What are the Implications of Proposed Tax Changes for Businesses?

The government is planning to implement tax changes this January and if they come into effect then family businesses may lose important tax benefits. As such, it will be necessary for you to understand the implications for your business so that you can take up the necessary restructuring of your business and make required changes during income tax preparation so as to maximize tax benefits. Let us go through the details of these proposed changes in the following sections.

Implication of Tax Changes for Businesses

Before the Proposed Tax Changes

  • Payment of Dividends
  • Income Tax Deferment
  • Withdrawal of Capital Gains 
income tax preperationPayment of Dividends: Until now, family businesses were benefiting from payment of dividends to trusts or family members who were acting as shareholders for family's private corporation. 
Income Tax Deferment: It was also possible to take advantage of income tax deferment during income tax preparation for excess earnings by way of retaining the same within the corporation. 
Withdrawal of Capital Gains: In addition to it, shareholders were able to withdraw any surplus in the form of capital gains. This was beneficial due to the fact that only fifty percent of capital gains are subjected to taxes and allows shareholders to achieve tax savings while withdrawing funds. 

The Proposed Tax Changes

Reasonability Test

These tax changes seek a reasonability test with respect to dividends that are paid to family members. Additionally, these will be subjective tests that will take into consideration:
  • The capital contribution made by any individual to business.
  • Individual's (who will be getting the dividend) labor contributions.
  • Those getting the dividend are in the 18-24 age group or are more than 25 years old.
As such, it will be important for you to document all the contributions of shareholders as part of your income tax preparation and for supporting your claim in case a dividend payment is challenged by CRA (Canada Revenue Agency).

Family Trusts

Income distribution to beneficiaries by way of a family trust will be subjected to taxation on split income as if the dividend has been paid to an individual directly. Due to this change, use of a family trust for income splitting between family members will become ineffective unless you are able to show that dividend paid was reasonable as per the reasonability test.
Moreover, if the proposed changes are implemented then individuals will not be able to claim what is known as LCGE (or lifetime capital gains exemption) for capital gains which accumulated in a time period where trust owned the shares.

A Final Note

We will conclude here with a final note that income tax preparation is certainly a complex task and it can become even more difficult in case the proposed tax changes are implemented by the government.  In this situation, you should work with a tax consultant to ensure that all available tax benefits can be utilized for maximizing returns your business earns and changes implemented are incorporated into tax planning for your business.

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