Morneau softens plan on passive income

Changes could ‘provide a lot of relief’, but questions raised on future investments

OTTAWA The finance ministry’s decision to soften a controversial proposed tax on passive investment income could go a long way in quelling recent discontent from private corporations, experts say, but leaves question marks about how future gains on currently held investments will be treated.

In an announcement Wednesday in New Brunswick, Finance Minister Bill Morneau said that the first $50,000 of passive investment income earned by Canadian private corporations would not be subject to a new tax the Liberals had proposed earlier this year.

According to the new plan, passive income below the threshold will be taxed at the same reduced rate as before, currently 10.5 per cent and falling to nine per cent by Jan. 1, 2019. Earnings above the threshold will be taxed at a yet-tobe determined rate, expected to be in line with personal tax levels.

Experts said the changes could help stem the recent uproar against the Trudeau government, which has been amending its earlier tax proposals after criticism from family run businesses and professional associations. A consultation period over the proposed changes ended earlier this month.

“It actually looks like it will provide a lot of relief,” said J.D. Greenberg, an accountant with Torontobased firm Paisley Pike, CPA.

In a document released Wednesday, the finance department said only about three per cent of private corporations in Canada earned passive taxable incomes above the $50,000 threshold in 2015, but accounted for 88 per cent of taxable income.

The latest changes will also only apply to future passive investments, rather than those held within corporations today — an aspect of the initial proposal that business owners and professionals strongly opposed.

But Greenberg said there are still open questions around the updated policy, including whether so-called “second generation” income will also be included under the lower rate.

An explainer provided by the finance department said passive incomes currently held inside a firm won’t be taxed at the higher rate, but doesn’t specify whether that will apply to growth on “future” gains on those investments, typically generated through dividend payments, interest or other means.

“It doesn’t look like that second generation is protected,” Greenberg said. “This wouldn’t have an immediate impact for businesses, but it has the potential to become a bigger issue.”

The document provided by the finance ministry says the new amendment will protect any current passive investments made by business owners, “including the future income earned from such investments.”

But Greenberg said protecting those future investments would mean companies would have to track and separate revenues generated from their current investments from other passive income, posing a challenge both to small business owners and to accountants.

The announcements come mere days after the federal government lowered its tax rate on small businesses, a move widely viewed as a sweetener for small businesses, which have been among the fiercest critics of the proposal.

The small business tax rate will be lowered to nine per cent in 2019, down from the current rate of 10.5 per cent.

But Paul Robey of Torontobased Capstone LLP said most of his small business clients won’t be affected by the passive investment changes.

“At this point most of them, generally speaking, are not investing in anything within their corporations,” he said.

He said the decision earlier this week to lower the small business tax rate is a welcome change, but he said the most pressing change for his clients is the removal of income sprinkling, which allows businesses to spread their income among family members.

The federal government could make amendments to the income sprinkling aspect of its proposal, but many tax experts say it is unlikely it will be removed entirely.

“That was some good news, and the bad news is probably coming,” Robey said.