The information released by the minister of Finance on July 18, 2017 scared many small business owners. Right now, investment income earned in a corporation is currently taxed at about 50% - and the Finance Minister wants to increase this to as high as 73%! If you saw a lot of unhappy small business owners on social media - this was why.
When it comes to proposed tax changes, a recent poll of small business owners shows that this is one of their biggest worries. The initial news was bad, however the government has since amended their proposal, allowing for some investment income to be earned. Here’s a quick overview of what is being proposed, and how these changes will affect you as a small business owner in Alberta.
Why they want to make this change
The Trudeau government believes that small business owners receive an initial advantage if they begin an investment portfolio within their corporation. With corporate tax rates being lower than most individuals’ tax rates, the government feels it’s unfair for small business corporations to have more dollars left after-tax to reinvest and begin earning investment income. The changes are intended to make corporations pay their excess cash out to business owners, who can then invest at the personal level, and use retirement planning tools like the RRSP and TFSA.
How will these changes affect my small business?
Investment income sourced from retained business earnings is going to be taxed differently, at higher rates, and with more complexity. The proposed changes are going to be effective on a “go-forward” basis, meaning existing investments should be grandfathered in. Let’s take a brief look at some of the proposed changes:
The main change that affects self-employed corporation owners is the elimination of the Dividend Refund. Currently, investment income is taxed at 50% at the corporate level, but a big chunk of this is refundable once the corp pays the dividend to the shareholder, and the shareholder is taxed a the personal level. The gov’t is not changing the 50% tax rate, but they want to eliminate the refundable tax. Add the 50% corporate tax to the tax the shareholder will pay personally and that is how we get the 73% tax rate.
A few of the other changes include restricting additions to the Capital Dividend Account, eliminating portfolio dividends adding to the General Rate Income Pool, and further restrictions to the types of income eligible for the small business deduction.
The gov’t says that current investments will be grandfathered in, which means business owners will have to track their types of income in different pools, as there will be a few extra “methods” of taxation for the various types of income. Depending on current activities and characteristics of your small business corporation, there will be some difficult choices to make related to how your company will be taxed. It will also make proper tracking and bookkeeping of each investment absolutely necessary.
Minimum Threshold of $50,000
The Minister recently adjusted the rule on passive income to include a minimum threshold of $50,000 per year of passive income from investments before the rules kick in. So if you have net rental income of under $50,000, don’t worry, the tax rates will not change on you. If you have interest and dividend income of under $50,000, the new rules will not apply.
If you have $100,000 in passive income in your corp during the year, the first $50,000 will be eligible for the refundable tax and the next $50,000 will not be eligible. At 5% annually, the $50k thresholds allows business owners to save and invest approximately $1 Million in their corps.
What options do I have?
The proposed tax changes are being updated and edited on a daily basis right now, so it’s a bit premature to take any tax planning steps at this point in time. However, once rules become more clear, here are some ideas to reduce the impact before the Jan 1, 2018 go live date:
- With the changes happening on a “go-forward” basis, it may be wise to maximize the grandfathering rules and put as much as you can into income generating investments prior to the rule change
- After the rule change, you might want to consider capital growth investments instead of income generating investments for your corp
- You may want to consider investing in something that will pay active business income rather than passive income
- Prior to Dec 31, you might want to crystalize some of the capital gains you currently have in your portfolio so you can preserve that Capital Dividend Account addition
Every situation will be different and significant planning at this stage wouldn’t make sense given how these changes are evolving on an almost daily basis. These changes will impact different sized corporations differently - and the information in this blog is relevant to self-employed, service-based Alberta corporations earning less than $500k Net Income per year.
Read more about Corporate Tax topics that may be helpful to you and your small business.
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