Pending Changes To Income Tax Act

One of the reasons that family businesses thrive and become successful is that they are able to organize their corporations to allow members of the family to become owners through share ownership or as a beneficiary of a family trust.

In becoming an owner of the business, each family member would then be entitled to share in the profits of the business through the business’s payment of dividends. If the business is sold, each of the owners may become eligible to receive capital gains and perhaps be able to claim their personal capital gains exemption. In receiving dividends or capital gains, the owners of the family business pay favourable rates of tax.

All of this is about to change if the tax changes tabled in the House of Commons on July 18th are adopted in the 2018 Federal Budget.

While your accountant can provide you with the finer details concerning dividends, here is a summary including how those tax changes will affect family-based businesses:

Income Splitting. If the proposed tax changes are adopted, dividends will become subject to a “reasonableness” test and be based on the family member’s involvement in the business. In cases where the family member works in the business AND the dividend is in an amount that the business would have paid to an individual who is not related to perform the same job, no changes to the dividend taxation will apply. However, if the dividend is not “reasonable”, dividend income will be taxed at the individual’s highest marginal rate.

Unless the proposed legislation recognizes child care/elder care as being an aspect of a family business or unless a child works in the business over the summer and earns a “reasonable” compensation, families with stay at home spouses or children attending post-secondary schools will no longer be able to “split” income and pay lower rates of tax.

Capital Gains. The proposed legislation is also looking to reduce opportunities to claim both capital gains and capital gain exemptions. If the shares of the business are acquired while a family member is a minor, any capital gains occurring while the family member is a minor will be denied and any gains thereafter will be prorated to account for the time the family member was a minor.

Taking that concept one step further, adult children who have acquired shares in the family business as part of the family’s succession plans will now have their dividends taxed at a rate that is higher than the rates paid by their siblings or cousins that work in the business.

With their capital gain opportunities also being affected, does this make their shares less valuable to them? Does it spur them to want to sell their shares? If it does, how does the family business deal with that?

The above is a short summary, however there are further issues which are more properly addressed by an accountant.

There are bound to be issues among family members in both the payment of dividends by the business and the receipt of dividends as a result of the proposed legislation. Those discussions may need some facilitation by a FAMILY ENTERPRISE ADVISOR™.

For more information about FEA’s, or to find a FEA to work with your family, go to https://family-enterprise-xchange.com.

If you have a question or issue that you would like to read about in future columns, please feel free to email me at reid@null2020law.ca.

Until next time.

Reid

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