2018 Federal Budget: Taxation of Passive Income
25 Apr 2018
In late February, the Honourable Bill Morneau presented his third budget as Minister of Finance, entitled “Equality and Growth”. One of the main focuses of the budget was continuing with the government’s agenda of changing the tax rules for private companies by introducing new measures that impact the taxation of passive income.
In the budget, the government has introduced two separate measures to reduce the tax deferral benefit of earning investment income in a private corporation. These new rules will apply where the corporation also earns active business income taxed at the small business rate and will apply for tax years beginning after 2018; although certain anti-avoidance rules exist that could result in their earlier application.
The first measure is designed to limit access to the small business tax rate. When a Canadian-controlled private corporation (CCPC) pays tax on its active business income up to the small business limit, the combined Federal and Ontario tax rate for 2018 is 13.5% and will be 12.5% in 2019. The small business deduction limit Federally and in Ontario is $500,000.
The budget proposes to limit a CCPC’s access to the small business tax rates where a corporation combined with its associated corporations earn more than $50,000 of passive income in a year by reducing the small business deduction by $5 for every $1 of investment income above the $50,000 threshold. The small business deduction will be fully eliminated when investment income reaches $150,000. This reduction will work in tandem with the existing small business reduction for taxable capital employed within an associated group.
The second measure is designed to prevent a CCPC from accessing refundable taxes on the payment of certain eligible dividends. Currently, a corporation can receive a refundable dividend tax on hand (RDTOH) refund upon the payment of eligible dividends, which are taxed at a lower rate personally in Ontario, in situations where the corporation’s RDTOH was generated from investment income that would need to be paid as a non-eligible dividend.
The budget proposes that an RDTOH refund will generally only be available in cases were a private corporation pays non-eligible dividends. An exception will be allowed where RDTOH arises from eligible portfolio dividends received by the corporation.
Please contact your tax advisor to determine how these new rules could impact your private corporation and to discuss any planning that could be completed to minimize its impact.
Joel Russell, CPA, CA is a tax senior manager with BDO Canada LLP (bdo.ca). Joel works primarily with owner-manager type businesses, supporting them with their tax planning, with a specific focus on estate and trust planning, corporate restructuring, business succession, retirement planning, and purchases and sales of businesses. BDO Canada LLP is the fifth largest accounting firm globally, offering accounting, assurance, domestic and international tax, and advisory services.