By Connor Lynch
OTTAWA — When the federal government announced in July it was increasing business taxes, there was an uproar across the nation. Doctors, small business owners, and farmers all weighed in to decry the changes. Tax experts offered what criticism they could; much of it on how opaque and confusing the new rules were. The government defended its proposals, claiming it was making the taxation system fairer.
For farmers, the largest concerns centred around changes to retirement planning, succession, and funding children’s education and spouses or family members helping out on the farm. Whether by design or inadvertently, the government targeted many farm accounting practices.
There were four major practices targeted: Income sprinkling (the process of giving income to spouses or family members via dividends from the business); passive investments (money made from corporate investments, like stocks); the capital gains exemption (that was going to be axed); and surplus-stripping (a complex process that allows a farmer to save on the tax bill when transferring the farm to his child rather than a stranger).
The government proposed a “reasonability test” for income sprinkling to determine if a family member really works the farm, slapped a hefty tax bill on passive investments, axed some lifetime capital gains exemptions, thereby killing surplus-stripping and making it cheaper to sell the farm to a stranger than to your own child.
But the government has backed off on a number of its proposals. It also announced it will be dropping the small business tax rate on income up to $500,000 from 10.5 per cent, to 9 per cent in 2018. Here’s how the four major issues for farmers have changed in recent weeks:
Income sprinkling: The government’s shy on details, likely because that’s what got them into trouble in the first place, said the Canadian Federation of Independent Business’ (CFIB) chief economist, Ted Mallett. The original proposal would’ve required very extensive paperwork to justify giving dividends to a spouse and appears to have been relaxed. “We’re being told it’s a much simpler way,” Mallett told Farmers Forum.
Federal director of the Canadian Taxpayers Federation, Aaron Wudrick, expects something closer to an exemption on spouses. “It will probably be easier for spouses to get paid than adult children,” he said. He cautioned, however, that any farmer who is “income sprinkling” in the new year must pass Canada Revenue Agency’s “reasonability test” or will owe back taxes on what the CRA will consider is employment income, which is taxed more heavily than dividends.
Some farmers use income sprinkling as a way to fund a child’s education. Expect that practice to become difficult, if not impossible, Wudrick said.
Passive investments: The government tweaked its proposal by announcing there would be a $50,000 cap on annual income withdrawn from investments held within a corporation. But the government has been mum on details. Will the government tax income when it comes out of the corporation or before? There isn’t an accountant in the country who can say right now, said Wudrick.
The CFIB’s Mallett cautioned, however, that business owners don’t always know how the money in a corporation will be used ahead of time. That raises questions about how the government will decide whether a business has violated the rules or not. Plus, business capital fluctuates, and businesses have good and bad years.
“Would you still be dinged if you went over one year but your average stayed below (the $50,000 threshold)? The mechanics are going to be very complex.”
Wudrick added it’s also important to note that existing investment arrangements are going to be grandfathered — the government will leave them alone.
Wudrick said the government set a $50,000 cap to stop people from setting up corporations as a nest egg for investments. Going forward, the debate will be on whether that $50,000 is high enough. Over 20 years, it adds up to $1 million, which likely won’t be enough for some to retire on, he said.
Capital gains exemption: This one the government decided to drop entirely, said Wudrick, which segues directly into another farmer concern.
Surplus stripping: The government also dropped its proposed restriction on capitals gains exemptions in a number of ways, including conversion of income into capital gains. That would have made it easier to sell the farm to a stranger than to one’s own child. “Farmers were quite vocal about their concerns on this.” Wudrick said. “The government does not want to be seen as killing the family farm.”
Among all groups affected by the tax changes and tweaks, Wudrick said farmers have the most reason to be optimistic. But “we caution declaring victory.” Until the government releases information on how its final proposals will work, which could be as late as next year’s budget release in the spring, “It’s too early to say the problem is completely settled,” he said.