On February 27th, the Finance Minister presented the 2018 Federal Budget. The most anticipated proposal in the budget related to the income tax changes for corporations earning passive or investment income. Our conclusion on the passive income changes was that they were “Better than Proposed”. That’s not to say we agree or disagree with the changes but rather recognize that the proposal included in the budget is better than what was originally presented in the summer of 2017.
The following are our key takeaways:
Passive Income
There are two measures that are proposed by the Budget for tax year ends starting on or after January 1, 2019:
- A reduction to the small business deduction for corporations earning in excess of $50,000 of passive income.
- A change to the dividend refund when dividends are paid. These rules will be effective for tax year ends starting on or after January 1, 2019.
Reduction of SBD
These rules will impact corporations and associated groups of corporations that are earning in excess of $50,000 in passive income. This ensures that one corporation cannot be used to shelter passive income while other corporations in the group are able to claim the full small business deduction.
The small business deduction will be reduced by $5 for every $1 that the passive income exceeds $50,000. At $150,000 of passive income the full small business deduction will be gone.
Generally, passive income includes all investment income. For the purposes of calculating the reduction in the small business deduction, gains or losses on the sale of business operating assets and the sale of shares of an operating subsidiary will be excluded.
Changes to Refundable Tax Pools
The Budget proposes to change the refundable balance into two separate pools, the eligible RDTOH pool and the non-eligible RDTOH pool. The eligible RDTOH pool will track refundable taxes that are paid on eligible dividends that are received during the year. These dividends are generally received from public companies. The non-eligible RDTOH pool will track the refundable taxes that are paid on other investment income such as interest, rental income, or other foreign income received on investments.
Dividend refunds can only be received from the non-eligible RDTOH pool by paying non-eligible dividends. A dividend refund can be received from the eligible RDTOH pool by paying an eligible or non-eligible dividend.
The table below shows how RDTOH is increased and refunded from its respective pools:
| Eligible RDTOH | Non-Eligible RDTOH | ||
| Increases to Pool | Eligible dividend income (typically public company dividends) | Interest
Rent Foreign income Other investment income |
|
| Refund of RDTOH | Payment of eligible or non-eligible dividends | Payment of non-eligible dividends |
Any opening balance in their RDTOH balance will be allocated between the two RDTOH pools based on the corporations General Rate Income Pool (GRIP).
The Budget has proposed these measures to align the dividend refunds to the payment of dividends resulting from that passive income.
Previous Measures
Reduction to Small Business Deduction Rate
As previously released, the federal tax rate has been reduced to 10% effective January 1, 2018 and it will be reduced to 9% effective January 1, 2019. The overall combined rate in Alberta is 12% starting January 1, 2018 and 11% starting January 1, 2019.
Split Income and Tax On Split Income (TOSI)
The measures that were released on December 13, 2017 regarding income sprinkling and the Tax On Split Income (TOSI) were also mentioned in the Budget and they are going ahead with these rules. Historically there were ways to split income with a spouse or children to minimize the amount of personal income tax that was being paid.
The TOSI rules came into effect on January 1, 2018 and the rules are similar to the “Kiddie Tax” rules, however, the TOSI rules could also apply to adults. The TOSI rules will apply to many different types of income that are received from a related individual such as:
- Dividends
- Interest
- Shareholder benefits
- Income from a trust that is considered to be split income
Split income does not include salaries that are paid to an individual. There are other rules that apply to ensure that salaries that are paid are reasonable.
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There are a few exclusions that are available when considering the TOSI rules. Some of the exclusions are:
- If the income is received due to the death of a related person. This would occur if you received shares from an estate and received a dividend on those shares.
- If the individual is engaged on a regular, continuous and substantial basis. This is defined as working for the business for 20 hours a week during the year or any 5 year period.
- If the amount received is reasonable.
- If your spouse is over age 65 and the amount would not be subject to TOSI.
An additional exclusion that is available is if the shares are excluded shares. In order for the shares to be excluded shares all of the following conditions must be met:
- Less than 90% of the corporate income is from providing services
- The corporation is not a professional corporation
- You must own 10% of the votes and value
- Less than 10% of the corporate income is from a related business