Bill Morneau presents
his 2018 federal budget

Promoting equality and growth for a strong middle class

By Jean-Luc Burlone

Invited by the CORIM to present his recent budget at a breakfast conference, the honourable William Morneau underscored his government’s dedication to gender equality and the middle class.

Relying on a strong economic performance, the 2018 Federal Budget is more a social budget than an economic one; it swaps short term infrastructure investments for additional spending in favour of women’s entrepreneurship, veteran’s pension plans, aboriginal state of affairs, innovation and industrial research.

By and large, projected deficits remain unchanged with an estimated $19.4B in 2017/18 and $18.1B in 2018/19, for a total of $98B over the next six years but without sketching a plan to reach a balanced budget.

Relying on a strong economic performance, the 2018 Federal Budget is more a social budget than an economic one…

Many economists have reminded the minister that, when an economy is doing well, the conventional wisdom suggests striving for a balanced budget and fiscal reserves to meet the next inevitable economic downturn.

Similarly concerned over the idiosyncrasies of Donald Trump’s trade policies, the business community has expressed its wishfulness for a Canadian response to US threats regarding NAFTA and unilateral tariffs slapped on imports.

Unswerving, Mr. Morneau reminded the interviewer, Pierre-Yves McSween, that Canada has one of the best performing economies in the world and the distribution of wealth through measures in favour of gender equality and the middle class will be instrumental in sustaining economic growth.

Canada has one of the best performing economies in the world and the distribution of wealth through measures in favour of gender equality and the middle class will be instrumental in sustaining economic growth.

The minister also stressed the importance of a thorough analysis on American policies before reacting to it. He reminded the audience that the Canadian tax rate for large corporation is barely 1% higher than the American rate while the Canadian tax rate for small businesses is lower than its US counterpart.

The current budget maintains Canadian advantage, but two tax issues add significant complexity to small businesses. Passive investment and income splitting are touched upon below.

Looking at two new business tax issues

The proposal to tax income from passive investment held in Canadian controlled private corporations (CCPC) was watered down from the original intent. It is nonetheless a complex matter that may increase the tax burden.

The first $500,000 business income is taxed at a lower rate than individual income to entice direct reinvestment in the corporation. As it happened, the lower rate also provided a significant tax deferral opportunity when the after-tax income is invested ‘passively’ in financial markets rather than in the corporation or distributed as dividend to shareholders.

‘… two tax issues add significant complexity to small businesses. Passive investment and income splitting…’

The budget tackles the issue with two measures. First, the budget will reduce the first $500,000 of business income that is eligible for the low rate, by $5 for every $1 of investment income over $50,000. Hence, with an investment income of $150,000 or more, the business income will no longer be eligible for the low small business tax rate.

This measure mainly targets professional businesses (like incorporated doctors, accountants and lawyers) that do not need significant reinvestments in the business and thus could have significant capital invested in passive investments. For those professional corporations with passive investment income over $150,000, the corporate tax rate on their business income would increase from 17%-20.6% to 26.6% in 2019. (Dominic Leduc, CPA, CA, D.Fisc)

‘The budget tackles the issue with two measures. First, the budget will reduce the first $500,000 of business income that is eligible for the low rate, by $5 for every $1 of investment income over $50,000.’

Secondly, the investment income earned by a CCPC is normally distributed to shareholders as a non-eligible dividend, taxed at a high rate. A portion of the corporate tax paid is returned to the corporation when it distributes dividends to its shareholders. More precisely, the refund is made through the corporation’s refundable dividend tax on hand (RDTOH) account.

The RDTOH account does not differentiate between non-eligible dividends (that are paid from passive investment income and business income eligible to the lower rate) and eligible dividends (that are paid from business income taxed at the general rate).

Non-eligible dividends end up being taxed at a higher personal tax rate than eligible dividend. This created an opportunity for corporations earning both investment income and business income taxed at the general tax rate to recover RDTOH while paying an eligible dividend to its shareholder. (Dominic Leduc, CPA, CA, D.Fisc)

‘… the second measure will create two RDTOH accounts: One account for eligible dividends that will not return tax monies to the CCPC and another RDTOH for non-eligible dividends.’

Hence, the second measure will create two RDTOH accounts: One account for eligible dividends that will not return tax monies to the CCPC and another RDTOH for non-eligible dividends. Tax refund from the latter will be available only in cases where a CCPC pays non-eligible dividends.

This measure simply ensures that the general principle that corporate investment income should be paid out as non-eligible dividend will be respected. This measure would mainly impact corporations that earn both business income over $500,000 and passive investment income. (Dominic Leduc, CPA, CA, D.Fisc)

Both passive investment measures will be applicable after 2018 and subject to non-avoidance clauses. On the other hand, the following income splitting new measure will be applicable for the 2018 taxation year.

‘The 2018 budget confirms the December 2017 rules regarding income splitting.’

The 2018 budget confirms the December 2017 rules regarding income splitting. It basically requires that any income splitting be in line with the activities, responsibilities or investments individuals have contributed to the family business. Any salary, dividend or realized capital gain received by an individual must be appropriate to his or her contribution.

Exceptions and criteria for what is considered a reasonable contribution are given. Some are welcome but most restrict income splitting possibilities and add a significant headache to entrepreneurs.

Note: Please consult a qualified fiscalist, a tax expert or a legal expert to sanction any tax decision under consideration.

Images: Sylvie-Ann Paré

Read also: The emergence of a new labour