Tax planning using private corporations involves new rules that have to be applied to the 2018 and the subsequent taxation years. The rule tends to restrict split income received by an adult individual. In this context, “split income” will generally include dividends or interest, but not salary, paid by a private corporation directly or indirectly to an individual from a related business (“Related Business”) in respect of the individual and certain capital gains unless the amount falls within a specific exclusion (the “Excluded Amount” or “Excluded Amounts”).
The exceptions
The rules include various exceptions when we use tax planning in private corporations. The split income rules do not apply in certain circumstances. The availability of these exceptions depends on one’s age. For adult individuals – amounts received from an excluded business. There is a broad exception that is available to anyone over age 17.
Excluded business
If an individual is above the age of 17 and the amounts are derived from a related business where the individual was actively engaged on a regular, continuous, and substantial basis in the activities of the business in the taxation year or in any five prior taxation years of the individual.
An individual will be deemed to be actively engaged if the individual works in the business at least an average of 20 hours per week during the portion of the taxation year of the individual that the business operates or meets that requirement for any five prior years. The five taxation years need not be consecutive. In any other case, whether an individual is actively engaged will depend on the facts and circumstances of that case. The CRA stated that “records such as timesheets, schedules or logbooks” and payroll records could be used to demonstrate the number of hours an individual has worked.
Excluded shares
In case the individuals are aged 25 or over, then income from a taxable capital gain from the disposition of excluded shares or a payment that qualifies as a reasonable return is an exception.
However, the said individual aged 25 to qualify for this exception the individual must hold a significant interest of 10 % in the corporation. The shares represent 10% or more of the votes and value of the corporation. Less than 90% of the corporation’s business income was from the provision of services. The corporation should not be a professional corporation. Corporations conducting sales that include both services and non-services, then such revenue will need to be tracked separately. All or substantially all of the income of the corporation is not derived from another related business in respect of the individual other than a business of the corporation.
Reasonable return
The split income rules do not apply if the income received is considered a reasonable return. Payments that represent a reasonable return based on the following criteria-
- The work performed in support of the related business
- The property contributed directly or indirectly in support of the related business
- The risks assumed in respect of the related business
- The total amounts paid or payable by any person or partnership to or for the benefit of the individual in respect of the related business
- For individuals between the age of 18 and 24 – return on property contributed in support of a related business that is a safe harbor capital return or a reasonable return having regard only to contributions of arm’s length capital to the business
Safe harbor capital return
A safe harbor capital return is determined as the return on property contributed by the specified individual to the related business. The formula to make this determination is the result of Y x Z, where:
Y is the highest prescribed rate of interest in effect for a quarter in the year; and Z is the fair market value of the property contributed by the individual, then pro-rated for the number of days the property was used in the related business in the year.
Arm’s length capital
Property of an individual, other than property that is derived from property income in respect of a related business, that is borrowed under a loan, or that is transferred from a related person (other than inherited property).
Capital gains
There are exemptions to the application of the proposed split income rules apply; these refer to certain capital gains realized on the disposition of private company shares. When an individual dies, he or she is deemed to have disposed of all of their capital property, including private company shares, at their fair market value. If such a capital gain arises on a person’s death as a result of this deemed disposition, then the split income rules do not apply. Another exception when we use tax planning in a private corporation is if the capital gain is derived from the disposition of either qualified farm or fishing property, or qualified small business corporation shares, on which the lifetime capital gains exemption1 could be claimed, then the split income rules do not apply.
Retirement
Income or a taxable capital gain that would be an excluded amount to a “spouse or common-law partner”, who is at least 65 years old at year end, if it were included in their income for the year. If a shareholder who is involved in the business is at least 65 years of age, and if income received directly by that person would not be subject to the split income rules, income received by the shareholder’s spouse or common-law partner will not be subject to the split income rules. This exception is available with respect to all corporations, including professional corporations.
The rules affecting the tax planning using a private corporation are extremely complex. Please call us at 403 281 8926 or email us at ralemao@shaw.ca