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Major Changes on the Horizon for Small Businesses

Posted under: News

The announcement on July 18th, 2017 by Federal Finance Minister Bill Morneau regarding the proposed changes to taxation within incorporated businesses in Canada represents a major change in corporate tax planning.  Corporate tax planning for the last 35 years has focused on after-tax corporate savings and the usage of dividends as a means for the business owner to split income amongst family members.

Historically, medical professional corporation tax planning focused on having family members as named shareholders and as such these shareholders receive dividends. The rules were put in place so that the incorporated physician would be able to use their corporation to reduce taxes as a trade-off to keeping fees paid to these professionals at a manageable level for the government.

Tuesday’s announcement targets the practice of dividend splitting, changes to the taxation of passive income within a corporation, and the claiming of business income as capital gains. These changes will result in 1 of 3 outcomes: some business owners will move to a more favourable tax jurisdiction, some professionals may reconsider incorporating all together, and business owners will retain less in their corporation and increase their T4 income.

For most, a move to another jurisdiction is not the desirable outcome. There could be tax advantages for professionals such as doctors; however it does come at the cost of uprooting families, starting from scratch, and leaving a place considered home.

For younger professionals the choice to incorporate may not be as straightforward as before. They will be able to take advantage of some savings in their corporation, but the proposed changes could play a key factor in them not incorporating at all.

For a large number of incorporated small businesses and professionals, the question will revolve around what other strategies can be employed to allocate corporate assets earmarked for retirement. With a concentrated focus on employment income versus dividends, and less of a focus on corporate savings, registered plans such as Individual Pension Plans (IPPs) offer the clearer path to retirement and can provide meaningful tax relief to the business and the business owner.

The IPP is a corporately sponsored defined benefit pension plan that offers larger contributions annually than that of RSPs. It provides the ability to fund for past years of employment as a means of jumpstarting their retirement plan, is creditor proofed, and all the investment and administration costs are deductible to the corporation.

For example, a 55 year old physician receiving maximum T4 for RSP purposes for the last 5 years, would be able to accrue over $1.2 million in tax sheltered assets within the IPP in a 10 year period. For many professionals the increased registered savings, coupled with corporate assets that have been saved over the life of the company would be more than sufficient to maintain a similar lifestyle in retirement as was experienced during active working years.

For those higher income earners, a Retirement Compensation Arrangement (RCA) can also be employed as a means of supplementing retirement income. The limits for funding can be more generous, and can be funded on a periodic or one time basis.

Employment income can also allow for the business owner to participate in a Health and Welfare Plan (HAWP) which can make out of pocket medical and dental expenses deductible to their company as a pre-tax expense. The benefits must be provided based on an employment relationship and it is through a higher T4 that this can be achieved.

The proposed changes are still at the consultation stage but there has been a clear mandate that how way one saves within a corporation is going to change significantly over the coming years. It will take some time to draft the changes and then for the tax professional community to digest and plan accordingly, but knowing that there are tax efficient strategies such as the IPP to help offset the increased tax burden can help mitigate the impact. This strategy aids clients, advisors and tax professionals to ensure they remain ahead of the curve.

By Fraser Lang, CFP, CLU, CHS Senior Vice President Sales and Business Development, GBL