TORONTO: Canadian Finance Minister Bill Morneau has announced that he intends to crack down on tax planning strategies that involve private corporations.
Morneau has launched a consultation on three tax practices that the Government believes are being used to gain unfair tax advantages.
One of the consultation’s main focuses is on so-called income sprinkling. According to the Government, income sprinkling involves diverting income from a high-income individual to family members with lower personal tax rates, or to family members who may not be taxable at all. By this method, the owner of a private corporation can “sprinkle” their income between themselves, their spouse, and their adult children.
The Government wishes to distinguish income sprinkling from reasonable compensation for family members. According to the consultation document, the Government intends to introduce new rules to “help to determine whether compensation is reasonable, based on the family member’s contribution of value and financial resources to the private corporation.”
The consultation also focuses on individuals who gain an unfair benefit by retaining passive investments in a corporation. This enables them to take advantage of the fact that corporate income tax rates are lower than the personal tax rates applicable to higher-income individuals.
The Government is seeking feedback on possible changes to ensure that the tax treatment of such passive investment income is fair. It will consider approaches can eliminate the tax-assisted financial advantages of investing passively through a private corporation, while also ensuring that the lower rates of tax on active business income earned by corporations continue to encourage growth and job creation.
The final issue on which the consultation concentrates is the converting of a private corporation’s regular income into capital gains.
Income is normally paid out of a private corporation in the form of a salary or dividends to the principals, who are taxed at their personal income tax rate (subject to a tax credit for dividends). However, only one-half of capital gains are included in income. The Government said that this system can therefore result in a significantly lower tax rate on income that is converted from dividends to capital gains.
The Government intends to amend the tax rules to prevent the surplus income of a private corporation from being converted to a lower-taxed capital gain, and stripped from the corporation.
Morneau said: “Many of the richest Canadians are unfairly exploiting the tax rules designed to help businesses thrive.”
“We know that businesses, including small businesses, help grow the Canadian economy. These tax advantages are in place to help these businesses reinvest and grow, find new customers, buy new equipment and hire more people.”
“We want to make sure those rules are used to do just that, and not to give unfair tax advantages to certain – often high-income – individuals.”
The consultation is open until October 2.
