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Posted on Dec. 14, 2017 By Stephanie Soong Johnston The Canadian government has announced further changes to its controversial proposals to address “income sprinkling” through private corporations, offering bright-line tests to limit the potential effect on those who are legitimately contributing to those businesses. The Department of Finance on December 13 published more amendments to proposals to revise Canada’s Income Tax Act, in particular measures to crack down on income sprinkling. The tax planning strategy involves funneling income from a wealthy individual using a Canadiancontrolled private corporation to other family members who may not have any role in the corporation and who are subject to lower personal tax rates or are not taxed at all. The revisions, which would take effect starting January 1, 2018, would simplify and improve the treatment of income sprinkling to ensure that family members who make legitimate contributions to family businesses are not unfairly affected. Specifically, the changes clarify how the Canada Revenue Agency will determine if a family member is significantly involved in a business and thus would not be subject to taxation at the highest marginal rate, also known as the tax on split income (TOSI), according to a government backgrounder. The CRA will use three bright-line tests to immediately exclude members of a business owner’s family from the TOSI. First, a business owner’s spouse who makes a meaningful contribution to the business and is 65 years of age or older would be exempt. Second, adults 18 years of age or older who have made a substantial labor contribution by averaging a minimum of 20 hours per week for the business would also fall outside the scope of the TOSI. And third, adults who are 25 years of age or older who own 10 percent or more of a corporation, which earns less than 90 percent of income from providing services and is not a professional corporation, will be exempt as well. Those who are 25 or older who don’t meet any of the bright-line tests would be subject to TOSI on income derived from a related business, if those amounts exceed a reasonable return. According to the government’s technical backgrounder on the changes, a reasonable return is "an amount that is reasonable having regard to the contributions of the specified adult individual to the related business relative to other family members who have contributed to the business.” The CRA also published guidance on the proposed measures. The government first announced its intention to address income sprinkling in its March 2017 Document generated for Roy Berg

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Canada Clarifies 'Income Sprinkling' Tax Measures

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To assure the public that the measures would not unfairly hit middle-income small business owners, Finance Minister Bill Morneau in October announced additional measures, including a C $50,000-per-year threshold on passive income. Morneau also confirmed that the government would cut the federal small business tax rate from 10.5 percent to 9 percent by 2019, and that it would abandon proposals to limit access to the lifetime capital gains exemption and restrict conversion of income from private corporations into capital gains. The revised proposals will reduce the estimated number of family businesses that will come under the scope of the income sprinkling rules from 50,000 to fewer than 45,000, which represents less than 3 percent of the 1.8 million Canadian-controlled private corporations, according to the Department of Finance. Aaron Wudrick, federal director of the Canadian Taxpayers Federation, welcomed the changes, noting that there were concerns that the income sprinkling measures were too broad and would hit many people who were legitimately contributing to businesses. “These tests represent the government's attempt to remedy that,” Wudrick told Tax Analysts. “I wouldn't say they're perfect, but they're a vast improvement on the original proposal. Allowing for a general reasonableness test, and ensuring the changes don't affect the 2017 tax year — so businesses now have a full year to adjust to these changes — are also very important.” Roy A. Berg of Moodys Gartner Tax Law LLP also welcomed the three safe-harbor provisions to exempt individuals working in a family-owned business from the TOSI. Under the original proposal, those individuals would have been exempt only if their compensation was reasonable, he added. “While the attempt to craft safe harbors is a welcome development, the safe harbors themselves rely on undefined terms such as ‘meaningful contribution to the business,’ which fail to provide the certainty one would expect from true safe harbors,” Berg told Tax Analysts. “The safe harbors released by Finance today, while well intended, fall short of providing the certainty taxpayers need in order to plan their affairs.”

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budget, and followed up in July with a consultation seeking input on proposed legislative changes.