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Here’s what you need to know if you hold passive investments in your private corporation, Part 1in Tax Advice Information and Updates
Last week, we took a detailed look at the proposed measures of the Government to address income sprinkling. This week, we’ll focus on the proposed measures to address the holding of passive investments inside a private corporation.
According to the Department of Finance, holding passive investments inside a private corporation provides the business owner with a significant tax deferral advantage – an advantage not available to most Canadians. In addition to this, the Department of Finance says that the current system does not achieve its objective of removing incentives to hold passive investments within a corporation in a broad range of other situations which leads to unfair tax results – a corporate owner preferring to retain business income, for passive investment purposes, within his or her corporation, rather than pay it out and invest directly as an individual.
The Government is considering approaches to establish fairness in the tax treatment of passive investment income of a private corporation and to ensure that the benefits of the corporation income tax rates are directed towards investments focused on business growth rather than conferring a personal investment advantage to the business owner. These approaches include:
1. The 1972 Approach - In 1972, Canada developed an approach aimed at limiting deferral opportunities associated with passive investments and included the following elements:
- The refundable tax regarding ineligible investments which was designed to reduce tax deferral benefits on passive investments, by effectively imposing an additional refundable tax when preferentially-taxed business income was retained and used to fund a passive investment. Thus, this provision denied the lower small business rate and instead imposed the general corporate income tax rate (In 1972, the combined federal-provincial corporate income tax rate was about 50%). A corporation can obtain a refund of the upfront tax paid upon disposition of the passive investment asset and reinvest the proceeds in business operations. This helped ensure that corporations were not denied the benefits of the small business corporate income tax rate if they redeployed the funds in business activities.
- The refundable tax on annual passive investment income (this part of the structure is still in place today).
Shortly after its implementation, the refundable tax in respect of ineligible investments was retroactively repealed because the provision was “complex and difficult.”
The Government is considering this 1972 Approach but did mentioned that it would have to be changed in a number of ways to take into account the changes since 1972 such as the fact that today both the small business and general corporate tax rates are significantly lower than top personal rates.
We’ll look into the 2nd approach that the Government is considering on our next blog! Please stay tuned!
In the meantime, we want to remind you that if you are a business owner, please contact your MP to voice out your thoughts on these proposed measures. You can also participate in the ongoing public consultations with the Department of Finance. Thank you and please check back for the 2nd part of our blog series!
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