Finance Minister, Bill Morneau, delivered the majority Liberal government’s third Federal Budget on February 27, 2018. Budget 2018 announces no tax rate changes either personally or corporately and confirms the corporate tax rate reductions previously announced. The big news is that the passive investment proposals were better than expected.

Holding Passive Investments Inside a Private Corporation

The private corporation tax proposals released in July 2017 included measures to deal with the increasing number of business owners holding passive investments inside their corporations, where they benefit from a tax deferral advantage compared to distributing the assets from the corporation and investing personally. Rather than removing access to the refundable taxes as proposed in July 2017, the Government is now proposing two new measures to limit deferral advantages from holding passive investments in a corporation.

Small Business Limit

The first measure proposes to limit the ability of businesses with significant passive investment income to benefit from the small business tax rate. The current small business limit allows for up to $500,000 of active business income to be subject to the lower small business tax rate (which the Government has proposed to reduce from 10.5% to 10% for 2018 and to 9% for 2019), versus the general business tax rate which is currently 15% federally.

Under the proposal, if a corporation (and its associated corporations) earn more than $50,000 of passive investment income in a given year, the amount of income eligible for the small business tax rate would be gradually reduced. It is proposed that the small business limit be reduced by $5 for every $1 of passive investment income above the $50,000 threshold, such that the small business limit would be reduced to zero at $150,000 of passive investment income.

Example 1

Elise owns an incorporated catering business which earns $100,000 (after tax) annually and pays out $75,000 as non-eligible dividends each year. She retains the extra $25,000 annually to build up a fund for a planned parental leave. Elise will not be affected by the new rules since the investment income on her savings will be well below the $50,000 annual threshold. Thus, she will have no income taxed at the general corporate rate.

Example 2

Louis operates a successful medical practice, which is incorporated and earns more than $500,000 annually. He has accumulated a portfolio with a value of $5 million, which he intends to pass on to his children. Given his level of savings and level of income, beginning in 2019, Louis will no longer receive the benefit of the small business rate to fund further passive investments. All of his business’ income will be taxed at the general corporate rate.

Disclaimer

The commentary in this publication is for general information only and should not be considered legal, tax or other professional advice to any party. Individuals should seek the advice of professionals to ensure that any action taken with respect to this information is appropriate to their specific situation.