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Here’s what you need to know if you hold passive investments in your private corporation, Part 2in Tax Advice Information and Updates
1. Deferred Taxation – As an alternative to the 1972 approach, the current regime of refundable taxes on passive investment income could be replaced with one that will maintain a tax rate on the passive investment income of private corporations equal to the top personal tax rates, as is the case under current rules, but which would generally remove the refundability of passive investment taxes where earnings used to fund passive investments were taxed at lower corporate rates.
In addition to denying refundability, this approach would align the tax treatment of passive income distributed as dividends with that of the earnings that are used to fund passive investments – earnings that could either be subject to the small business tax rate or the general tax rate, but could also be funds taxed at the personal level and contributed by shareholders.
This approach can also result in changes to how passive income is categorized and taxed at the individual level when distributed as dividends. The proper categorization of passive income as “eligible” or “non-eligible” is important to maintain neutrality between individuals and corporations. This categorization would follow the tax treatment of the income that is used to fund a passive investment rather than the tax characteristics of the passive income itself, in order to reflect the size of the tax advantage conferred to the corporate owner at the time the passive investment is made, and on which returns were generated.
The Government is considering 2 methods to determine the tax treatment of dividends paid from passive investments:
- Apportionment Method – This method would involve an apportionment of annual passive investment income that would be based on the corporation’s cumulative share of earnings taxed at the small business rate and the general rate, as well as amounts contributed by shareholders from their after tax income. This would result into 3 possible tax treatments for these amounts when distributed as dividends: eligible dividends, non-eligible dividends or dividends that would be received tax-free at the shareholder level.
- Elective Method – With this method, private corporations would be subjected to a default tax treatment, unless they elect otherwise. The choice between the default tax treatment or the elective treatment would determine whether passive income would be treated as eligible or non-eligible dividends when distributed to shareholders, without the need for tracking.
It is important to note that there is an on-going consultation regarding the design of the new rules regarding the tax treatment of corporate passive income. So please participate and let your voice be heard as these proposed changes has the potential to affect most, if not all, business owners. You can also write to your MP!
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