By: Vernon Fischer
Budget 2018 is an expensive increase for business owners who are using their companies to help fund their retirement and/or saving for other uses.
The last two federal budgets presented by the Liberal government were an attempt to make taxes “fair.” Several of the tax measures specifically targeted private corporations.
Currently, Canadian Controlled Private Corporations (CCPCs) may qualify for a small business tax deduction – a deduction that reduces the tax rate on business income under $500,001 to 12% (combined federal and provincial rate). This was designed for business owners to pay less tax and have more capital to reinvest in their business and for rainy days.
The Liberal government does not want business owners to invest in passive investments (e.g., real estate, stocks, bonds, cash), which brings us to the recent federal budget announcements on corporate passive investments, targeting business owners and professionals who are using their corporations to save for retirement or for pure investment purposes.
Here’s what you need to know:
- Companies are still allowed to have passive investments with no additional tax on investment income albeit the tax on passive income is 50.7%.
- If your company or one of your associated companies earns investment income exceeding $50,000 per year (determined through a new concept of “adjusted aggregate investment income”), the small business deduction is reduced.
- It’s a straight-line reduction of the $500,000 limit when investment income is greater than $50,000 per year, reducing to $0 when investment income reaches $150,000.
- At $150,000 of investment income, the small business deduction is eliminated, and all income is taxed at the general rate of 27% or the portions that are reduced as a result of more than $50,000 per year of passive income.
- The deduction varies from year to year based on that year’s investment income. The cost of losing the full deduction means $75,000 of additional tax on the first $500,000 of business income, for example if:
Before budget 2018 if a CCPC has a $500,000 active income earnings, plus a $100,000 of passive income earnings their tax bill would have been in BC ($ 500,000 *12% = $60,000 plus the tax on the passive income would be $100,000 * 50.7%=$50,700 for a total of $110,700).
After Budget 2018 if a CCPC has $500,000 of active income earnings, and a $100,000 of passive income; the calculation will be ($500,000-($100,000- $50,000)x5) for a total of $250,000 at the small business rate of 12% plus $250,000 at the active business rate of 27%.
The tax bill is now $250,000*12%=$30,000 plus $250,000*27%= $67,500 plus $100,000*50.7%= $50,700 for a total of $148,200 a 26% overall increase or an effective 88.2% tax rate on the passive income.
WHAT DOES THIS MEAN FOR YOU?
For starters, you’ll think twice about having passive investments inside your company. The taxation on passive investment amounts to a “just don’t do it” tax policy.
WHERE DO WE GO FROM HERE?
Life Insurance is the “go to” option as recommended by tax lawyers and accountants alike. Exempt Life Insurance policies do not create investment income and, therefore, will not impact your small business deduction. We recommend permanent insurance policies in most cases for this purpose.
- If you’ve already set up a Life Insurance policy to accumulate cash, within your corporation, congratulations! You did the right thing.
- If you have not set up a Life Insurance policy to accumulate cash within your corporation, then it’s time to consider it.
- Give serious consideration to leveraging your corporate owned Life Insurance policy and investing to loan proceeds in a personal investment.
- Consider further leveraging the corporate owned Life Insurance policy as resource to fund future cash flows outside of the corporation.
- Consider a Split Dollar or shared ownership Critical Illness policy as it accrues value but does not generate passive investment income.
- Investigate whether a Retirement Compensation Arrangement (RCA) or an Individual Pension Plan (IPP) makes sense for you. They are attractive under the new tax regime and higher tax rates.
We can help you figure out which options work for you – give us a call if you have any questions.