On February 27th, 2018, Finance Minister Bill Morneau tabled the 2018 Federal Budget. There were no changes to the personal income tax rates. However, the highly anticipated rules regarding the taxation of passive investment income in private corporations were announced along with several other tax measures including tighter reporting requirements for trusts and foreign affiliates. The Budget also confirms that the Government will proceed with previously announced measures such as the decrease in the small business tax rate and the income sprinkling rules, and signals the Government’s intention to move forward with several gender equality measures.
Our highlights of this year’s Budget are summarized below.
The Government first indicated its focus on reviewing certain tax planning strategies involving private corporations during last year’s Federal Budget. For the 2018 Federal Budget, they finally released their rules on the taxation of passive investment income in private corporations. One of the Government’s main concerns with holding passive investments inside a private corporation is that doing so may yield advantages compared to individual investors, because the lower corporate tax rates can facilitate the accumulation of earnings. The Budget proposes two measures, applicable to taxation years that begin after 2018, to limit tax deferral opportunities on passive investment income earned by private corporations. These measures are described in detail below.
The Budget proposes to reduce the $500,000 small business limit for Canadian-controlled private corporations (“CCPC”) (and their associated corporations) that earn significant passive investment income. The small business limit is reduced by $5 for every $1 of investment income earned by a CCPC (or the associated group) in excess of $50,000, resulting in a reduction of the small business deduction to nil when investment income reaches $150,000. This reduction to the small business limit is based on taxable income for the year that ended in the preceding calendar year. Taxable income earned by a CCPC in excess of the small business limit is taxed at the general corporate tax rate.
This mechanism will operate alongside the taxable capital business limit reduction rules that apply when taxable capital exceeds $10M. The reduction in the small business limit will be the greater of the reduction calculated under this measure and the reduction calculated under the taxable capital rules.
The term Adjusted Aggregate Investment Income (“AAII”) will now be relevant in calculating the business limit reduction. In general, AAII will be a CCPC’s aggregate investment income adjusted for the following items:
AAII will also not include investment income that is incidental to a CCPC’s active business.
The current regime taxes a private corporation’s investment income at an upfront rate that approximates top individual tax brackets. This system is designed so that investment income earned by a corporation should be taxed approximately the same as investment income earned by an individual, both upfront and on a flow-through basis (also known as “integration”). This flow-through tax rate was designed based on the assumption that dividends are paid out of passive income and not active business income. However, private corporations can earn both passive income and “high-rate” active income, creating a cocktail of tax pools between refundable taxes (“RDTOH”) and general rate income (“GRIP”) that can benefit each other. Before applying the measures from this year’s Budget, a modest tax deferral could be gained where “GRIP” dividends were paid to recover ”RDTOH”.
For tax years beginning after 2018, this deferral will no longer be available. Two RDTOH pools will exist, an eligible RDTOH pool and a non-eligible RDTOH pool. The proposed measures will effectively source the RDTOH to its underlying income and prevent [inappropriate] mixing to preserve tax integration. The refundable tax on investment income that is added to each pool is summarized as follows:
| Eligible RDTOH Pool | Eligible RDTOH Pool | |
| Part I refundable tax paid (example: tax paid on investment income, including rent, interest, foreign income and taxable capital gains) |
X | |
| Part IV refundable tax paid - eligibleX (example: tax paid on Canadian portfolio dividends designated as eligible) |
||
| (example: tax paid on dividends from a non-connected private corporation designated as eligible) | X | |
| Part IV refundable tax paid – Non-eligible (example: tax paid from Canadian portfolio dividends designated as non-eligible) |
X | |
| (example: tax paid on dividends from a non-connected private corporation designated as non-eligible) | X |
In the tax year that the rules take effect, a portion or all of the company’s opening RDTOH balance will be characterized as “Eligible RDTOH” in an amount equal to the lesser of the company’s RDTOH balance and 38.33% of its GRIP. This relieving provision appears to provide grandfathering.
Using the much-hyped “gender-based analysis” tool to examine how policy measures affect men and women differently, it is no wonder that the Government has released its Federal Budget with a large emphasis on gender equality. The Budget focuses on efforts to increase the participation of women in the workforce aiming to boost productivity and offset an aging population. Federal funding will be targeted towards new parental benefits, aid to female entrepreneurs, anti-harassment programs, as well as measures to promote pay equity.
In particular, the Budget proposes to create a new five-week “use-it-or-lose-it” Employment Insurance benefit for non-birthing parents to encourage women to re-enter the workforce. Furthermore, the Budget is designed to attract women to skilled trades jobs traditionally dominated by men, by piloting a new Apprenticeship Incentive Grant for Women. It also includes measures to boost the number of women entrepreneurs by increasing access to capital through the Business Development Bank of Canada and other agencies.
Further commitments were made to move forward on “proactive” pay equity legislation, as well as a “pay transparency” measure, to close the wage gap among federal workers and in federally regulated sectors. With the #MeToo movement fighting sexual harassment and assault against women building in strength, the 2018 Federal Budget has allocated funds towards a gender-based violence prevention program.
The Federal Budget proposes new reporting requirements for certain trusts that will require disclosure of trustees, beneficiaries, settlors and protectors. The new reporting requirements will apply to Canadian-resident express trusts and to non-resident trusts and will apply for the 2021 and subsequent taxation years.
The following types of trusts are excluded from these new reporting requirements:
To support these new reporting requirements, the Budget proposes new penalties for the failure to file a T3 return (along with a new beneficial ownership schedule if required), equal to $25 for each day of delinquency, with a minimum penalty of $100 and a maximum penalty of $2,500. If a failure to file the return was made knowingly, or due to gross negligence, an additional penalty will apply, equal to five per cent of the maximum fair market value of property held during the relevant year by the trust, with a minimum penalty of $2,500. As well, existing penalties will continue to apply.
The new penalties will apply in respect of returns required to be filed for the 2021 and subsequent taxation years.
The Budget proposes to align the information return filing deadline with a taxpayer’s income tax return filing deadline. This change shortens the filing deadline for information returns (form T1134) that must be filed by a taxpayer in respect of its foreign affiliates to 6 months (from 15 months) after the taxpayer’s taxation year-end. This measure will apply to taxation years that begin after 2019.
The Budget confirms the Government’s intention to proceed with the following previously announced tax and related measures, as modified to take into account consultations and deliberations since their release:
For further details on these and other proposals in the Budget, please follow the link below for a full commentary.