As you are probably aware, on October 16 and 18 of 2017, the Liberal Government (“the Liberals”) bowed to the pressure exerted on them by small business owners, professionals and entrepreneurs. As a result, they have “stepped back” from some of the four major changes in tax policy they had intended to implement. The changes to these proposals are summarized below:
|1.||Income Splitting Restrictions||Generally unchanged|
|2.||Elimination of LCGE for families||Delayed|
|3.||Measures to eliminate: conversion of Income to Capital Gains||Delayed|
|4.||Super-tax on corporate investment income||Minor changes|
It is important to note that, while it looks like the Liberals have capitulated on these issues, this is far from the case.
The awkward and broadly punitive income splitting (“income sprinkling”) measures appear to be essentially unchanged. These measures are going to be exceptionally complicated for business owners to implement and almost impossible to defend against CRA audit. These comments are based on the original proposals the Department of Finance has been instructed to re-write them and we will have to see if they turn out to be more friendly than the original proposals.
LIFETIME CAPITAL GAINS EXEMPTION
Access to the Lifetime Capital Gains Exemption for families appears to have been “given back”. Unfortunately, a careful reading of the income splitting rules reveals that they also include provisions which will eliminate the ability for family members to utilize their LCGE. Given the government’s commitment to shutting down income splitting in all its forms (except for pensioners) it does not seem likely the Liberals will be agreeable to backing off from the income splitting rules for families wanting to split capital gains.
Lost with this would be the “generous” LCGE provisions originally proposed which would have allowed families to crystalize or “lock in” their capital gains exemptions before the end of 2018. This leaves us with a dilemma: are the Liberals going ahead with their attack on income splitting or are they going to look away where it involves capital gains on small businesses, farms and fisherman? It would seem very disingenuous for the Liberals to offer to back off on the LCGE restrictions and then take it away through a back door. Unfortunately, they have made it clear that they are fixing one of the LCG provisions but have provided no assurance they are changing the other. We are hopeful that they will make the necessary changes to both provisions but the fact this has not been clarified yet makes us very nervous. If they do not make the required change to the income splitting rules we will be asking our clients if they want to crystalize their family capital gains exemptions. The problem is that we are running out of time and it will likely become a first come first serve or an auction scenario where our staff tries to work 24/7 to help our clients protect themselves from the government.
Given the government’s intense interest in reducing availability of the LCGE to families, businesses and professionals, we strongly recommend that you take steps to purify (clean investment assets (including cash) out of your operating companies). We are very concerned that all of our clients take steps to purify or partly purify their corporations as soon as possible.
If you are concerned about losing access to the LCGE’s of your family members, you might want to crystalize them before the end of December. Alternatively, you might want to “start the process”, put the wheels in motion to do that in order to preserve future tax savings of $204,575 (835,000 x 50% x 49%) per family member. Call us if you would like to discuss this further. In either case, cross your fingers and hope that the Liberals are going to honor what they implied they were going to do. It would be incredibly stupid for the Liberals to fail to fix this properly, but that’s how we got here in the first place, isn’t it?
CONVERSION OF INCOME TO CAPITAL GAINS
The provisions surrounding the commission of income to capital gains would have resulted in a huge number of extremely unfair and unintended tax consequences. Frankly, it was embarrassing to see how poorly the Department of Finance drafted these provisions. It is good to see these proposals shelved but we believe they will come back in a more thoughtful but perhaps more insidious form. Time will tell.
SUPER TAX ON CORPORATE INVESTMENT INCOME
Finally, the Liberals have thrown us “a bone” by clarifying that existing investments or retained earnings (we are not sure which) will be grandfathered and taxed under the current “old” rules while providing a $50,000 investment income exemption per year from the new rules on “new” investments or “new” retained earnings (we are not sure which). We don’t know if this this exemption will contain “averaging provisions” to accommodate investments which result in periodic capital gains or if those people are simply out of luck. This one provision is going to create the most complicated and difficult to administer tax provisions in the Income Tax Act. I believe that this provision represents the death knell for our current tax act. It is the time for a serious re-write, and re-think to our approach to taxation in Canada. Numerous clients have called and emailed us to ask how to prepare for these proposals and the honest answer is “We have no idea at present”. Should we borrow money to maximize our investments, leave capital in the company or something else? We have no idea: perhaps you should do all of these things.
Where do we go from here? Honestly, we are just not sure. It might be a good idea to start contacting your MP’s again to ask for clarity on how the income splitting rules are going to be revised to protect your access to the LCGE. Otherwise, find an uncomfortable chair and just wait.