The federal government is proposing changes to tax-planning strategies that could result in owners of some small- and medium-sized private corporations paying two to three times more in taxes, says Deborah MacPherson, a Chartered Professional Accountant and tax partner at KPMG’s office in Edmonton.
“Many business owners I’ve spoken to were not aware of the extent of the proposed changes and were under the impression that they will not be affected,” she says. “But any private corporation using the tax strategies targeted by the changes will be impacted— and that’s just about every private corporation in Canada.”
The Department of Finance announced the changes in a policy white paper sent out in July. If implemented in their current form, the proposals will apply very broadly across the small- and medium-sized (SME) business sector and could see owners facing effective tax rates that in some cases could reach 60 to 70 per cent compared to the current 48 per cent in Alberta, MacPherson says.
“These proposed measures are a move away from an integrated system and could push up effective rates quite substantially.”
According to the federal government, Canada had nearly 1.2 million SMEs employing 10.5 million people at the end of 2015.
MacPherson says the proposals target three common tax-planning strategies that have been used for years by owners of private corporations:
This practice involves splitting income with one or more family members who are subject to lower personal income tax rates, or no tax at all, thereby reducing the income tax payable by a private business owner who may be subject to a much higher personal income tax rate.
For example, if a business owner pays a dividend to a spouse who is also a shareholder, that dividend will be taxed at the top marginal tax rate unless it can be shown that the spouse is an active contributor to the business in terms of labour or capital. This could result in annual additional tax of as much as $30,000.
Converting private corporation income into capital gains:
The Department of Finance believes in some cases these circumvent the principal that the withdrawal of funds from a company should be in form of dividends, which are taxed at a higher rate than capital gains. For example, on $100,000, the difference in tax rates could mean additional tax of $17,000. These rules could also apply to planning done prior to the July announcement and may result in double taxation of the same income.
Passive investments held inside a private corporation:
New rules strive to eliminate the financial advantages of investing business profits passively through a private corporation by introducing an alternative approach to taxation. The results of another taxation approach could mean effective tax rates on reinvested business profits of up to 70 per cent.
Legislation to address changes to the taxation of passive investments “has not yet been published so the impact is unclear and appears to be very broad at this point,” MacPherson says. “For the other two proposed changes, draft legislation accompanied the paper so we are able to assess the impact of these changes for business owners.”
While most of the federal government’s proposed measures are set to begin in 2018, the changes to capital gains have already gone into effect, meaning that some business owners could find that their planning has already been impacted.
One of the proposed changes could also have a serious impact for the heirs of business owners who die while still owning the business. It could undermine years of tax strategy and succession planning put in place to ensure a smooth and financially stable transition of the business by subjecting the heir to substantial additional taxes.
MacPherson suggests that owners of small- and medium-sized businesses need to take a close look at their current tax strategies and tax structure to make sure they don’t get caught flat-footed if the changes come into effect. “Many business owners may have to change the way they do things,” she says.
“If you pay more taxes that will impact the cash flow of your business and lead to further pressures in this challenging economy,” MacPherson says. “Lower cash flow can mean that you need to borrow more on your line of credit and have less capital to invest back into the business.”
MacPherson says there are still opportunities to address the implications of the proposed changes before they come into effect “but business owners need to act quickly.”
“The first step is to understand what the impact could be on them, their family and their business and then work with their tax adviser to develop a strategy to address the changes.”
Speak with a KPMG adviser to assess the impact on your business or visit kpmg.ca/Edmonton.
This story was created by Content Works, Postmedia’s commercial content division, on behalf of KPMG.