Dec 15, 2017
This week, Federal Finance Minister Bill Morneau announced revisions to the income splitting proposals set to take effect in 2018. The announcement served to clarify income splitting rules amongst family members and introduced specific tests to determine whether or not a family member is able to receive income from a small business.
For all family members who receive income from a small business that do not meet the revised conditions outlined in Morneau’s announcement, all income will be taxed at the highest marginal tax rate.
Family members who meet the following conditions will not be subject to taxation at the highest marginal tax rates:
- The business owner’s spouse, provided the owner meaningfully contributed to the business and is aged 65 or over.
- Adults aged 18 or over who have made a regular, substantial labour contribution—generally an average of at least 20 hours per week—to the business during the year, or during any five previous years.
- Adults aged 25 or over who own 10% or more of a corporation that earns less than 90% of its income from services, and isn’t a professional corporation.
- For those who do not meet these requirements, there is an option to self-assess if they meet the qualifications for “reasonable” payments on their tax return. Self-assessed income to family members would potentially face a review by the Canada Revenue Agency in order to prove “reasonability”.
These proposals will drastically increase income taxes for Canadians operating small to medium sized businesses. They are effectively removing the ability for companies to allocate income to legitimate corporate shareholders. Furthermore, the wording of the rules is vague and open to interpretation. It would appear that the government wants business owners to pay 50% tax on their personal incomes.
As these rules take effect in 2018, we would recommend that increased distribution to family members be made for 2017 rather than delaying and paying resulting higher taxes in 2018 and beyond.
Please contact us to discuss what would work for your situation:
Maple Ridge: email@example.com
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The proposed changes are complex and may be far-reaching with respect to how private corporations are taxed in the future. EPR Maple Ridge Langley will continue to monitor these developments to be able to provide you with timely updates and advice.
Your shareholder loan account is made up of all capital that you contribute to the corporation and all purchases made on behalf of the corporation using personal funds or personal credit cards netted against cash withdrawals and personal expenses paid by the company on your behalf.
As long as you do not withdraw more than what you initially contributed to the business, you can withdraw the balance of your shareholder loan account on a tax-free basis. If you draw too much money from your business so that you end up owing the corporation money, you have one year from your fiscal year-end date to pay it back. This can be repaid either via direct repayment, salaries or dividends. If the amount is not repaid, the amount of the loan will be included in full on your personal income tax return.
Withdrawals from your shareholder loan account include cash, personal expenses paid by the corporation, and property transferred to you personally. If you take property out of the corporation be sure that you transfer the asset at the fair market value just as if you purchased it from a company that you had no interest in.
Interest does not have to be paid on the amounts owing to the shareholder however, if interest is paid, then a legal contract should be drawn up stating an obligation to pay interest and the actual amount of the interest. The interest paid on the shareholder loan is then deductible to the corporation and taxable to the shareholder.
CRA has specific rules about corporate shareholder loans. Since corporations often pay tax at preferred rates, CRA is concerned that owners could take money out of their company without paying personal income tax on it. CRA specifies that if a shareholder owes money to the company on two consecutive year-end balance sheets, the principal portion of the loan must be included in the shareholder’s income tax return. It also notes that a series of loans and repayments will be viewed as one continuous loan. This prevents the shareholder from paying the loan off just prior to year-end and then re-borrowing the money just after year-end so the loan does not show up on the balance sheet.
You need to be continuously aware of your shareholder loan balance. From a tax perspective, it is often advantageous to eliminate the amount that you owe the company by issuing a bonus or declaring a dividend to the shareholder rather than having the amount included on your personal income tax return by CRA.
For more information on shareholder loans, please contact your EPR office.
Reprinted with permission from EPR Canada.