New passive income tax rules

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Dawn Loeffler, BA (Hons), CPA, CA Staff Accountant, Gilmour Knotts

Tax Question:

What are the tax changes on passive income earned in a private corporation?

Facts:

As a result of the response to the proposed tax changes on passive income released in 2017, the Canadian government has released new tax rules on the tax treatment of passive income on investment portfolios held inside a private corporation as part of the 2018 federal budget. This targets private corporations being used as investment vehicles for retirement.

Discussion:

Currently, Canadian corporations pay a reduced tax rate on the first $500,000 of active income if they qualify for the Small Business Deduction Limit (SBDL). The Canadian government is attempting to eliminate the perceived financial advantage that these corporations have the ability to invest more funds than a personal investor due to this reduced tax rate.

As proposed in July 2017, the new tax rules set a threshold for passive income within a private corporation of $50,000 a year. As long as a company stays below this $50,000 of passive income earnings of dividends, interest and 50% of capital gains each year, there is no penalty. Once a private corporation exceeds this passive income threshold, the corporation’s access to the SBDL will be gradually eroded until it is eliminated at $150,000 of passive income. This means that if you have passive income earnings over $50,000 a year, your corporation will pay more tax as more income will be taxed at the higher general tax rate and less income will be taxed at the lower small business tax rate.

For example, in 2019 your corporation generates more than $500,000 of earnings (so you use all your SBDL) and your corporation generates $90,000 of passive income. This exceeds the passive income limit by $40,000 ($90,000-$50,000). According to the new passive income rules formula, your SBDL for 2019 will be reduced by $200,000 ($40,000*5) and you would be taxed at the higher general corporate rate on this $200,000 of income. If the general corporate tax rate is 15% and the SBDL tax rate is 10%, you will pay an additional 5% of tax on $200,000 of income for an additional tax cost of $10,000.

These tax changes for passive income inside a private corporation will be effective in 2019.

Dawn Loeffler, BA (Hons), CPA, CA
Manager, Gilmour Group CPA’s
Email: faqs@gilmour.ca
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