Passive Investment Rules and Small Business Deduction

24 Oct

Passive Investment Rules and Small Business Deduction

Budget 2018

  • Reduction of small business deduction (SBD) for CCPC’s that have significant passive investment income
  • Theory appears to be a CCPC that has accumulated a material amount of passive investments ($1 million) is taking undue advantage of the tax deferral afforded by the small business deduction
  • Will apply to tax years beginning after 2018

Small Business deduction changes

  •  The SBD will be reduced to extent the CCPC (and associated corporations) earn more than $50,000 of adjusted aggregate investment income (AAII) in a year
  • The SBD will be ground to zero once AAII reaches $150,000 in a year (resulting in approximately $75,000 more tax being initially payable by the corporation)
  • Will not have a significant impact on “larger” CCPCs as their SBD is already ground down to nil once taxable capital reaches $15 million

Adjusted Aggregate Investment Income

  •  Generally, the aggregate investment income of the CCPC

But

  • Excludes capital gains/losses on the disposition of “active assets” (property used in the business)
  • Excludes gains on shares of connected CCPC carrying on active business
  • Excludes capital losses of other years carried over
  • Excludes investment income incidental to an active business (e.g. interest earned on working capital account)
  • Includes dividends from non-connected corporations

Corporate Owned Insurance

  • Includes accrual income earned in a non-exempt policy
  • Includes annuity income
  • Includes income arising from the disposition of an exempt policy
  • Does not include the accumulating reserve (including the cash value) of an exempt policy

But…need to ensure you are marketing exempt insurance for risk protection and not as a way to avoid the grind to the SBD

 

How Will It Work

  • Jane owns all of the shares of a Holdco that has a passive investment portfolio. In the current year, it will earn $100,000 of investment income (AAII)
  • Holdco also owns all of the shares of a CCPC that carries on an active business. The business is expected to have profits of $500,000 in the current year after issuing a bonus to Jane. SBD reduction = ($100,000 – $50,000) x $5 = $250,000
  • CCPC pays small business rate on $250,000, and the regular business rate on $250,000

 *Based on 2018 Ontario tax rates with Ontario introducing similar restrictions

Loss Deferral

  • SBD grind is a loss of the tax deferral gained from the lower small business tax rate
  • Fully integrated, overall tax is generally intended to be similar

Important Things to Note

  • No grandfathering for current passive investments
  • Investment income includes income from the disposition of an exempt life insurance policy, income from non-exempt insurance policies and annuity income (but not tax-deferred accumulation in an exempt policy)
  • There is no “income averaging provision” to account for “choppy” investment income
  • Certain provinces could choose to “opt out” of these changes to the SBD (Quebec and Ontario have announced they will adopt these rules)
  • These rules are not effective until 2019 – planning opportunities in 2018…

Planning Opportunities

  •  Planning generally to invest so as not to produce AAII:
  • Corporate-owned life insurance
  • Individual Pension Plans (IPPs)
  • Retirement compensation arrangements (RCAs)
  • Capital gains and gains realization strategies
  • Managing investment expenses

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