Corporate Passive Income Taxation Changes

In the July 2017 announcement, the federal government announced some significant changes to the taxation of passive income within corporations, specifically CCPCs. After a strong backlash from business owners, the government released a more “watered down” version of these changes in the 2018 budget. In this instalment, we take an in-depth look at these new rules.

Applicability

The rules mentioned below will be applicable for taxation years that begin after 2018.

Business Limit Reduction

The first change is in annual business limit. The business limit, which is at $500,000, will be reduced on a straight-line basis for passive income that is above $50,000 [ITA 125(5.1)(b)]. This limit is eliminated once passive income is above $125,000. If the active business income [ITA 125(1)] is below this reduced limit, the CCPC’s tax rate will not be affected.
Table - Active business income qualifying for the small business tax rate under new business limit ($)*

*Reproduced from the 2018 budget

The formula for this reduction of the business limit is [ITA 125(5.1)(b)]:

D/$500,000 × 5(E − $50,000)

D represents the business limit, E represents the “adjusted aggregate investment income” [ITA 125(7)] (defined below) of the CCPC, or any corporation that is deemed to be associated with that CCPC (see below).

A new anti-avoidance rule has been added that defines associated companies for the purposes of this reduction. On top of existing association rules as defined in ITA 256(1), 3 more rules are added that deem companies associated to each other [ITA 125(5.2)]:

• The corporation lends or transfers property to another corporation by means of a trust or any other means.
• The other corporation is related but not associated under ITA 256(1).
• It can be reasonably determined that one of the main reasons for the loan or the transfer of property (see first bullet) is to reduce adjusted aggregate investment income.

What is interesting in this anti-avoidance rule is that government does not allow a shift of passive income between corporations, even if this transfer is not to an associated company.

Adjusted Aggregate Investment Income

The income that triggers the reduction of the business limit is the “adjusted aggregate investment income” [ITA 125(7)]. This new concept starts at “aggregate investment income”, as defined in ITA 129(4), and makes adjustments to that amount.  The adjustments are:

• taxable capital gains (and losses) will be excluded to the extent they arise from the disposition of
  • a property that is used principally in an active business carried on primarily in Canada by the CCPC or by a related CCPC; or
  • a share of another CCPC that is connected with the CCPC, where, in general terms, all or substantially all of the fair market value of the assets of the other CCPC is attributable directly or indirectly to assets that are used principally in an active business carried on primarily in Canada, and certain other conditions are met;
• net capital losses carried over from other taxation years will be excluded;
• dividends from non-connected corporations will be added; and
• income from savings in a life insurance policy that is not an exempt policy will be added, to the extent it is not otherwise included in aggregate investment income.