On December 13th, Federal Finance Minister Bill Morneau announced revisions to the income splitting proposals set to take effect in 2018. The announcement served to clarify income splitting rules amongst family members and introduced specific tests to determine whether or not a family member is able to receive income from a small business.
For all family members who receive income from a small business that do not meet the revised conditions outlined in Morneau’s announcement, all income will be taxed at the highest marginal tax rate.
Family members who meet the following conditions will not be subject to taxation at the highest marginal tax rates:
- The business owner’s spouse, provided the owner meaningfully contributed to the business and is aged 65 or over.
- Adults aged 18 or over who have made a regular, substantial labour contribution—generally an average of at least 20 hours per week—to the business during the year, or during any five previous years.
- Adults aged 25 or over who own 10% or more of a corporation that earns less than 90% of its income from services, and isn’t a professional corporation [emphasis added].
For those who do not meet these requirements, there is an option to self-assess if they meet the qualifications for “reasonable” payments on their tax return. Self-assessed income to family members would potentially face a review by the Canada Revenue Agency in order to prove “reasonability”.
SENATE CALLS FOR FURTHER DELAY
Earlier this week, the Canadian Federation of Independent Business called for a one-year delay to give businesses time to adjust.
On the same day the proposed changes were announced, the Senate finance committee released a report saying the government should scrap or postpone its proposed tax changes, including those to income sprinkling.
It is interesting to note the timing of the announcement by Morneau. The initial proposals for tax changes took place on July 18th, when parliament was on summer recess. The revisions as they relate to income splitting were announced on December 13th, the last day of parliament before an extended recess over the holidays. The timing associated with these announcements leaves little time to question the specifics of the policy change and provides even less time to plan for 2018.
There has yet to be clarity on the definition of “meaningful” when relating to whether or not a spouse aged 65 or over are able to receive income from their partners business. In the information provided, the definition of “meaningful” relates back to the “reasonableness” tests, which takes a number of factors into consideration:
- Labour contributions
- Property contributions
- Risks assumed
- Historical payments
- Other relevant factors
There has yet to be any information released with regards to family trusts and whether or not income distributed to beneficiaries would be subject to the same guidelines as outlined above.
These new income splitting rules take place in 2018. As such, income allocations for 2017 can still include income to family members who hold shares of a corporation. In looking at the needs for future years, it may make sense to increase distributions to family members for 2017 rather than removing funds in a future year at a significantly higher marginal tax rate. Please discuss with your accountant, or your TPC Financial Advisor to determine the best allocation amongst shareholders for 2017.