Summary of the proposed measures announced on July 18, 2017 relating to income splitting strategiesJuly 25th, 2017
On July 18, 2017, Canada’s Minister of Finance published, for consultation purposes, a series of measures to counter and limit certain tax planning strategies involving private corporations, including, among others, income splitting strategies. Canadians will be able to present their comments to the Minister until October 2, 2017.
The proposed amendments are perceived as necessary by the Minister based on the belief that certain tax structures available under the current regime result in inequities when compared to the regime applicable to employees. The measures amending the rules on income splitting affect two important elements: (1) income splitting with adults; and (2) the multiplication of the capital gains exemption (the “CGE”).
1. Income splitting with a person over the age of 18
To date, only income splitting with individuals under the age of 18 was limited by the split income rules (known as “kiddie tax”). More specifically, any “split income” received by a minor is taxed at the highest marginal rate. “Split income” includes, among other types of income, dividend on shares of a private corporation as well as income from a partnership or a trust which comes from the business of a related person (i.e. a parent).
The announced measures propose a broader scope of the split income rules.
Among others, the split income rules would apply to family members aged 18 years and older to the extent that the amounts received do not meet certain criteria of reasonableness. These criteria differ whether a person is between the ages of 18 and 24 or is 25 years old or older. These criteria are essentially based on the work done by the adult family member in the business, his or her capital contribution and previous remuneration received in connection with the business.
Moreover, the definition of “split income” will now include the following types of income: (i) income from certain types of debt obligations; (ii) gains from dispositions after 2017 of certain property, the income from which is split income and (iii) for minors and adults under 25 years old, compound income (i.e. income on property that is the proceeds from income previously subject to the tax on split income or attribution rules).
In practical terms, these new rules will generally apply to a family trust or discretionary dividend shares in order to pay income to members of the family, including spouses. The rules, if enacted, would apply on income paid after 2017.
2. Multiplication of the CGE
Under the current rules, a family trust holding qualified small business corporation shares may distribute the capital gain, when the gain on such shares is triggered, to the beneficiaries of the trust (generally the owner of the corporation and minor or adult members of his/her family) in order to use the CGE of each beneficiary (i.e. $835,716 in 2017) and thus multiply the tax savings associated with the CGE.
The announced measures essentially propose the following limitations to the multiplication of the CGE:
2.1 individuals under the age of 18 would no longer qualify for the CGE. In addition, gains realized or accrued before they reach 18 years of age would not be eligible for the CGE;
2.2 individuals over the age of 18 would have to meet the same criteria of reasonableness as for “split income” (i.e. labour or capital contribution) in order to be allowed to use their CGE against the realized gain;
2.3 individuals would no longer be able to use the CGE for capital gains accumulating while a trust holds the property, unless the property is held by:
(a) a spousal or common-law partner trust or alter ego trust, where the individual claiming the CGE is the trust’s principal beneficiary;
(b) certain employee share ownership trusts.
The trust would be able to continue undertaking share rollovers to its beneficiaries, but no CGE would be allowed in respect to the underlying capital gain transferred from the trust through a share rollover to a beneficiary.
However, transitional rules would allow individuals affected by these measures (except for minors) to trigger, at the latest in 2018, a capital gain by way of a deemed disposition of the shares for proceeds of up to the fair market value of such shares. This election would be available only for the shares owned by the individual continuously from the end of 2017 until the day of the deemed disposition (or by a trust of which the individual has been a beneficiary continuously from the end of 2017 until the day of the deemed disposition). These transitional rules will essentially allow affected individuals (except for minors) to avail themselves of the rules that are currently in effect for the gain on the shares accumulated until December 31, 2017.
In practical terms, these new rules will prevent the use of a family trust to multiply the CGE with minor and adult family members and will prevent minors and adults not meeting the criteria of reasonableness from using their CGE against a gain realized by them when disposing of shares otherwise qualifying for this purpose. Such rules, if enacted, would essentially apply to dispositions occurring after 2017.
We recommend to our clients not to modify their current structure until the proposed measures are finalized. Each situation will have to be analyzed individually. The proposed income splitting rules will not apply until 2018.
Do not hesitate to contact us if you need more information or if you wish to discuss the various restructuring options in that regard.