Over the holidays Finance Minister Bill Morneau unveiled the finalized version of the tax changes announced July 18, 2017, which spurred much controversy.
The federal government is targeting ‘income sprinkling’, amounts paid from a private corporation to family members, in the form of salary, dividends or other sources of income which are deemed not to be reasonable. Amounts deemed not reasonable would be taxed at the highest marginal tax rate – currently 53.53% in Ontario.
What is the federal government trying to do, or trying to prevent? They are trying to prevent income splitting between family members of business owners that have incorporated. Targeting those who have family members as shareholders or employees of the business which would normally pay out dividends or salary to family members which have lower income and tax rates, in order to have the income taxed at a lower rate.
Terms of the Revised Income Sprinkling Rules
- When a family member is 18 of age or over and has made a substantial labor contribution in the business, so they are actually working in the business.
- o Finance has proposed a bright line test, which states that if they have been working twenty hours during the week with the business then there wouldn't be any income sprinkling rules that apply to them
- o For seasonal businesses, they will only focus on the part of the season or part of the year where the corporation is actually operating. Such as fishing where there are certain seasons you are not operating.
- o the new rules would not apply
- When a family member is 25 years of age or older, owns a percentage of the business equal or greater to 10% of the shares, including 10% of voting shares, and the business is not earning more than 90% of its income from consulting services
- Where there is a professional corporation, regardless of the amount of income being earned, regardless of the share ownership of any family member, the income splitting rule would apply
However if the business owner is 65 or over the rules would not apply to them, which is meant to match up with the pension income splitting rules allowing business owners to split their income with their spouses
If those situations do not involve you, then we go back to the initial rules where they have provided some clarification, however the amount being paid needs to be reasonable and in determining what is reasonable the C.R.A. would look at a few different factors.
They look at:
- Labor contributions,
- Capital contributions,
- The risks that the family members are assuming within a business, and
- Also look at previous payments, historical payments made to those family members.
The timing of this was quick, however we were expecting it. These changes took effect January 1, 2018. For those of you potentially affected by these changes, we have already discussed this and addressed your personal situation. Going forward it will be very important for business owners that have family members contributing to the business to document all contributions, making sure that they can substantiate any amounts being paid if they are providing labor contributions or capital contributions to the business.