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Finance Minister William Morneau in the 2018 federal budget speech

2018 Federal Budget©

On 27 February 2018, the Minister of Finance, Honourable William Francis Morneau tabled the Liberal government's third budget (hereinafter known as the Budget) after winning the federal election in 2015. The following are not an exhaustive list of changes proposed by the Budget.

Selected Budget Impacts on Individuals

Selected Budget Impacts on Businesses

  1. To reduce tax advantage enjoyed by private corporations in passive investment income, the following two measures will apply to taxation years that begin after 2018:
    1. If a corporation and its associated corporations earn more than $50,000 of passive investment income
      In Income Tax Act subsection 125(7), a Canadian Controlled Private Corporation’s first $500,000 of active business income is taxed at a much lower rate. This is known as the small business deduction.

      Active business income is essentially exactly what is sounds like. Active income is typically anything other than investment income, rental income, leasing income, income from a specified investment business or a personal services business. These types of income are usually passive income, and passive income does not qualify for the small business deduction.

      Rental and leasing income may qualify as active income in certain situations.

      CRA Resource: IT-73R6 The Small Business Deduction
      in a given year, the amount of income eligible for the small business tax rate would be gradually reduced. Corporation’s active business income could hence be potentially taxed at the general corporate income tax rate. There is no change in tax position on corporate passive investment income under $50,000. Regardless of whether the assets producing passive income were acquired before or after Budget Day, the small business deduction limit will be reduced by $5 for every $1 of passive investment income above the $50,000 threshold (equivalent to $1 million in passive investment assets at a 5% return), such that the business limit would be reduced to zero at $150,000 of investment income (see the graph on the right).

      Capital gains realized from the sale of active investments or investment income incidental to the business (e.g., interest on short-term deposits held for operational purposes) remain excluded from the measurement of passive investment income for purposes of this measure. With the proposed approach, incentives will be maintained such that Canada’s venture capital and angel investors would continue to invest in Canadian innovation.

      It is noteworthy to mention that not every corporation will be affected these changes. Some examples
      How These Changes May Affect Businesses That Hold Passive Investments

      Elise owns a catering business. Her corporation earns $100,000 (after tax) in business income each year, and pays out $75,000 as dividends to cover Elise’s living expenses. She saves the other $25,000 in each of the next three years to build up a fund for her planned parental leave. Elise will not be affected by the new rules because the investment income on her savings will be well below the $50,000 threshold, and she does not earn business income taxed at the general corporate rate.

      Simon is an incorporated farmer. Whenever possible, he puts aside excess income to manage weather and other risks affecting his livelihood. His goal is to save $500,000. He chooses to save through his corporation in the AgriInvest program to take advantage of matching government contributions. Investment income from AgriInvest is not considered passive income. As such, Simon will not be affected by the new rules.

      Claire launched a successful retail business and now uses the retained earnings in her corporation to invest in promising start-ups. She sold her 20% stake in a growing clean-tech firm, and realized a $1 million capital gain, which she reinvested into two new start-ups. Claire will not be affected by the new rules because her ownership stake in this active business is such that her capital gain will not count towards the $50,000 threshold, and she is actively reinvesting.

      Amrita owns a hotel. Her income depends on a number of factors outside her control, so she sets aside funds each year to ensure she can continue to pay salaries and expenses in case of a downturn. She has $400,000 in savings in her corporation that she invests in low-risk bonds. Amrita will not be affected by the new rules because the investment income on her savings will be well below the $50,000 threshold, and she does not earn business income taxed at the general corporate rate.

      Saanvi owns a retail store and keeps cash deposits to pay her suppliers and the salary of her employee. She earns interest income on these deposits, which in her circumstances is considered incidental to her business. As a result, Saanvi will not be affected by the new rules.

      Louis owns a very profitable private corporation that earns more than $500,000 annually. He has accumulated a portfolio with a value of $5 million, which he intends to pass on to his children. Given his level of savings and level of income, Louis will no longer receive the benefit of the small business rate to fund further passive investments, starting in 2019. All of his business’ income will be taxed at the general corporate rate.
      are embedded herein.

    2. Currently, passive investment income in Canadian-controlled private corporations (CCPCs) is taxed at a higher rate, a portion of which is refunded when investment income is paid out to shareholders in dividends. Through the Refundable Dividend Tax on Hand (RDTOH)
      RDTOH is a notional account found in a private corporation's My Business Account under "View Return Balances". The current year RDTOH is determined in the box labelled "Refundable dividend tax on hand" on page 6 of the T2 return. The RDTOH at the end of the previous tax year is reduced by the dividend refund for the previous tax year. The result is to establish a new balance at the beginning of the current tax year from which a dividend for the year may be computed based on dividends paid.
      RDTOH in CRA MyAccount
      A private or subject corporation may be entitled to a dividend refund for dividends it paid while it was a private or subject corporation, regardless of whether it was a private or subject corporation at the end of the tax year. To claim a dividend refund or to apply the amount to another debit for any tax year, including the same tax year, you have to file your income tax return within three years of the end of the tax year.

      RDTOH tracks a defined portion of a private corporation’s income tax paid on Aggregate Investment Income (AII), along with tax paid on dividends from non-connected corporations (corporations where share ownership is 10% or less). Generally, this means investment portfolio dividends.

      AII includes interest, rent, royalties, income from property and net taxable capital gains, less business investment losses and related expenses. Depending on the province, AII is taxed at 45.67% to 50.67%. The calculation for that tax rate is:
      1. basic federal tax of 38%, less
      2. federal tax abatement of 10%, plus
      3. additional refundable tax of 6.67%, plus
      4. provincial tax rate (11% to 16%, depending on the corporation’s province of residence).
      The corporation adds 26.67% of the AII amount to its RDTOH account. RDTOH is a federal mechanism; no provinces participate in the account’s operation. When RDTOH is factored into the effective rate of tax paid by a private corporation, the federal government nets 8% tax on AII.
      account, taxable dividends can allow for a refund of taxes on investment income, whether that dividend comes from investment income or active business income (which is taxed at a lower rate). When there is a balance in the RDTOH account, amounts are refunded to the corporation at a rate of $1 for each $3 of taxable dividends paid. This allows CCPCs to pay out lower-taxed dividends from their active income and claim a refund on taxes paid on their investment income, which the Budget calls “a significant tax advantage.”

      To close this loophole, CCPCs are no longer able to obtain refunds of taxes paid on investment income while distributing dividends from income taxed at the general corporate rate after 2018. This measure reduces the “significant tax advantage” that larger CCPCs can pay out lower-taxed dividends from their pool of active income taxed at the general corporate rate, and still claim a refund of taxes paid on their investment income which is intended to be taxed at higher tax rates.
  2. The Budget proposed a new federal excise duty framework for cannabis products, which will be effective when non-medicinal cannabis becomes available for legal sale. Excise duties will be imposed on federally-licenced producers at the higher of a flat rate applied on the quantity of cannabis contained in a final product and a percentage of the dutiable amount of the product as sold by the producer. In addition, cannabis products are also subject to the GST/HST.
Remarks

In the foreseeable future, the federal government will be running a deficit. The Budget projected a $18.1B deficit for 2018-19 (falling to $12.3B by 2022-23) with emphasis on archiving gender equality, "use-it-or-lose-it" EI incentive for new fathers to take parental leave, small business tax reform, cyber security, research and innovation. With the huge emphasis on gender equality, the Budget inevitably delivered an appearance of preparation for the federal election in October 2019.

In the next two years, the problem-plagued Phoenix pay system, which has overpaid, underpaid or completely failed to pay tens of thousands of public servants, will be replaced by a new payroll system that costs $16-million over two years. Eventually, taxpayers often pay for the consequences when there is no accountability in government.

Proposed tax changes of passive investment income in CCPCs are more targeted, simpler and less burdensome for businesses than those discussed in the government's July 2017 consultation paper. New measures are designed to limit perceived tax advantages from holding passive investments within a private corporation.

The Budget allocated about $1.4 billion over the next six years to support Indigenous children in foster care and promote family reunification. Foster homes warehouse children removed by child protection agencies (a provincial ministry or delegate in Canada) from their families. Supporting both foster care and family reunification appears to be self-contradictory and counter intuitive.

With legalization of cannabis in the late summer of 2018, Ottawa is spending another $62.5-million on public education campaigns on the dangers of drug use and $10-million on research, including assessing the impact of legalization on mental health.

[This page was added on 27 February 2018, last revised 1 March 2018.]