Many small businesses are skeptical about the small business tax changes that are about to be implemented by the federal government. Though the government claims that the tax changes are geared towards making the system fair for all players and not just to increase the amount of revenue they earn, small businesses are likely to be the most affected.
A Highlight Of The Tax Changes
The government reported that there’s a significant number of businesses that use certain loopholes in tax legislation to avoid high tax rates. One of the strategies that some business owners use to reduce their tax bill is known as income sprinkling. This is simply where some business owners split their income with their family members in order to fall in a different tax bracket.
The other change that the government wants to make affects how dividends and capital gains are converted to income. The changes are set to affect mostly businesses that have incomes higher than $150,000 every year. Those businesses that still have substantial profits after contributing RRSP and TFSA every year will also be affected by the tax changes.
The Government Targets Income Sprinkling
Business owners have, for many years, used income sprinkling as a way of reducing income tax. In fact, the government recently reported that more than 50,000 Canadian families are using income sprinkling to reduce the tax burden on the family. This method works in the sense that it allows the owners to divert their income to other family members who earn a low income in the form of salaries, wages, and dividends. Sometimes these family owners don’t work for the company but still qualify for dividends and other sources of income. By splitting the income to other family members, it results in a reduced tax burden.
How Income Sprinkling Will Be Identified
The CRA now wants to put in place certain tests that will help them to identify business owners using income sprinkling. For instance, they will take measures to determine if the family members earning a wage or salary are directly involved in the activities of the business. If they are not actively involved in the business or how much they earn is not considered a reasonable wage (it’s too high) if you compare with market rates, it will be thoroughly scrutinized by the CRA when filing taxes.
Changes In Capital Gains
Some businesses can take advantage of the fact that they can convert their corporate income into capital gains in order to avoid paying income taxes. Capital gains include things like stocks or property that is above the purchase price. At the moment, businesses are allowed to take out retained earnings which will not be taxed if they sell the shares to a holding company. However, the proposed changes will ensure that any access to these assets will result in taxation. This step is not welcome by most small business owners as they claim it will make it difficult for the company to grow or plan for retirement programs.
Sohail Afzal, CPA, CMA, MBA
Sohail Afzal, (CPA, CMA, MBA) is the founder & CEO of GTA Accounting Professional Corporation. He is a highly experienced Chartered Professional Accountant and businessman himself and understands the challenges that many businesses face when it comes to cash flow management. As an experienced business consultant & tax advisor, he is helping companies grow by providing the technical, financial, and contractual information necessary for strategic decision-making.