2016 Budget Overview: Business Tax Measures

New 2016 federal budget includes business tax measures addressing tax changes for business income.

BUSINESS TAX MEASURES

Incorporation Costs to be Deductible

Effective January 1, 2017

The first $3,000 of incorporation costs will be deductible as a current expense rather than being added to a new CCA class for eligible capital property as described below.

Eligible Capital Property

Effective January 1, 2017

A new class of depreciable property for CCA purposes will replace the current ECP system.  Expenditures that are currently added to the Cumulative Eligible Capital account at 75% will be added at 100% with an annual 5% depreciation rate (instead of 7% of 75% of costs and a 7% amortization rate).  Existing recapture, capital gains rules and the half year depreciation rules will apply.

Special rules will apply for goodwill.  According to the Budget every business will be considered to have goodwill even if there was no expenditure for it. An expense that does not relate to specific property will increase that capital cost of this class.  Transitional rules will apply.  Small balances of eligible capital property carried over to the new classes will be allowed to be deducted more quickly. Specifically, on expenditures incurred before 2017, the greater of $500 per year and the amount otherwise deductible for that year will be allowed.   For existing properties, the amortization rate will be 7% until the property is disposed or until the last taxation year ending before 2027.

Donation of Real Estate and Shares of Private Corporations - Cancelled

High net worth families will be not be able to take advantage of a generous provision introduced in Budget 2015 pertaining to the donation of certain dispositions of private corporation shares or real estate to charity.  Starting in 2017, cash proceeds from the disposition of these assets within 30 days of sale to a qualified donee were to be exempt from tax.  This measure has been cancelled.

Small Business Tax Rate

Effective 2017

The Budget will retain the small tax rate at 10.5 after 2016.  The rate reductions to 9% announced by the former government will not occur.  In discussing the issue with Finance Canada resources, the reductions slated to take the rate down to 9% by 2019 will be deferred.  The current gross up factors to non-eligible dividends (dividends distributed from corporate income taxed at the small business rate) will be maintained at 17% and the corresponding Dividend Tax Credit will be 21/29 of the gross up which is 10.5% of the taxable (grossed-up) amount or 12.3% of the actual dividend.

Other Technical Measures for Small Business

Multiplication of the Small Business Deduction

On or after budget day

The Budget will immediately preclude the multiplication of access to this deduction for certain partnerships and corporate structures. 

Specifically the multiplication of small business deductions in a partnership of corporations not associated with one another is prohibited.  In these cases there is one small business limit allowed to the partnership.  These rules have been circumvented by planning arrangements in which the shareholder of a CCPC is a member of a partnership and that partnership pays the CCPC as an independent contractor.  These types of arrangements will be curtailed.

Avoidance of the Business Limit and the Taxable Capital Limit

The associated corporation rules apply the $500,000 business limit and the $15 million taxable capital limit to CCPC (Canadian Controlled Private Corporations).   Under section 256(2) there is a special rule under which two corporations not otherwise associated will be treated as if they were associated, if they are each associated with the same third corporation. Their small business limit will be affected if the taxable capital limit of all the corporations exceeds $15 Million.  An exception to that rule exists to allow the two corporations not to be treated as associated for the purposes of the small business deduction if the third corporation is not a CCPC or elects not to be associated with the other two.  In such cases, the third corporation could still pay investment income such as rentals, interest and dividend income, and have that income taxed as active business income.   That income will now be taxed at general corporate income tax rates.  In addition the third corporation will be associated with each of the other corporations for the purposes of applying the $15 million taxable capital limit.

Consultation on Active vs. Investment business

The Budget will not propose any modifications to the active business income rules at this time.  Active business income does not include income from a “specified investment business” which principally earns income from property (interest, dividends, rents, and/or royalties) 

It’s important to note that under current rules and now, for the foreseeable future, the number of employees of a business carried on by a CCPC is not relevant in determining the eligibility for the small business deduction, unless the principal purpose of the business is to earn in come from property.  Even if those cases, the CCPC may still qualify if the business has more than five full-time employees.

Back-to-Back Loans:   Shareholder Loans

Budget Day

Where a shareholder is a non-resident, income inclusions due to the failure to repay shareholder loans within one year are considered to be deemed dividends subject to a withholding tax.  This can be avoided by interposing a non-connected third party shareholder.  This will be curtailed as of Budget day by applying existing rules on back-to-back loans to debts owing to Canadian resident corporations.

Life Insurance Policy Distributions

The portion of policy benefits received in excess of adjusted cost basis may be added to the capital dividend account of a corporation or to the adjusted cost base of a partnership’s interest in a partnership.  Under some structures, an artificial increase in the CDA balance may occur to allow income tax to be avoided on dividends payable by a private corporation or on gains from the disposition of a partnership interest. 

The CDA rules for private corporations and the adjusted cost base rules for partnership interest will be amended to provide that the insurance benefit limit applies whether or not the corporation or the partnership that receives the policy benefit is a policyholder.   New reporting requirements will be required if the corporation or partnership is entitled to a policy benefit.

Transfers of Life Insurance Policies

On or After Budget Day

Under current rules, where a policy holder disposes of an interest in a life insurance policy to an arm’s length person, the FMV (Fair Market Value) of any consideration is included in computing the proceeds of disposition.  If the disposition is to a non-arm’s length person, a policy transfer rule deems the policyholder’s proceeds of disposition and the acquiring person’s ACB (Adjusted Cost Base) to be the interest’s surrender value.  This is also known as the “Policy Transfer Rule”.  

To ensure that amounts are not received tax-free as a result of a disposition of an interest in an life insurance policy, both by shareholders of a corporation and the private corporation itself, the rules will be amended to apply the FMV of any consideration given for an interest in a life insurance policy in the policyholder’s proceeds of disposition and the acquiring person’s cost. 

Also, there will be a limit imposed on any increase in paid up capital of a class of shares and the ACB of the shares or interest in the partnership equal to the amount of the proceeds of disposition, if a disposition arises on a contribution of capital to a corporation or partnership.       

Finally, regarding the excess of the proceeds of the disposition determined under the Policy Transfer Rule, the amount of policy benefit otherwise permitted to be added to a corporation’s CDA or the ACB of an interest in a partnership will be reduced by the amount of the excess.

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