Federal Finance Minister Bill Morneau shared new details on his government’s proposed tax policy changes for income splitting or sprinkling on Wednesday, the last day before MPs head home for Christmas.
The revised changes include “bright line” tests designed to determine whether a business owner’s family members make meaningful contributions to the business, and are eligible to claim income from the business without paying the highest marginal tax rate on it.
The finance department says the changes are proposed to be effective for the 2018 tax year, and will be legislated as part of the 2018 federal budget.
“It is extremely concerning to see the federal government drop this lump of coal during the busiest season for hundreds of thousands of firms and only days before all small business owners are expected to implement the new rules. This seems the very opposite of tax fairness,” said Dan Kelly, president of the Canadian Federation of Independent Business, which has been strongly opposed to the tax changes since they were first proposed in mid-July. “How our government expects small businesses to understand the new rules and make any needed changes to their corporate structures in two and a half weeks is beyond me.”
Family members who meet the following criteria, as shared by the department, would automatically be excluded from the tax on split income:
- The business owner’s spouse, provided that the owner meaningfully contributed to the business and is aged 65 or over. In recognition of the special challenges associated with planning for retirement and managing retirement income, the new approach to income sprinkling will be better aligned with the existing pension income splitting rules. This also reflects the fact that a business can play an important part in supporting its owner in retirement.
- Adults aged 18 or over who have made a 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. For businesses with seasonal operations, such as may be the case with farms and fisheries, the labour contribution requirement will be applied for the part of the year in which the business operates.
- Adults aged 25 or over who own 10 per cent or more of a corporation that earns less than 90 per cent of its income from the provision of services and is not a professional corporation.
- Individuals who receive capital gains from qualified small business corporation shares and qualified farm or fishing property, if they would not be subject to the highest marginal tax rate on the gains under existing rules.
Beyond these cases, a reasonableness test would be applied to determine how much income would be subject to the highest marginal tax rate in the province.
The Canada Revenue Agency also published this guidance document on how the proposed changes would be applied.
“While the bright-line test may offer relief to some families, the Canada Revenue Agency will still need to determine whether a firm qualifies for the exemption,” said Kelly. “We remain concerned that the new income sprinkling provisions won’t take into account many of the formal and informal ways family members participate in the business.”
Ottawa says the number of family businesses affected by the changes is estimated to be less than 45,000.
Just hours before Morneau shared the income splitting details, the Senate Finance Committee released its report on the Liberals’ tax changes. After holding 30 public hearings and hearing from 138 witnesses, the Senate committee recommended the Liberals drop the entire tax change proposal, or at least delay implementation until 2019.
(Read more on the Senate report here.)