Liberal’s small business tax change plan: how will you be affected?

The Canadian government is planning on closing loopholes that have apparently allowed high-earning business owners (including dentists) to avoid paying higher tax rates. Finance Minister Bill Morneau claims that the proposed tax changes are about making the system fair, as opposed to generating revenue for the government.

Here’s the Liberals’ latest tax plan explained:

Back in July, Morneau announced the plan to close loopholes which the government says have allowed dentists (and other high earners) to avoid higher tax rates. The changes are designed to target so-called “income sprinkling,” which allows dentists to split their income among family members, whether they are involved in the business or not. The Canadian government also wants to adjust methods of converting income into dividends and capital gains, while limiting passive business income taxation. The government claims that the biggest impact will be experienced by dentists earning $150,000 or over.

Time to “test” income sprinkling?

Income sprinkling allows dentists to divert their income to lower-earning family members by paying them salaries, wages or dividends, even if they don’t work for the company. That lessens the family’s overall tax burden.

The government now wants to apply a “reasonableness test” to income sprinkling to determine whether a dentist’s adult child or spouse actually contribute to the business. The test would partly involve determining whether a family member is actively engaged in the duties of the business. The compensation they receive would not be considered “reasonable” if it surpassed what “an arm’s length party” would have agreed on considering the caliber of work.

Are retirement difficulties in your future?

Capital gains are profits earned from the sale of securities, stocks or property exceeding the purchase price. The government claims that converting a private corporation's income into capital gains can provide “an unfair opportunity to reduce income taxes,” by taking advantage of the lesser tax rates on capital gains.

With these proposed changes, accessing those resources would result in immediate taxation, which many say will make growing a company and planning for retirement difficult.

The problem with passive investment

Passive investment refers to income derived from a portfolio of investments, rather than active income earned from operating a business. The Department of Finance says that some individuals unfairly benefit from retaining passive investments in their businesses, seeing how they’re taxed at the significantly lower corporate rate.

“This is a problem when an individual holds money inside a corporation, not to invest it in growing the business, but simply to shield it from the higher personal tax rate,” the department states.