Tax change answers — Part 2: Passive investment income


The federal government thinks too many Canadians are using private corporations as tax-advantaged personal savings accounts, and so it’s proposing having much higher tax rates apply to income that comes from investments made within a company.

For an incorporated farm business, this “passive” investment income might include returns from GICs, mutual funds, stocks, bonds, or even rental income from land or buildings.

In part one of this mini-series on the federal government’s proposed tax changes, we focused on changes to income splitting. Several accountants we’ve talked with say they foresee the changes to passive investment income having a much larger overall impact.

Currently, an individual who is a shareholder in a corporation can defer paying personal income tax on business profits by leaving that money inside the corporation. Those profits are taxed at the corporate rate of ~15 percent. Higher personal tax rates would only be applied as the money is withdrawn from the company.

The objective outlined by Finance Canada is to neutralize the advantage of leaving a passive investment in a corporation starting in 2018.

“What they want to do is if a private corporation invests in passive investments, at the end of the day when the individual pulls that money out, they want to put them on the same footing as someone who had pulled all the money out on year one, and the only way they can do that is by levying a significant tax rate,” explains Jesse Moore, senior manager, tax, with BDO Canada in part two of our conversation.

As Moore notes, many business owners, including farmers, have built up rainy day funds and equity for retirement within their corporations.

“There’s going to be a big impact there for farmers who are considering retiring, who have been working through a company and are trying to use the equity in their company to plan for retirement. That’s where I see the biggest impact for farm businesses,” he says.

Unlike the proposed changes to income sprinkling and capital gains reporting, Ottawa has not published draft legislation in the area of passive investment income.

“We don’t know how the rules would work exactly, so there’s a lot of uncertainty…I think the reason they haven’t introduced legislation is it’s going to be extremely complicated to achieve what they’re trying to achieve,” says Moore.

It should also be noted these changes would not apply to active income earned through regular business.

We’ll delve into what the government is planning for capital gains, and conversations farm business owners should have with their accountants to prepare for these proposed changes, in our third and final part of this series.

Related: Tax change answers — Part 1: Income splitting

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