How the proposed federal tax changes could affect you

Tax changes
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Federal tax changes

What the proposed tax changes mean for you

UPDATE: Over the summer, the federal government proposed the most drastic overhaul of the tax system in decades. These changes would have hurt small business owners by increasing your tax burden and adding complex red tape—so we fought back.

In reaction to pressure from CFIB and small business owners like you, the government announced that they would make some adjustments to the sweeping tax changes they proposed. They will also reinstate the promised reduction of the small business tax rate to 9% by 2019. Learn more about the original proposals below.

Here are three areas where your business might feel the pain:

1. Making it harder to share income with your family

Income-splitting allows you to reduce your income taxes by transferring business income (via dividends or capital gains) to family members. The government is not going to eliminate this measure, but they are trying to restrict its use in the following ways:

  • Using a “reasonableness test” to assess if your family members work for you. This could add more red tape to your operations, as you’ll need to prove that your family members are “legitimately” earning income by working for you. If the government says your family members are not legitimately involved, it will force them to pay the top tax rate—regardless of their overall income.
  • Making it much harder to split income with your adult children. Currently, you cannot split your business income with minors under the age of 18. The government is considering making it more difficult to split income with children between 18-24 by imposing an even stricter “reasonableness test”.

These changes will affect tens of thousands of Canadian family businesses and show that the government doesn’t understand how a small business works. When you start a business, everyone in your family is involved and takes on risk—whether you directly employ them, or they provide other informal support. If the government moves forward with these proposals, changes would apply starting in the 2018 tax year.

UPDATE: The government will still apply a “reasonableness” test to income-splitting to ensure that family members “meaningfully contribute” to a business. We remain worried this will not reflect the formal and informal ways family members participate in a business.

2. Dramatically increase the taxes on your business investments

Current tax rules allow you to keep certain “passive” investments (such as real estate or stocks) or excess income in your business or a holding corporation—like a sort of savings account. These investments are important for owners investing in their business, because they assume so much risk and can’t easily access financing. Many of you also use these investments as a buffer against emergencies or unforeseen costs, and to save for retirement, because you don’t enjoy the pensions, benefits, and income security that are offered to civil servants.

These investments are currently taxed at the small business rate, which is lower than the personal income rate, because they are used for business purposes. But the government says this is unfair to people whose investments are taxed at the personal rate.

The government is considering increasing taxes on small business owners’ passive investments, to bring their tax burden closer to that of a salaried employee. The new rules would apply starting in the 2018 tax year.

The government doesn’t understand how higher taxes on your investments will harm your ability to invest in your business and save for the future. This is the top issue that has been raised by small business owners like you from all sectors of the economy!

UPDATE: The government has tempered this proposal. Passive investment income under $50,000 (the equivalent of a 5% return on a $1,000,000 investment) will still be taxed at the small business rate. Income above $50,000 will be taxed at the higher personal rate. Details on this measure will come in Budget 2018.

3. Prevent you from passing down your business 

Currently, business owners can convert their surplus into capital gains, which are taxed at a lower rate than dividends or salary. You can sell shares to either family members or a non-arm’s-length corporation (often called a holding corporation). Then, you can dispose of the shares and apply a capital gain tax, rather than a higher dividend tax. This is a complex tax planning tool as it requires that your business be structured in a certain way.

The government is seeking to curb this type of tax planning and the changes would apply to amounts that are received or become receivable on or after July 18th, 2017. These changes could affect business value appreciations from the past, as a form of retroactive taxation. It could also result in the double taxation of some estates. These rules would also make it more difficult if you are looking to transfer your business to your children.

UPDATE: In October 2017, the government announced that it is shelving this proposal. This is great news for owners hoping to pass their business to the next generation!

How to take action and protect your small business

These planning measures are not “tax loopholes” like the government claims. They’re legitimate ways for small businesses to reinvest in the business, ensure the stability of the firm or save for the retirement of the business owners. The government’s proposed changes could harm your ability to do those things.

CFIB will continue to fight for you and urge the federal government to take these unfair proposals off the table.

We encourage you to stand up for your small business and sign the petition.