Backtracking on tax changes — what Ottawa’s updates mean for farmers

Finance Minister Bill Morneau announces changes to the small business tax rate in Stouffville (source: PMO).

The dust is starting to settle after Finance Minister Bill Morneau’s flurry of announcements backtracking on the federal government’s proposed small business tax changes.

Now that the news conferences are over and we’ve had a few days to analyze the changes to the changes, how will the updates affect farm businesses?

First of all, we know incorporated small businesses will be seeing a lower tax rate on their first $500,000 in income, as Morneau introduced a reduction from the current 10.5 percent rate to 9 percent by 2019.

The decision to cancel plans to restrict access to capital gains exemptions and the conversion of dividends to capital gains, referred to “surplus stripping,” will also address some of the serious concerns farmers and small business owners had about intergenerational transfers.

“That’s great news, particularly for farm clients,” Jesse Moore, senior manager, tax with BDO Canada, says in the interview below. “It means we’re not faced with possibly significant increases in tax costs of selling qualified farm property or small business shares.”

The cancelled surplus stripping proposal was also the area where a shareholder would have had a better tax result selling shares outside the family, and there could have been a significant increase in estate planning costs, he says.

Updates to federal small business tax changes:

  • small business tax rate will be cut from 10.5 to 9 percent by January 1, 2019 (on income up to $500,000)
  • plans to restrict access to Lifetime Capital Gains Exemptions have been dropped
  • plans to restrict the conversion of income into capital gains have also been cancelled
    measures to restrict income splitting/sprinkling will go ahead, but will be “simplified” to supposedly provide more certainty that family members who contribute to a business will not be impacted
  • the government will allow passive investment income of up to $50,000 inside an incorporated business before much higher tax rates kick in.

While the capital gains changes have been dropped, accountants are still seeking answers from the federal finance department on the updated proposals for the other two of the three pillars in the original tax reform proposal: income splitting and passive investment income.

It’s unclear how the measures meant to restrict income sprinkling or splitting will be handled, with Morneau saying the government will “simplify” the reasonability tests used to determine if a family member is contributing to a business.

“I still struggle with how they’re going to make this work and how we’re going to have a reduced compliance burden. We still don’t have draft legislation, so it’s really hard to plan around what those rules are going to mean,” says Moore.

Regarding passive investment income, Ottawa is going ahead with changes to discourage Canadians from collecting passive income inside corporations, but is now proposing to allow income of up to $50,000 per year, while protecting current investments and the income from those investments.

“If you sell a piece of farmland, how do those gains factor into the $50,000? Will the $50,000 accumulate year after year? How does it work if you sell a grandfathered investment and buy a new investment? Is this limit spread over one or more corporations? There are still a tonne of questions on that measure,” he says.

If existing investments are grandfathered in, existing corporations may have two tracks of investments to account for, adding a whole new layer of complexity, he notes.

Again, until there’s draft legislation, Moore says it’s difficult to provide firm advice to clients.

“Overall, they’ve moved in the right direction, but personally, I still think these need to be dropped altogether,” he says. “I don’t think myself as a tax advisor or any of our clients are against tax reform… but you can’t do this within a 75 day consultation period. This needs to be something that takes the span of several years.”

BDO’s Jesse Moore also joined us back in September to discuss the tax changes and the impact the original proposal would’ve had on farms in a three-part series on income splitting, passive income, and capital gains changes.

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