Twenty years after the B.I.G. (along with Puff Daddy and ) released the hip-hop single “Mo Money Mo Problems”, Canada’s own Notorious B.F.M. (Honourable Bill Francis Morneau, Minister of Finance) released an updated and tax-focused take on the hip hop classic that, for some, will mean “Less Money Mo’ Problems”.

In this paper on tax planning using private corporations, Minister Morneau sets out a series of proposed tax reforms that could significantly impact private corporations, business owners, incorporated professionals, and other individuals who have relied on legal tax planning structures. These reforms, if implemented, will hinder previously legal tax-planning strategies such as:  Splitting income among family members (“income sprinkling”)  Utilizing multiple lifetime capital gains exemptions  Converting dividend income into capital gains  Investing in passive investments within private corporations

Except for changes to capital gains conversions (which are effective as of 18 July, 2017), the proposed changes will come into effect in 2018. However, it appears that the Department of Finance is still looking for the best way to implement some of these reforms. Between now and October, the department is undertaking public consultation concerning the proposed changes and it is possible that the details may change depending on the volume and nature of feedback received. Given that tax reform played a significant role in the Liberal’s election platform, owners of private corporations should not simply hold their breath and hope the changes go away. At this point, the best course of action for anyone potentially impacted by the changes is to:  Provide comments to the federal government on the changes themselves as well as implementation details (this can be done by sending comments to [email protected]).  Engage your taxation and legal teams on how your business structure might be impacted and what you should be doing to prepare

Owners of private corporations often “split” or “sprinkle” income earned from their business through payments of dividends, interest or employment income to adult relatives. Once sprinkled, they become taxed at comparatively lower rates in the hands of the recipients.

The proposed changes to the Income Tax Act would restrict the ability of shareholders to split income with relatives [1] unless the payments satisfy a vaguely-defined “reasonableness” test. This test, which we anticipate will be the subject of many tax disputes, will look at factors such as:  The labour or services contributed to the business by the recipient

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 The assets contributed by the recipient, directly or indirectly, in support of the source business  The risks assumed by the recipient in respect of the source business  The total of all amounts that were previously paid to or for the benefit of the recipient

Currently, each Canadian is entitled to a lifetime capital gains exemption of over $800,000. This means each individual can sell their interest in a business and not be taxed on the first $800,000+ of capital gain. Where multiple family members are either shareholders or beneficiaries of a trust that owns an interest in a business, each of them can use their capital gains exemption on the sale of the business – essentially “multiplying” the capital gains exemption.

The proposed changes to the Income Tax Act will:  Eliminate the use of the lifetime capital gains exemption for children under 18  In many cases prevent the multiplication of the capital gains exemption through structures that attempt to allocate gains to non-arm’s length individuals  Tax any increase in the value of a business while owned through a trust at a significantly higher rate by making these gains ineligible for treatment as capital gains

The total impact of these changes will be that many trust structures aimed at maximizing available capital gains on the sale of the business will not be as effective after 31 December, 2017. In fact, many of these trust structures may actually prevent owners from accessing capital gains tax treatment for increases in the value of the business from and after 1 January, 2018.

The proposed changes also contain anti-avoidance rules pertaining to “dividend stripping”. “Dividend stripping” is a process by which income from a private company can be “stripped” out and converted into capital.[2] Proposed changes to the Income Tax Act will prevent this type of planning from and after 18 July, 2017 (the date the paper was released).

The last proposed change will concern the use of corporate profits to invest in passive investments. Some business owners use money within the corporation (which has only been taxed at the corporate tax rate) to invest in passive income such as publicly-traded securities as opposed to making these investments with personal money (which has been taxed at higher rate). The principle is simple: if you start with more money, your investment should grow more quickly.

The Department of Finance perceives this practice as unfair to taxpayers who only have the option of investing personally. It is seeking recommendations on how to regulate this investment so as to level the playing field. While it appears that the Department has yet to decide on how to implement this change, it is intent on seeing changes take effect in 2018.

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To paraphrase the 2007 Notorious B.I.G. classic in the 2017 Canadian context:

I don’t know what they want from me It’s like it’s less money we’ll come across And more problems we see

Full certainty regarding “what they want from me” will only come once final legislative changes are brought into effect in 2018. In the meantime, the more business income that relies on the now-scrutinized but previously acceptable tax planning practices, the more tax-planning problems that a business and its owners will have.

For those businesses and business owners who want to be proactive in managing these problems, now is the time to provide input to the federal government (remember: the call for comments closes on 2 October, 2017) and to engage your advisory team (tax advisors, lawyers and estate planners) to ensure that you are ready for the changes in 2018 – which is only a short five months away.

If you would like more information or any assistance in preparing for the upcoming changes, please contact your MT+Co. lawyer or any member of the corporate structuring team: Rob Miller, David Ford and Avery Saunders.

[1] The proposed reforms include additional restrictions for family members between the ages of 18 and 24.

[2] For those interested in how it works: The shareholder exchanges shares in the private corporation for shares (and cash) of a related company (i.e. holding company), using the section 85(1) rollover to defer taxation on the disposition of the shares. The shareholder then avails herself of the lifetime capital gains exemption on the amounts paid in cash. In the end, the shareholder continues to control the private company (and holding company) and has “stripped” out income without paying taxes (as she would have in the case of a taxable dividend).

Miller Titerle + Company LLP is one of MSI’s Vancouver based law firm. Miller Titerle + Company LLP started in 2010, but most of its lawyers are experienced veterans who have chosen to leave national law firms to build a business law firm with a more passionate and more personal way of practicing law.

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