Budget 2017: How will tax changes impact business owners?
The feds held off on major reforms, but storm clouds loom large on the horizon. Here’s how to prepare for what might be coming
Date: June 1, 2017
Business owners across Canada exhaled en masse in March when Finance Minister Bill Morneau rose to deliver the Trudeau government’s second budget.
Despite widespread speculation among media and financial-industry pundits, the federal government did not increase capital gains tax rates. In fact, the budget was largely a ho-hum affair; much fiscal ado about nothing as the Liberals held off on major reforms (unofficially) in anticipation of a potential tax system overhaul in the U.S.
But during that speech, Mr. Morneau did single out several tax tools commonly used by private corporations that would be up for review in the coming months – so-called income sprinkling, the holding of passive investment portfolios within corporations and the conversion of regular income into capital gains.
The government said it would be scrutinizing what it called the “unfair tax advantage” that each measure could potentially be delivering to corporate directors and their shareholders.
Even though business owners dodged an initial financial storm with the 2017 federal budget, clouds loom large on the horizon, says Jennifer Poon, director of tax and estate planning with Sun Life Financial.
“It looks benign because none of the rates have changed, but combined with last year’s budget changes, there is a lot happening with business owners,” says Ms. Poon.
Now may be the time for business owners to consider revising their tax-planning strategies, in anticipation of potential federal tax amendments down the road. The question is: how?
Much uncertainty remains as the government floats trial tax balloons in advance of a policy paper that will provide a more detailed outline of planned amendments – if any.
Those changes would come on the heels of a 2016 budget that introduced new measures requiring associated businesses to share the small business tax deduction, rather than claiming it wholly for themselves.
This year, the government attempted to clarify those association rules, which inform many business owners’ tax-planning strategies and ability to access lucrative benefits such as the Scientific Research and Experimental Development Tax Incentive Program, as well as how they distribute dividends from their corporations.
“The combination of everything is a game-changer; it’s a perfect storm,” says Ms. Poon.
One example is the holding of passive investment portfolios inside corporations – a common tactic leveraged by entrepreneurs hoping to build wealth at lower corporate tax rates. As Ms. Poon explains, the small business tax deduction on a corporation’s first $500,000 in revenue provides an annual tax deferral of at least $150,000, money that business owners can use to grow their investment portfolios.
“That they changed the small business tax deduction and are now looking to do this, it’s quite concerning,” says Ms. Poon. “This is how entrepreneurs without private pensions save for retirement.”
Paul Moloughney, a senior tax manager with BDO Canada, explains that in the case of income sprinkling, any change could have a major bottom-line impact on entrepreneurs. The tool essentially allows business owners to pay shareholders or employees – usually family members such as a spouse or children – a dividend or salary to help retain income within their family.
“[Income sprinkling] is used by owner operators who have been in business longer and are starting to be very successful and want to take advantage of family members having a lower marginal tax rate,” says Mr. Moloughney.
In Ontario, for example, the highest marginal tax bracket of 50.5 per cent takes effect at the $220,000 income threshold. If a business owner’s combined household income is less than $200,000, then any changes to income sprinkling rules would have little effect on their personal financial situation.
But if that combined household income is in the $300,000 to $400,000 range, the impact would be significant, potentially totaling tens of thousands of dollars in lost tax savings each year.
Changes to measures such as the ability to convert income to capital gains would be less significant, according to Mr. Moloughney, because that tool tends to be wielded by business owners positioning themselves for retirement.
However, it’s a tactic that may be used more widely in the coming years as an expanding cohort of baby boomer entrepreneurs continue to exit their businesses.
The fact that these measures are only up for review poses a conundrum for business owners with private corporations. Better to take a wait-and-see approach, or be proactive and act now?
Ms. Poon recommends the latter approach, at least for those who utilize income sprinkling on a regular basis.
“Whatever tax savings you have, take advantage of them now,” she says. “If you have family members as shareholders and you haven’t paid them, I would do that now.”
When it comes to more complex restructurings, Ms. Poon advises business owners to hold off and allow the government to introduce changes before acting.
Most importantly, she says, don’t panic – but do prepare. It’s a good time for business owners to meet with financial and tax advisors to chart tax-planning scenarios and begin strategizing for the likelihood that corporation tax changes will be implemented sometime in the future.
“Most of the changes enacted will be small,” she says. “But a buildup of changes only creates more uncertainty for business owners. It’s tough to be them right now.”
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