On July 18, 2017, the federal government announced its intention to eliminate a number of tax planning strategies commonly used by small business owners. The proposed changes were widely contested and subsequently revised on October 16, 2017. The revisions included promises to simplify the proposal on income sprinkling and to provide draft legislation by the Fall of 2017.
Details were released on December 13, 2017 along with confirmation they will take effect in 2018. The “kiddie tax” will be expanded to include dividends paid to spouses and adult children that do not fall within any of the exclusions and do not meet a reasonability test.
Exclusions:
- Dividends paid to a spouse will be excluded from the new rules provided the business owner meaningfully contributed to the business and is aged 65 or over,
- Dividends paid to adults aged 18 or over will be excluded from the new rules provided the individual made a substantial labor contribution (generally, an average of 20 hours per week) to the business during the year or in any of the 5 previous years (the 5 previous years do not need to be consecutive). If the business is seasonal, the labour contribution requirement will only be applied for the part of the year in which the business operates. Records such as timesheets, schedules, log books or information contained in the payroll records will be used to establish the number of hours the individual worked in any given year,
- Dividends paid to adults aged 25 or over will be excluded from the new rules provided the adult owns at least 10% or more (measured in votes and value) of a corporation that earns less than 90% of its income from the provision of services and is not a professional corporation,
- Generally, the measures will not limit access to the lifetime capital gains exemption,
Reasonability test
For individuals between the ages of 18 and 24, dividends received must represent a reasonable return on property contributed to the business. The reasonableness criteria include:
- “Safe Harbour Capital Return”: the return on property contributed to the business will be reasonable provided it does not exceed a prescribed returned determined by a formula, and
- “Arm’s Length Capital”: the property contributed cannot be property derived from property income of a related business, borrowed under a loan or transferred from a related person.
For individuals aged 25 or over, payments that are reasonable based on the following criteria:
- Work performed in support of the business
- Property contributed directly or indirectly to the business
- Risk assumed in respect of the business
- Amounts paid or payable by any person or partnership to or for the benefit of the individual in respect of the business; and
- Other factors that may be relevant
Where an individual acquired property as a consequence of the death of another individual, special rules will apply for determining whether a dividend is excluded or reasonable or is a taxable capital gain from the disposition of excluded shares.
Next Steps
Dividends paid to family members in 2018 and subsequent years that do not meet the “excluded” or “reasonableness” test will be taxed at the highest marginal tax rate. We recommend that you speak to your professional tax advisor regarding paying dividends to family members prior to the end of the year.
The government has also confirmed its intention to limit tax deferral opportunities by retaining passive investments inside of a corporate. However, details will only be released in the 2018 Federal Budget.
We will continue to keep you informed of changes as they occur.
Cedric Paquin, CPA, CA, CFP
Wealth Planning Consultant
National Bank Financial is an indirect wholly-owned subsidiary of National Bank of Canada. The National Bank of Canada is a public company listed on the Toronto Stock Exchange (NA: TSX). The particulars contained herein were obtained from sources we believe to be reliable, but are not guaranteed by us and may be incomplete. The opinions expressed herein do not necessarily reflect those of National Bank Financial.
