RBC Advice Event for Small Business Owner Week Recent Tax changes impacting small business owners Tax on Split Income and Tax impact of passive Income October 18, 2018
SAV Associates Chartered Professional Accountants
RBC – Royal Bank of Canada Yonge and Hollywood Branch 5001 Yonge Street, 2nd Floor North York, Ontario M2N 6P6
Disclaimer
This material is for educational purposes only. As it deals with technical matters which have broad application, it is not practical to include all situations. As well, the course material and the references contained therein reflect laws and practices which are subject to change. For this reason a particular fact situation should be reviewed by a qualified professional. Although the course material has been carefully prepared, none of the persons involved in the preparation of the material accepts any legal responsibility for its contents or for any consequences arising from its use.
Presented by Sanjay Chadha CPA, CA, MBA 647 831 8322 sanjaychadha@savassociates.ca
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ACCOUNTING ASSURANCE TAXATION BUSINESS ADVISORY RISK ADVISORY CONFIDENTIAL - CONTENT OF THIS PRESENTATION IS NOT AN ADVICE AND SHOULD TO BE USED FOR EDUCATIONAL PURPOSES ONLY
Agenda
Tax on Split Income
Passive Income and Small Businesses
Confidential - Content of this presentation is not an advice and should to be used for educational purposes only
Tax on Split Income
SAV Associates Charted Professional Accountants
Old Rules- Pre 2018 (widely known as Kiddie Tax)
Tax on Split Income (TOSI)
• Family members (Canadian resident) under 18 years of age. Had a parent residing in Canada during the year. • Purpose - Splitting income among family members of a Canadian owned corporation • Type of Income – Private company dividends, shareholder loan, partnership income run by a related person, income from Trust that is traced to one of the sources above • Intention – Tax planning arrangement to reducing overall tax paid to the CRA for Income tax purposes Result: Income was taxed at the highest marginal rate in recipient individual’s hand (in Ontario upto 53.5%)
Confidential - Content of this presentation is not an advice and should to be used for educational purposes only
Scenario 1
Tax on Split Income (TOSI)- Old Rules Example
One Person Corporation
Profit: $100,000
Total Tax Liability: apx 35% Confidential - Content of this presentation is not an advice and should to be used for educational purposes only
Scenario 2 A One-Person Corporation
Tax on Split Income (TOSI)Old Rules Example
Splitting Income among family members to reduce tax by paying dividend the family members The owner Spouse Child 1 – over 18years old Child 2 – under 18 years old
Confidential - Content of this presentation is not an advice and should to be used for educational purposes only
Income splitting was accepted by Supreme Court of Canada in Neuman v Queen Decision Tax Rules limiting income splitting
Current Legislative Limits in ITA – Income Splitting
• Section 67 – Deduction from income must be reasonable. • Sections 56, 74.1 to 75.1 – Income attributed back to transferor. • Sections 15, 246 and subsection 56(2) – Tax benefit conferral • Section 74.4 – Imputes income where attribution done indirectly through corporations. • Sections 74.1 and 60.03 – explicit permission for seniors to split CPP and eligible pension income. • December 13, 2017 proposal significantly expands the scope of the TOSI rules. Confidential - Content of this presentation is not an advice and should to be used for educational purposes only
Tax on Split Income(TOSI) Decision Tree Flow Chart
Confidential - Content of this presentation is not an advice and should to be used for educational purposes only
“specified individual” - Rules expanded to include Canadian resident family members (spouses, minor and adult children, parents and siblings) for split income purposes
Tax on Split Income(TOSI) - New Rules as of January 2018
“related business” - For individuals 18 or over, rules only apply if an amount (i.e. dividend, capital gain or interest) is derived directly or indirectly from a “related business” “Source individual” is an individual who at any time in the year is resident in Canada and is related to the specified individual “Related” if individual is your mother, father, spouse, son, daughter, brother, and sister and any of the above as a result of marriage (e.g. sonin-law) For TOSI to apply (at a high level) - the business is operated by a corporation and the source individual owns at least 10% of the total fair market value of the corporation If there is no business, TOSI rules may not apply
Confidential - Content of this presentation is not an advice and should to be used for educational purposes only
taxable dividends from corporations (non – listed)
Tax on Split Income(TOSI) - New Rules as of January 2018
income derived directly or indirectly from a “related business” – (provided services / property or disposition of interest in business) income from the rental of property if a related person is actively engaged on a regular basis in the activities or owns an interest in the partnership or trust interest, if other amounts would be classified as TOSI income
capital gains realized on properties the income from which is specified as TOSI income
Confidential - Content of this presentation is not an advice and should to be used for educational purposes only
Tax on Split Income(TOSI) - New Rules as of January 2018 Section 120.4(2) “Split Income� ITA Where a specified individual earns split income, there will be a tax applied at the top marginal rate Split Income X Top Marginal Tax Rate
Confidential - Content of this presentation is not an advice and should to be used for educational purposes only
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Tax on Split Income(TOSI) - New Rules Example
XYZ Corporation Inc
Dividend paid to daughter: $100,000
Only Source of daughter’s Income (over 18years old)
Daughter does not work in the business
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Under older rules: Apx $ 17,000
Under new rules: $ Highest Marginal rate
Income is considered excluded if one or some of the following conditions are met:
Excluded Amounts = No TOSI
• Inheritance Exception (Under 25 years of age) – parent of an individual or any person if individual is full time student • Breakdown of relationship (Divorce) exception • Death exception – taxable capital gain arising as a result of death • Income from excluded business or not related business if 18 or older • Safe harbor capital return exception (between 18 to 24) – reasonable return on arm’s length capital • Reasonable return exception (over 24 years) – work performed, property contribution, risk assumed etc. • Unlimited Income Splitting allowed if Individual with a contributing spouse age 65 or over in the present year Confidential - Content of this presentation is not an advice and OR has died should to be used for educational purposes only
Income from Excluded Business = No TOSI
No TOSI - if business is excluded business and individual is 18 or older • for all amounts other than capital gains, individual must be actively engaged (average 20 hours per week), on a regular, continuous and substantial basis in the year or any 5 previous years • for capital gains, in any 5 previous years – if business sold after 3 years, in business – “Tricky” - may be challenged
Confidential - Content of this presentation is not an advice and should to be used for educational purposes only
No TOSI - if 24 or older before the year and shares are excluded shares
Income from Excluded Shares = No TOSI
• less than 90% of business income is from services (business income); • corporation is not a professional corporation (accountant, dentist, lawyer, medical doctor, veterinarian or chiropractor); • individual owns 10% or more of votes and value of corporation; and • income of the corporation not derived directly or indirectly from another related business – Probably to prevent business being split into two businesses and letting specified individual own shares in non-service business
For 2018 only, 10% votes and value must be met either before the relevant time or by the end of 2018
Confidential - Content of this presentation is not an advice and should to be used for educational purposes only
Possible Consideration to avoid TOSI • Salaries • Consider Capital Gain Exemption crystallizations • Convert professional corporation to a regular CCPC if it is no longer active • Restructure to fit within “excluded shares” definition • TOSI vs Income Attribution (unreasonable salary) • More option when entrepreneur turns 65
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Passive Investment Income and Its Impact on Small Business Tax Reduction
Presented by Sanjay Chadha SAV Associates Charted Professional Accountant
In 2018, tax on small business income at 10 percent federally
To be reduced to 9 percent in 2019
Grind on Small Businesses Limit
Small business limit $500,000 federally and in most provinces (provided capital employed is less than 10 Million)
Under the Proposals, the small business limit will be reduced by $5 for every $1 of investment income above a $50,000 threshold
Therefore, the Small Business Deduction Rules (SBD) will be eliminated when investment income reaches $150,000 Confidential - Content of this presentation is not an advice and should to be used for educational purposes only
Purpose • To remove perceived advantage of corporations’ ability to invest in passive investment using earnings that were subject to corporate tax rates (as opposed to having to invest with earnings subject to the much higher personal income tax rate). • Therefore, to promote fairness and neutrality, under the new regime, earning passive income through a corporation or personally should yield the same aftertax return. • Targets private corporations only.
CRA Rules on Passive Income for Small Businesses The Small Business Deduction Rules (SBD) reduces the corporate income tax that a corporation would otherwise have to pay in a taxation year throughout which it was a Canadian-controlled private corporation (CCPC). A corporation’s SBD for a taxation year is generally calculated by multiplying its SBD rate by the lesser of its:
income for the year from an active business carried on in Canada, excluding certain income and exceeding certain losses;
taxable income for the year (including associated corporations)
business limit for the year (To be tested every year)
Confidential - Content of this presentation is not an advice and should to be used for educational purposes only
Calculating CCPC’s Passive Business Limit Reduction • A CCPC’s passive income business limit reduction for a particular taxation year will be the amount determined by the formula: • BL/$500,000 x 5 (AAII - $50,000) • where • BL is the CCPC’s business limit otherwise determined for the particular year (i.e., its business limit as described above); and • AAII is the total of all amounts each of which is the adjusted aggregate investment income of the CCPC, or of any corporations with which it is associated at any time in the particular year, for each of their taxation years that ended in the preceding calendar year.
• The clawback limit pertains to the amount of investment income, and not on the amount of small business income in the corporation.
https://www.canada.ca/en/revenue-agency/programs/about-canada-revenue-agency-cra/federal-government-budgets/budget-2018-equalitygrowth-strong-middle-class/passive-investment-income/small-business-deduction-rules.html
Confidential - Content of this presentation is not an advice and should to be used for educational purposes only
Example
Calculating CCPC’s Passive Business Limit Reduction
ABC Company is a CCPC having a December 31, 2020, taxation year end, and is not associated with any other corporations in the year. ABC Company’s adjusted aggregate investment income for its December 31, 2019, taxation year was $75,000.
ABC Company’s passive income business limit reduction for its 2020 taxation year is determined as follows:= $500,000/$500,000 x 5($75,000 $50,000)= 1 x 5($25,000)=$125,000
Consequently, ABC Company’s business limit for its December 31, 2020, taxation year will be reduced from $500,000 to $375,000 (i.e., $500,000 $125,000)
Confidential - Content of this presentation is not an advice and should to be used for educational purposes only
If a corporation has $150,000 of business income and $75,000 of investment income, the clawback will be 5 x ($75,000-$50,000), or $125,000. This will reduce the small business limit to $375,000. Since the corporation has only $150,000 of small business income, it will be fully eligible for the small business deduction.
Example 2
Same facts as Example 1 in last slide, except that ABC Company is associated with XYZ Company, which had $55,000 of adjusted aggregate investment income in its December 31, 2019, taxation year. The entire business limit for the 2020 taxation year was allocated to ABC Company.
Consequently, ABC Company’s business limit for its December 31, 2020, taxation year will be reduced from $500,000 to $100,000 (i.e., $500,000 - $400,000).
ABC Company’s passive income business limit reduction for its 2020 taxation year is determined as follows:= $500,000/$500,000 x 5(($75,000+$55,000) - $50,000)= 1 x 5($80,000)=$400,000
Calculating CCPC’s Passive Business Limit Reduction
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Investment Income measured by Adjusted Aggregate Investment Income
Capital gains (and losses) on disposition of property
Non active rental income
Income earned from savings in a non-exempt life insurance policy
Dividend, capital gains and interest received from an investment
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Excludes: Capital gains - on property used in an active business; disposition of shares to connected CCPC; NCL C/F from other years and Dividends from connected corporations
2018 Corporate Income Tax Rates for Active Business Income
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Q&A
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