OTTAWA CRACKS DOWN ON ‘SPREADING’ INCOME
Individuals using private corporations to drastically reduce their tax bills
The federal government announced a proposal Tuesday that would crack down on the practice of wealthy individuals spreading their income among family members to create major tax savings.
Ottawa is taking aim at three major loopholes, affecting as many as 50,000 families, including what is called “income sprinkling” using private corporations to shift income from an individual facing a higher personal income tax rate to a family member who is subject to lower personal tax rates or who may not be taxable at all.
“Many of the richest Canadians are unfairly exploiting the tax rules designed to help businesses thrive. We know that businesses, including small businesses, help grow the Canadian economy. These tax advantages are in place to help these businesses reinvest and grow, find new customers, buy new equipment and hire more people. We want to make sure those rules are used to do just that, and not to give unfair tax advantages to certain — often high-income — individuals,” said Bill Morneau, the federal finance minister, in a statement.
As an example of sprinkling income, the government pointed to a scenario where two people both earned $220,000 annually in Ontario. One person is paid a salary of $220,000, while other draws a salary of $100,000 but pays dividends to family members of $102,000 after corporate tax.
The after-tax income for the person paying straight salary is $141,000 while the after tax-income for the person sprinkling their income is $176,000.
To clamp down on the practice, Ottawa plans to extend the existing tax on split income for minors to apply to adults in certain circumstances. Dividends and other amounts received from a business, by an adult family member of the principal of the business, may be subject to a reasonableness test, which will be stricter for 18-24 year olds.
It also crack down on other sprinkling issues, including the multiple claims to the lifetime capital gains exemption through family members.
Kevyn Nightingale, an international tax partner with MNP LLP, said the tax planning of spreading income has widespread use.
“It’s just standard business owner planning. If you’re not doing it, you are not doing what everybody else is doing and something is wrong with your accountant and your lawyer.”
The tax planning method comes down to where you are located in the country, Ontario having made it very difficult to do for lawyers but easier for doctors and dentists.
“If you are a lawyer in Ontario, your spouse cannot own shares in your company,” said Nightingale, noting that the province specifically exempted doctors as part of a political plan to give them a raise by partially dipping into federal tax coffers.
The savings really depends on the amount of income you make and can be really advantageous for an individually with universityaged children. “Their kids can be shareholders in the company and they will pay dividends to the kids and the kids will use that money to pay for school and the tuition (tax) credits will eat up most of the tax on the income (being diverted to them),” said Nightingale.
He said there shouldn’t be much of a surprise that doctors have this giant loophole in Canada’s largest province because the corporate law legislation in Ontario was redrawn for doctors and dentists.
“It’s not by accident. The government was negotiating with doctors backs in the late 1990s and the doctors wanted more money as they always do. The province didn’t want to pay more money and that’s normal too.”
Ottawa will be taking submission on the proposals, until Oct. 2.
The income-sprinkling changes alone are expected to save $250 million annually.