Private Company Tax Changes – Income Sprinkling and Passive Income

In July 2017, the federal government announced proposed legislation to address tax planning using private companies; some of these measures have been amended in response to feedback from various groups. Since many residents intend to incorporate their practices at some point, this is of particular relevance to them.

Income Sprinkling

One of the benefits of having a professional corporation is the ability to allocate income from a high income physician (in a high tax bracket) to a lower income family member (in a low tax bracket).

The latest amendments released in December 2017, effective January 1, 2018, mean that dividends paid to family members must now be “reasonable” on the basis of labour and capital contribution as well as risk assumption. As such, dividends can only be paid to family members in line with remuneration paid to unrelated persons for the same work. For example, it will no longer be feasible to pay dividends to family members, including a spouse or children attending university, who do not or have not contributed to the business. Furthermore, dividends should not be paid to children under 18 due to “kiddie tax” that would be applied to the parents.

There are certain circumstances that exempt family members from the reasonability test, such as the spouse of an owner who is aged 65 or over, and family members aged 18 or over who work at least 20 hours a week in the year or any past five years. Although not eligible for professional corporations or companies who more than 90% of their income from services, family members aged 25 or over who own at least 10% (by vote and value) of such a business are also exempt.

Tax Deferral and Taxation of Passive Income Earned in a Corporation

Another benefit of having a corporation is to defer taxation since corporate tax rates are usually lower than personal tax rates. Indeed, the federal government has announced plans to drop the small business corporate tax rates to 12% in 2018 (from 12.5%) and 11% in 2019 in BC on active income.

The low corporate tax rate leaves more funds for the corporation to invest. Although investment earnings within a corporation are not eligible for the low corporate tax rate, this is offset by the fact that there are more funds to invest at the start.

Due to business owners leaving excessive investments in corporations, the government has announced measures to increase the tax on investment or passive income earned in a corporation. The government has since announced that the additional tax on passive income will NOT apply to existing investments and will only apply to income in excess of $50,000 from new investments. While not finalized, it is expected that draft legislation will be announced in March with the 2018 Federal Budget.

Conclusion

As a result of these new measures, residents contemplating incorporation in the future are encouraged to consult their accountants to ensure that they are in compliance and in the best position to optimize their tax situation. Nonetheless, there are still significant tax benefits to be potentially realized through professional corporations.

If you have any questions or want to discuss further, please feel free to contact me at rwong@wm.ca or at 604-691-6886. 

This article is courtesy of Richard Wong, CPA, CA of Wolrige Mahon LLP. Richard has extensive experience in providing accounting and tax services to physicians and other health professionals.