taxes on investment income no matter if the dividend comes from investment income or active business income, which is taxed at a lower rate.

This loophole allows private corporations to pay out lower-taxed dividends from their active income and claim a refund on taxes paid on their investment income. Budget 2018 calls this "a significant tax advantage."

By reforming the rules governing refunds through distribution of dividends, the government will prevent private corporations from obtaining refunds of taxes paid on investment income while distributing dividends from income taxed at the general corporate rate.

A refund of the refundable dividend tax on hand (RDTOH) will only be available "in cases where a private corporation pays non-eligible dividends," the accompanying Tax Measures document explains.

The Bottom Line
So how will these changes affect you as a small-business owner?

Budget 2018 has cleared the air, providing certainty for investors on how passive income will be treated going forward.

These measures will apply to taxation years that begin after 2018. An anti-avoidance rule will apply to prevent the deferral of the application of this measure through the creation of a short taxation year.

In our view, investing in your business remains a good strategy, but now you have to anticipate future passive income to determine your best course of action.

Based on these changes to the small-business tax rules, you many need to review your current investment approach. Call me if I can be of any assistance – I would be pleased to help.
Tax Tip:

While the government has proposed adding a business limit reduction measure when income from passive investments exceeds $50,000, your tax planning could include corporate class funds and individual pension plans to help reduce or eliminate passive income.

Get Started

We encourage you to explore the links in the right sidebar. They'll take you to articles with answers to many common tax questions. You'll also find information and ideas that will help you plan a more effective tax strategy for you and your family. If you have any questions, send us an email and we would be pleased to help.

 
 
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