As many of you are aware, the Liberal Government has bowed under the pressure from entrepreneurs and professionals to reduce the nature and extent of their attack on small/medium sized businesses and professionals.
Of significant note is their statement that they will back down on their plan to eliminate the ability for families to claim the Lifetime Capital Gains Exemption (“LCGE”). While this sounds good, in the same breath, they have stated that the “Tax On Split Income” rules (“TOSI”) will be brought out with only minor changes. Surprisingly, buried in the TOSI rules is a second layer of rules which would effectively prevent most family members from claiming their LCGE anyways. We are waiting to see if the Liberals are going to be true to their word and allow families to continue to use the LCGE or if they are going to try and use this “loophole” to attack the LCGE claims of family members through the TOSI backdoor. If these comments make it sound like we don’t trust the Liberal Government – you are right, we don’t. In the previous proposals there was a program that included a mechanism to ensure that families could “lock in” their LCGE claims. Under this change, we lose that mechanism and we are still not certain as to whether we need to crystallize our LCGE before December 31 because of the TOSI rules or not.
As stated in My August 23 blog post, income splitting as we currently know it, using dividends, is indeed dead. TOSI or Tax on Split Income, will go through more or less as originally proposed. The Government has said that they will tweak it to clarify its application and make it easier to administer but that’s all. Being on the front lines and dealing with auditors in the field, I can unequivocally state that this is going to create a tremendous compliance and reporting burden for small and medium businesses. And this reporting and compliance work will still be subject to attack by the CRA Audit Department, who will use all kinds of arguments which we, as taxpayers, will need to prove are wrong – an almost impossible task.
The Liberal Government also backed down on their recent proposal to prevent, what they described as, “conversion of income into capital gains”. Their proposal actually stood for taxing family transactions at double the tax rate of arm’s length transactions and taxing property on death at rates of up to 93%. Obviously, we view this reversal as very important in ensuring that the tax system treats business owners with some of the fairness received by employees. However, under the existing rules family businesses and family farms are still stuck with either paying tax on the sale to family members or making the purchaser family member pay double or quadruple the tax to pay off the business. A the same time the family could sell their business to outsiders on a tax-free basis without penalty to the purchaser. To be truthful, the rules under the proposed Sections 84.1 and 246.1 were horrendously unfair to all business owners, had retroactive effect and would have been insidious in their application to future transactions between family members and related companies. Good riddance. That being said, we think they may be reintroduced in the future in some form or another.
The proposals on the taxation of investment income in private corporations will generally proceed in accordance with the vague outlines offered in the original proposals. Yes, they have been limited in their application to investment income in excess of $50,000 per year. And this limit would be used up by an investment of $1,000,000 making a 5% return (as in the government’s example) or by an investment of $250,000 making 20%. What they have been silent on is what happens if you have an investment in say a rental property which breaks even for 10 years which you sell in the 10th year for a taxable capital gain of $300,000: do you get to average the gain over the previous 10 years when you made nothing or do you pay the super-tax in year 10 on the gain received? They also clarified that existing investments would be “grandfathered” so they would be taxed under the old rules. But what happens if you sell one investment and replace it with another one (i.e. –is that a continuation of the old investment and grandfathered or is it a new investment and subject to the new rules)? And what happens if you have some investments making 20% and others making 5% – do we get to choose which one gets to be subject to the old rules and which one subject to the new rules? There is so much we just don’t know.
So, where do we stand? We really have no idea what we are going to end up with. That leaves us with hoping for the best but preparing for the worst. If we do not get more information soon, we will need to begin taking further steps to protect our clients from the possible loss of their family capital gains exemptions (LCGEs).
Let’s hope we get some clarity soon.