Budget Tax Changes Hit Business Activities Broadly

The March 21, 2013 budget was a significant document, which upon reflection, will require high net worth clients, particularly business owners, and their advisors to rethink wealth, retirement  and estate plans. 

This Knowledge Bureau Report is a continuation of our March 21, 2013 Federal Budget coverage, with contributions from our MFA, DFA-Tax Services Specialists, Alan Rowell, and Walter Harder, legal specialist Greer Jacks, and Managing Editor, Evelyn Jacks.

Corporate Tax Changes. There were few happy tax incentives announced in the March 21, 2013 budget, although manufacturers did get a leg up on their ability to compete in a global market with some incentives on asset purchases. However, this budget made other significant tax changes that specifically limit corporate tax loss trading, kill the opportunity for corporate groups to be taxed together, and increase the compliance burden on investors in Small Business Corporations and those with foreign investments.

Capital Gains Exemption and Dividend Taxation Changes. In last week’s Special Report we noted that the Lifetime Capital Gains Exemption is proposed to increase by $50,000 to $800,000 starting in tax year 2014 and be indexed thereafter. We see this as a positive development for small business owners as a measure of certainty for the development of real wealth in the equity of a business, after taxes and inflation. 

However, the budget also adjusted the gross up factor applying to non-eligible dividends from 25% to 18%, with the offsetting dividend tax credit falling from 18% to 11%. This will have the effect of raising taxes for many business owners who pay themselves with dividends after 2013 and will impact retirement income planning as well.  

Therefore these changes will require extra reflection by both tax and wealth advisors who are managing intergenerational family wealth through the lifecycle of a business, the planning for income in retirement, and as you will discover later in this issue, that the use of trusts in estate planning is also under review. Also note changes to leveraged insurance arrangements and 10/8 arrangements, discussed last week.

Taxation of Corporate Groups. Corporate Group Taxation has long been requested by Accountants, Tax Professionals and Business Owners. Unfortunately, for now at least, the simplicity that would occur under such a system, as opposed to the current system of each corporation taxed individually, is on the backburner, largely because of uncertainty of tax losses around corporate tax loss utilization.

Currently a business owner who owns two or more related corporations is required to file tax returns for each corporation separately. While on the face of it this may make sense, it becomes a cost burden to the individual as well as more extensive exercise to achieve a “Consolidated Tax Picture” for the corporate group.

Mechanisms currently exist within the corporate tax systems to allocate income between related and associated corporations for the purposes of allocating the Low Rate Income Pool and the lower corporate rates enjoyed by Canadian Controlled Private Corporations. What doesn’t exist is a clear and simple method of allocating losses from one corporation to another when there is common ownership.

With this announcement, Budget 2013 essentially closes the book on simplifying the ability to achieve a “Consolidated Tax Picture” for related corporate groups. In addition, the government has noted it will continue to work with provinces and territories to minimize uncertainty associated with tax loss utilization.

Corporate Loss Trading. Through a series of transactions in arms-length corporations, a profitable corporation has been able to arrange its financial affairs to utilize loss carry-forwards available to another corporation. This is commonly referred to as Corporate Loss Trading. Under current legislation this is possible by avoiding acquisition of control restrictions.

Budget 2013 proposes to introduce additional or enhanced anti-avoidance rules and regulations that will tighten the ownership and control requirements, in essence introducing a “deemed acquisition of control”, which could result in eliminating the use of this type of tax planning. This provision may have a significant impact on loss utilization.

Over the next several months, Knowledge Bureau will be exploring these issues of concern with Finance Canada in preparation for the November Distinguished Advisor Workshops in Winnipeg, Calgary, Vancouver and Toronto, where the theme will be “Corporate Tax Bootcamp.”