Last week, we reported on how the Department of Finance’s draft legislation proposes to change the process of Income Splitting. Today, in Part 3 of our 4-Part series, we’ll look at how the legislation would affect the Enhanced Capital Gains Deduction (“ECGD”).
Third Area of Concern: The Enhanced Capital Gains Deduction.
The ECGD allows business owners, farmers and fishermen to shelter a lifetime maximum of capital gains on the sale of qualified small business corporation (“QSBC”) shares qualified, farming property, and qualified fishing property. For 2017, the amount that could be sheltered from taxation was up to $835,716 on QSBC shares, and $1 million for qualified farming and fishing property.
As we mentioned last week, a business owner is currently able to save tax by introducing his or her family members as shareholders of the CCPC, and paying annual dividends to them. An equally important benefit of this form of tax planning is when an owner-manager becomes ready to sell the business through a corporate share sale. In this case, the ECGD can potentially be claimed by each family member who is a shareholder of the corporation, even though such family members may have no active involvement in the corporation’s business.
The Department of Finance sees this tax benefit as unfair. The new legislation will seek to apply the following measures to dispositions after 2017 eligible for the ECGD claim:
- The ECGD claim will no longer be available to minors.
- If the individual held the shares while a minor, any portion of the capital gain which accrued during that time is ineligible for the ECGD.
- If the taxable capital gain is considered split income (refer to last week’s email), it will not qualify for the ECGD.
- The ECGD will not be available where the capital gain was accrued while the shares were held by a trust (certain trusts are exempt from these rules).
Determining whether a taxable capital gain is considered “split income” is very subjective. Therefore, there will now be uncertainty surrounding the ECGD claims made by individuals. Additionally, the proposed ECGD changes will inevitably lead to future disputes with the CRA regarding the valuation of accrued gains, where the shares sold were formerly owned by a minor child or by a trust.
A transitional rule has been proposed, to deal with existing structures where the corporate shares are held by a trust. This rule will enable the trust to crystallize a capital gain on its QSBC shares, and allocate the designated capital gain to its beneficiaries, allowing them to avail themselves of their ECGD on the accrued gain of such shares to that date (minor beneficiaries, however, may not benefit from this transitional measure).
Tomorrow, we’ll be concluding our series by examining the final area of concern in the proposed legislation: The conversion of income into capital gains.
For more information on this topic, contact your Zeifmans advisor or reach out to us at 416.256.4000 or firstname.lastname@example.org.
Part 1: Passive Investments
Part 2: Income splitting
Part 4: The conversion of income into capital gains
Federal Government tax changes announced Oct 16
Oct 18 and 19 updates on the taxation of owner-managed businesses
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