Finance Targets Tax Planning Involving Income Sprinkling

In the future, private companies’ tax planning may be restricted due to the release of Department of Finance’s recent 63-page consultation paper on July 18, 2017, along with proposed legislation and notes on some of the topics addressed.

This paper includes significant measures and complex proposed rules to address certain tax planning strategies involving private corporations, including “income sprinkling”. Income sprinkling involves reducing income taxes by shifting income that would otherwise be taxed by an individual at a high personal income tax rate to family members who are taxed at lower personal tax rates.

The proposed legislation significantly expands the scope of the “tax on split income” (also known as the “kiddie tax”) to prevent non-arm’s length persons from splitting income and reducing their overall tax burden. Finance proposes to extend the kiddie tax to apply to certain adult individuals. If an amount paid to a non-arm’s length person is determined not to be reasonable, the top marginal tax rate will apply. These rules will be more restrictive for family members aged 18-24. In addition, Finance proposes applying kiddie tax to compound income (income earned from investment income that is already taxed at the top marginal tax rate due to kiddie tax rules). Under the current rule, kiddie tax does not apply to compound income; instead, such income is taxed at the tax rate applicable to the family member who earns the compound income.

Finance proposes to limit income sprinkling by multiplying the lifetime capital gains exemption across multiple family members. The proposals would generally eliminate the ability to claim the capital gains exemption on gains that accrue before an individual turns 18 and on gains that accrue while property is held by a trust (other than a spousal trust or common law partner trust or certain trusts established to hold shares for employees).

These changes could adversely affect family businesses that have undertaken common estate planning transactions, especially where shares are held by a trust or by family members. Individuals with private corporations should contact professional advisors like MCA Cross Border Advisors as soon as possible to determine how these changes may affect them and what can be done to minimize their impact.

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