Proposals Tax Kids Working in The Family Business

The proposed changes to the taxation of private business income and equity, released on July 18, 2017, will affect the income paid to family members who are not actively engaged in the business, as well as limit their access to the Capital Gains Exemption.

Here is a brief overview:

Prevention of Income Splitting with Non-Active Family Members – The government proposes to expand the current “kiddie tax” known as “Tax on Split Income” to include adults, effectively eliminating dividend sprinkling in many cases. That’s because this income is removed from regular personal tax calculations and taxed at the highest marginal rates for ordinary income. For minor children, CRA defines exceptions to the rules, if income is:

• from property inherited from a parent;
• from property inherited by the child from anyone else and during the year, he or she either is enrolled full-time in a post-secondary institution or is eligible for the disability tax credit or in cases where
• the child was a non-resident of Canada at any time in the year, or neither of the child's parents were residents of Canada at any time in the year.

Now, as noted in the pre-amble leading up to the proposed changes the government hopes to distinguish income splitting through income sprinkling to adults, from compensation that is reasonable. They propose to base that judgement on an adult family member’s contribution of value and financial resources to the private corporation. Again, there are exceptions to the income splitting rules, this time, in the case of an adult who is:

• Under 25 and involved in the activities of the business on a regular, continuous and substantial basis — these are the conditions of a “reasonableness test” for 18 to 24-year olds.
• Over 24 and involved in the activities of the business
• Under 25 who receives less than 1% (prescribed rate) return on their capital contributions
• An adult over 24 who has contributed assets or assumed risk
• Or in cases where total payments do not exceed what would have been paid to a third party for the contributions to the business.

Bear in mind that these changes also come at a time when the government has reduced the tax credits available on the personal tax return for students. Starting in 2017, the credit for the monthly education amount and the textbook credit have been eliminated.

In addition, the new extension of the Tax on Split Income rules will also apply to “connected individuals,” not just related individuals. Connected individuals are those who have significant strategic, income, equity or investment influence over the corporation. Further, second generation income (reinvestments of the income taxed at top rates) will also be considered “split income.”

Changes to the CGE – Capital Gains Exemption. The CGE will no longer be available to taxpayers under age 18, nor will it be available to any taxpayer whose income from the corporation would be considered “split income” on dispositions after 2017. Further, the CGE will not be available to most trusts. 

An election to crystalize taxable capital gains under the old rules and use up the lifetime $835,716 exemption for qualifying small business shares and the $1,000,000 qualifying farm/fishing properties will apply to the 2018 tax year. Further increases in value of the corporate shares owned will not be eligible for the capital gains exemption to the shareholders listed above. We will embellish on these provisions in future editions of Knowledge Bureau Report and in particular at our CE Summits which will be held later in the fall across Canada.

Evelyn Jacks is president of Knowledge Bureau, a national educational institute focused on providing excellence in continuing professional development for tax and financial advisors. She is also the author of author of 52 books on family tax preparation and planning.

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