On February 27th, 2018, Finance Minister Bill Morneau tabled the 2018 Federal Budget. There were no changes to the personal income tax rates. However, the highly anticipated rules regarding the taxation of passive investment income in private corporations were announced along with several other tax measures including tighter reporting requirements for trusts and foreign affiliates. The Budget also confirms that the Government will proceed with previously announced measures such as the decrease in the small business tax rate and the income sprinkling rules, and signals the Government's intention to move forward with several gender equality measures.
Our highlights of this year's Budget are summarized below.
Passive Investment Income
The Government first indicated its focus on reviewing certain tax planning strategies involving private corporations during last year's Federal Budget. For the 2018 Federal Budget, they finally released their rules on the taxation of passive investment income in private corporations. One of the Government's main concerns with holding passive investments inside a private corporation is that doing so may yield advantages compared to individual investors, because the lower corporate tax rates can facilitate the accumulation of earnings. The Budget proposes two measures, applicable to taxation years that begin after 2018, to limit tax deferral opportunities on passive investment income earned by private corporations. These measures are described in detail below.
Business Limit Reduction
The Budget proposes to reduce the $500,000 small business limit for Canadian-controlled private corporations ("CCPC") (and their associated corporations) that earn significant passive investment income. The small business limit is reduced by $5 for every $1 of investment income earned by a CCPC (or the associated group) in excess of $50,000, resulting in a reduction of the small business deduction to nil when investment income reaches $150,000. This reduction to the small business limit is based on taxable income for the year that ended in the preceding calendar year. Taxable income earned by a CCPC in excess of the small business limit is taxed at the general corporate tax rate.
This mechanism will operate alongside the taxable capital business limit reduction rules that apply when taxable capital exceeds $10M. The reduction in the small business limit will be the greater of the reduction calculated under this measure and the reduction calculated under the taxable capital rules.
The term Adjusted Aggregate Investment Income ("AAII") will now be relevant in calculating the business limit reduction. In general, AAII will be a CCPC's aggregate investment income adjusted for the following items:
- Taxable capital gains and losses will
be excluded to the extent that they arise from the disposition of
any of the following
- Property that is used principally in an active business carried on primarily in Canada by the CCPC or by a related CCPC; or
- A share of another CCPC that is connected with the CCPC and all or substantially all of the fair market value of the assets of the other CCPC is attributable (directly or indirectly) to assets that are used principally in an active business carried on primarily in Canada, and certain other criteria are met;
- Net capital losses carried over from other taxation years will be excluded;
- Dividends from non-connected corporations will be added; and
- Income from savings in a life insurance policy that is not an exempt policy will be added, to the extent that it is not otherwise included in aggregate investment income.
AAII will also not include investment income that is incidental to a CCPC's active business.
Refundability of Taxes on Investment Income
The current regime taxes a private corporation's investment income at an upfront rate that approximates top individual tax brackets. This system is designed so that investment income earned by a corporation should be taxed approximately the same as investment income earned by an individual, both upfront and on a flow-through basis (also known as "integration"). This flow-through tax rate was designed based on the assumption that dividends are paid out of passive income and not active business income. However, private corporations can earn both passive income and "high-rate" active income, creating a cocktail of tax pools between refundable taxes ("RDTOH") and general rate income ("GRIP") that can benefit each other. Before applying the measures from this year's Budget, a modest tax deferral could be gained where "GRIP" dividends were paid to recover "RDTOH".
For tax years beginning after 2018, this deferral will no longer be available. Two RDTOH pools will exist, an eligible RDTOH pool and a non-eligible RDTOH pool. The proposed measures will effectively source the RDTOH to its underlying income and prevent [inappropriate] mixing to preserve tax integration. The refundable tax on investment income that is added to each pool is summarized as follows:
In the tax year that the rules take effect, a portion or all of the company's opening RDTOH balance will be characterized as "Eligible RDTOH" in an amount equal to the lesser of the company's RDTOH balance and 38.33% of its GRIP. This relieving provision appears to provide grandfathering.
Gender Equality
Using the much-hyped "gender-based analysis" tool to examine how policy measures affect men and women differently, it is no wonder that the Government has released its Federal Budget with a large emphasis on gender equality. The Budget focuses on efforts to increase the participation of women in the workforce aiming to boost productivity and offset an aging population. Federal funding will be targeted towards new parental benefits, aid to female entrepreneurs, anti-harassment programs, as well as measures to promote pay equity.
In particular, the Budget proposes to create a new five-week "use-it-or-lose-it" Employment Insurance benefit for non-birthing parents to encourage women to re-enter the workforce. Furthermore, the Budget is designed to attract women to skilled trades jobs traditionally dominated by men, by piloting a new Apprenticeship Incentive Grant for Women. It also includes measures to boost the number of women entrepreneurs by increasing access to capital through the Business Development Bank of Canada and other agencies.
Further commitments were made to move forward on "proactive" pay equity legislation, as well as a "pay transparency" measure, to close the wage gap among federal workers and in federally regulated sectors. With the #MeToo movement fighting sexual harassment and assault against women building in strength, the 2018 Federal Budget has allocated funds towards a gender-based violence prevention program.
Other Measures
Reporting Requirement for Trusts
The Federal Budget proposes new reporting requirements for certain trusts that will require disclosure of trustees, beneficiaries, settlors and protectors. The new reporting requirements will apply to Canadian-resident express trusts and to non-resident trusts and will apply for the 2021 and subsequent taxation years.
The following types of trusts are excluded from these new reporting requirements:
- Mutual fund trusts, segregated funds and master trusts;
- Trusts governed by registered plans;
- Lawyers' general trust accounts;
- Graduated rate estates and qualified disability trusts;
- Trusts that qualify as non-profit organizations or registered charities; and
- Trusts that have been in existence for less than three months or that hold less than $50,000 in assets throughout the taxation year (provided, in the latter case, that their holdings are confined to deposits, government debt obligations and listed securities).
To support these new reporting requirements, the Budget proposes new penalties for the failure to file a T3 return (along with a new beneficial ownership schedule if required), equal to $25 for each day of delinquency, with a minimum penalty of $100 and a maximum penalty of $2,500. If a failure to file the return was made knowingly, or due to gross negligence, an additional penalty will apply, equal to five per cent of the maximum fair market value of property held during the relevant year by the trust, with a minimum penalty of $2,500. As well, existing penalties will continue to apply.
The new penalties will apply in respect of returns required to be filed for the 2021 and subsequent taxation years.
Foreign Affiliate Reporting
The Budget proposes to align the information return filing deadline with a taxpayer's income tax return filing deadline. This change shortens the filing deadline for information returns (form T1134) that must be filed by a taxpayer in respect of its foreign affiliates to 6 months (from 15 months) after the taxpayer's taxation year-end. This measure will apply to taxation years that begin after 2019.
Previously Announced Measures
The Budget confirms the Government's intention to proceed with the following previously announced tax and related measures, as modified to take into account consultations and deliberations since their release:
- The income tax measure announced on October 16th, 2017 to lower the small business tax rate from 10.5 per cent to 10 per cent, effective January 1st, 2018, and to 9 per cent, effective January 1st, 2019, which was included in a Notice of Ways and Means Motion tabled on October 24th, 2017 along with related amendments to the gross-up amount and dividend tax credit for taxable dividends. Essentially, the effective individual tax rate on non-eligible dividends is increased by approximately 0.5% in 2018.
- Income tax measures released on December 13th, 2017 to address income sprinkling. For details on these rules, please see our article " Updated Proposed Rules on Income Sprinkling" from December 15th, 2017.
- Measures confirmed in Budget 2016 relating to the Goods and Services Tax/Harmonized Sales Tax joint venture election;
- Income tax measures announced in Budget 2016 expanding tax support for electrical vehicle charging stations and electrical energy storage equipment;
- The income tax measure announced in Budget 2016 on information reporting requirements for certain dispositions of an interest in a life insurance policy; and
- The income tax measure announced on October 24th, 2017 in the Fall Economic Statement to provide for the indexing of the Canada Child Benefit amounts as of July 1st, 2018 instead of July 1st, 2020.
For further details on these and other proposals in the Budget, please follow the link below for a full commentary.
CPA Canada Federal Budget Commentary 2018
Looking for more information on specific sections? We have provided some quick links for you:
2018 Federal Budget Introduction
2018 Federal Budget – Business Income Tax Measures
2018 Federal Budget – Personal Income Tax Measures
2018 Federal Budget – International
2018 Federal Budget – Charities
2018 Federal Budget – Sales Tax and Excise Tax Measures
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