Are you one of the following:
- A business owner?
- A shareholder in a private company?
- A real estate owner?
- Have, or plan to have, real estate holdings in a trust or corporation?
- Are you a professional service provider?
If yes, then the Federal Government of Canada has proposed some tax changes that could affect you greatly. If you own or invest in commercial real estate property in Canada, then keep reading to see how these changes might affect you. These changes will alter one's ability to operate or plan in the future. If implemented, these tax changes will impact all Canadians who use private companies, including incorporated professionals and family businesses. The Federal Government intends to incorporate these changes starting in 2018. Keep reading to get the basics on the proposed tax changes.
Holding Passive Investments Inside a Private Corporation
Passive investing refers to an investment strategy that aims to maximize returns over a longer period of time by keeping the amount of buying and selling to a minimum in order to avoid the fees and drag on performance that often occurs from frequent buying and selling. The current system for holding passive investments inside a private corporation allows an owner who has a business in a private corporation to pay the same amount of tax on that business income as they would on their personal income tax. This allows for a tax deferral on individual tax payable if a shareholder leaves the funds in the corporation. The Federal Government is proposing a change to this system because there is a belief that the current tax deferral laws give a huge tax advantage to owners of private corporations. The proposed tax changes for passive investment income include having to identify the source of the funds in a private corporation being used to generate income, to which the government will determine what tax rate should be applied when earning from those funds. The government plans on using this system to remove the refundability of passive investment income taxes in which earnings that were used to fund such investments were taxed at low corporate tax rates.
Converting Income into Capital Gains
Capital gain refers to an increase in the value of a capital asset, either investment or real estate, that give it a higher worth than the purchase price. Capital gain can be either short-term or long term and has to be claimed on income taxes.The Federal government wants to alter the rules to eliminate extra income from a private corporation being converted into capital gain and avoid earning stripping. Earning stripping is a technique used by corporations to avoid high domestic taxation. The proposed changes plan to incorporate an anti-avoidance rule and bring in a new anti-stripping rule. If these two new rules are brought into effect, it will impact the way private corporations extract funds and convert surplus into lower-taxed capital gains.
Another major change that is being suggested is in terms of income splitting. If this tax change is approved, business owners will not be permitted to split their income with family members as they currently do. Income splitting will become more limited, such as in the way payment of dividends on separate classes of shares held by their family members. In terms of commercial real estate, as a real estate partner, you'll want to familiarize yourself with the proposed changes, such as the extension of the tax on income splitting (TOSI), restricting access to the lifetime capital gain exemption (LCGE), and trusts.