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5 Ideas for Limiting the Impact of Coming Tax Changes for Business Owners

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Given we are through personal tax season and well into 2018, I wanted to summarize some key points that business owners need to be aware of, given the changes coming in 2019, particularly focusing on earning passive income in a Canadian-controlled private corporation(CCPC).
 

Currently, in Ontario, the small business tax rate is 13.5% on income of $500k and below, known as the Small-Business Deduction(SBD), and 26.5% for income above this amount and not eligible for SBD.  Currently there is a tax-deferral advantage created by passively investing active business income, taxed at the SBD rate, instead of reinvesting back into the business.  It is a deferral because incorporated professionals and business owners will eventually have to pay personal tax when the CCPC portfolio is ultimately liquidated in retirement,  The federal government is implementing measures to reduce or eliminate these benefits at specific thresholds.  

 

Under the Proposals, the small business limit will be reduced by $5 for every $1 of investment income above a $50,000 threshold.  Under this formula, the SBD will be eliminated when investment income reaches $150,000 in a given taxation year.

Here's a summary of how the math works out:
 


I encourage those impacted to read the full report here from our friends at BDO Canada LLP.

 

To give you some perspective, $1mm earning 5%/year, would produce $50k of passive income. 
 

What can be done to limit the impact of this, if you fall into this bracket?  Here are some actionable ideas to review before these changes come into effect in 2019:  

 

  • Focus on ways to reduce investment income.
    • Calculations are based on realized returns, net of expenses such as Investment Counsel fees, interest expenses incurred to earn investment income and even salaries paid to the owner/manager.  Consider what expenses can be used to reduce investment income.
       
    • Take advantage of vehicles/strategies that shelter passive investment income from tax in a corp, such as Permanent Life Insurance and Individual Pension Plans (IPP) or Personal Pension Plans (PPP).  Note that these tools should be used in context of a proper financial plan, to accurately determine their appropriateness and effectiveness.
       
    • Use investment strategies that limit income and gains incurred, such as:
      • Reducing portfolio turnover, eg. "buy and hold"
      • Corporate-Class Mutual funds can reduce investment income, although less effective than in the past.
         
    • Strategize the timing of realizing any gains and losses, eg.
      • limit realized any paper gains in years when investment income will fall between $50k and $150k.
      • Realize gains in years that you will be either below $50k investment income or above $150k
      • Utilize a capital loss selling strategy  to adjust the net realized income number in your favor.  
         
  • Look for tax-efficient ways to withdraw corporate funds to stay below the threshold and retain your small business deduction, such as:
    • Repaying a shareholder loan or accessing a capital dividend account.
       
    • TFSA and RRSP contributions are still advantageous for business owners as a vehicle for long-term savings vs. keeping funds inside the corp and investing.  Review strategies to maximize these savings vehicles.
       

Note that this is not an exhaustive list.  I strongly encourage those impacted to explore what strategies would be useful in your specific situation, in context with your financial plan, and also with your tax professional.
 

If you don't have either of these things in place, or would like some objectivity on your current plan, please contact us and we can help.

 

Sincerely,

 

Dymond Scruton Advisory Team

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