Finance Minister Bill Morneau will be releasing the 2018 budget on February 27. Small business owners, including physicians and other incorporated professionals should circle this date on their calendars as the expected "reveal day" for how the government plans to implement changes to taxation of passive investment income earned by small businesses.
On July 18, 2017, Minister Morneau released a discussion document outlining proposed changes to the taxation of Canadian controlled private corporations. One of the most controversial proposals will dramatically increase the tax on passive investment income earned by these businesses. The graph below from the AdvisoryMD accounting team at Saeed & Company demonstrates the punitive nature of the planned tax rates.
On October 18, 2017, Minister Moreau announced that the passive income taxation proposal will be adjusted . Once implemented, $50,000 of investment income (on a go-forward basis) will be sheltered from the new tax rates. The technical description of how this change will be implemented is expected in the Spring Budget announcement.
Small business owners have been left with many questions which makes planning difficult.
1. What does the $50,000 threshold actually mean?
The government backgrounder explains that the $50,000 threshold was set to "provide more flexibility for business owners to hold savings for multiple purposes, including savings that can later be used for personal benefits such as sick leave, parental leave, or retirement." Does this mean that the $50,000 threshold will be treated like RRSP contribution room with annual inflation adjustment and carry-forward of unused amounts?
2. When will the changes be implemented?
The tax changes will apply to investment income on a "go-forward" basis. Will the start date be January 1, 2018, the date of the budget announcement or some other date in 2018.
3. How will "grandfathered/mothered" investments be identified?
Investments already made by the business owner(s) will be protected from the new tax treatment. What will the government consider as an "investment." Will they use retained earnings, or only existing investments in stocks, bonds, and funds? What about accounts receivable for services already provided for which payment has not been received?
4. How will the business owner/CRA keep track of each dollar of passive investment income pre- and post-implementation of tax changes?
It is unclear how future income earned by investments already held by a corporation will tracked and taxed. For example, will future gains (dividends/interest) on existing investments be sheltered in perpetuity? Will business owners have to separate and track income earned from investments pre- and post-tax implementation? The compliance costs through bookkeeping and accounting fees could be significant. Business owners hoping for guidance from the CRA may be disappointed. The Auditor General reported that the CRA only answers 1/3 of the calls it receives.
What to do next?
1. Delay discretionary corporate expenditures/paying personal dividends until after the budget announcement. This will allow you to maximize the retained earnings which may be protected from the new tax treatment.
2. Submit billings ASAP and ensure payment for any outstanding accounts receivable.
3. Get professional advice. Whether you are contemplating becoming incorporated or trying to navigate these tax changes, obtain professional advice from an experienced team.