To get the most benefit from tax planning strategies, you should start well before the end of the year. This will put your business in a much better position to manage income tax costs for 2019 and future years.
Here are five key strategies to keep in mind when planning the taxes for your business. Some are available even to tax-planning procrastinators; others require a business owner’s early attention to tax detail.
1. Pay your family wisely
As a private business owner, you likely know the value of revisiting your family business remuneration strategy at least annually. In determining the best mix of salaries and dividends for you and your family members, consider factors such as each individual’s marginal tax rate and need for cash, as well as the corporation’s tax rate and the benefits of deferral.
Since 2018, this process has become more complex due to the expansion of the tax on split income (TOSI) rules. These rules further restrict the use of a private corporation to split income with family members. They do this by applying a high rate of tax to certain types of income, in particular, dividends paid from private corporations. When these rules apply, they eliminate the benefit of income splitting. However, there are situations where you can still split income in a tax-efficient manner with family members. The TOSI rules are very complex. Therefore, it’s important to work with your trusted BDO tax advisor to determine an optimal remuneration strategy.
One thing to keep in mind is that the TOSI rules don’t apply to wages paid for actual work performed. If your spouse or children work for your business, consider paying them salaries for their work in 2019. You should always remember that salaries must be reasonable and commensurate with the services performed. A good rule of thumb is to pay them what you would have paid a third party and to maintain adequate documentation to support such payments. Also, remember that payment of salaries and bonuses accrued in your 2019 fiscal year must be made within 179 days of your business’s year-end for the amounts to be deductible in the current fiscal year. For fiscal year ends between July 6, 2019 and Dec . 31, 2019, a bonus for the 2019 fiscal year can be paid in 2020 (but within 179 days of the 2019 fiscal year-end). This means that your business will get a deduction in the 2019 fiscal year, but your family members won’t be taxed on it until 2020.
Whenever you pay salaries to your spouse or children, ensure that withholdings for income tax, Canada/Quebec Pension Plan, employment insurance/Quebec Parental Insurance Rates (where an exemption is not available), and any applicable provincial payroll taxes are remitted as required. Where the remuneration is paid in 2019, the remuneration and related withholdings must be reported on T4 slips for 2019, which are due on or before March 2, 2020 (since Feb. 29 falls on a Saturday). Note that the equivalent form to the T4 slip in Quebec is the RL-1 slip. RL-1 slips are due on or before Feb. 29, 2020. Quebec does not generally follow the same conventions for an extended due date when the deadline falls on a Saturday. However, the province may extend the deadline by making a special announcement close to the time of the statutory due date.
2. Understand the new restriction on the small business deduction
The small business deduction (SBD) reduces the corporate tax rate for qualifying businesses and therefore creates a greater deferral of tax than for business income taxed at the general corporate rate. As such, the SBD is one of the most common tax advantages available to Canadian-controlled private corporations (CCPCs). The small business limit is currently $500,000 federally and in all provinces and territories except for Saskatchewan (where the limit it $600,000). In 2019, the combined corporate tax rate on income up to the small business limit is 15% or less in all jurisdictions—at least 11.5 percentage points lower than the general corporate tax rates, and as much as 19 percentage points lower in some jurisdictions. This allows for a significant tax deferral where active business income is retained in the company.
Certain restrictions apply to limit access to the SBD, and recent changes to the tax rules have significantly expanded these restrictions. For taxation years that begin after 2018, your business faces a new restriction to using the SBD.
New SBD restriction explained
CCPCs that earned investment income over a $50,000 threshold in 2018 are generally subject to a reduction in the amount of SBD that can be claimed in 2019. Under the new rules, the small business limit will be reduced by $5 for every $1 of investment income above the $50,000 threshold. Under this formula, the SBD will be eliminated when investment income reaches $150,000 in a given taxation year. Note that investment income is aggregated for all associated corporations for purposes of this threshold.
As part of these changes, a new definition of investment income—adjusted aggregate investment income (AAII)—was introduced. Generally, AAII includes investment income, such as interest, rent, royalties, portfolio dividends, dividends from foreign corporations that are not foreign affiliates, and taxable capital gains in excess of current year allowable capital losses from the disposition of passive investments. A trusted BDO tax advisor can help you to understand this definition and how the new rules may affect your corporation.
Annual planning for the new SBD restriction
Because the new SBD restriction is based on AAII earned in the previous year, annual planning may make sense in situations where the amount of AAII shows growth or fluctuates year to year so that the following year’s SBD can be managed. There are strategies for reducing investment income within your corporation while retaining investment funds within the company (as withdrawing the funds from the company will be taxable to you). Keep in mind that any such action to reduce investment income must make sense from an overall investment perspective and not just with a view to tax minimization.
For example, you could look at the investment portfolio in your company, and if it makes investment sense, look at a more tax-efficient mix of investments. One way to achieve this might be to hold more equity investments within your corporation rather than fixed income investments. This would be helpful because only 50% of the gains realized on the sale of shares would be taxable whereas investment income earned on bonds is fully taxable. This means that only 50% of the gain on the sale of equities is included in AAII compared to 100% of the income earned on fixed income investments.
As an alternative, you could also consider investing excess funds in an exempt life insurance policy because investment income earned within an exempt life insurance policy is not included in AAII. To learn more, read our article, Tax Q&A: Using corporate-owned life insurance to accumulate wealth.
Finally, you may also consider setting up an individual pension plan (IPP). The new passive investment rules don’t apply to these plans, which makes them an attractive retirement savings option for business owners. To provide some background, an IPP is a defined benefit pension plan available to owners of incorporated businesses. Under an IPP, the benefits are set by reference to your salary, and contributions are made to build sufficient capital to fund a defined pension benefit. The contributions made by your company are tax deductible and the investments inside the plan grow on a tax-deferred basis. For eligible individuals, the use of an IPP can allow for greater contributions (which generally grow with age) when compared to a registered retirement savings plan (RRSP). Over time, the use of an IPP can produce substantial tax advantages over an RRSP. Additional benefits of an IPP include the ability to make up for poor investment performance and the possibility of higher retirement benefits.
Keep in mind that you should evaluate whether these plans make sense by also taking into account the non-tax considerations before changing your investment strategy.
3. Purchase depreciable assets before year end and claim the enhanced first-year capital cost allowance on eligible property
If you’re planning to purchase depreciable assets for use in your business in the near future, you should consider doing so before the end of your fiscal year. If such assets are acquired and in use before your fiscal year end, you can claim tax depreciation, or capital cost allowance (CCA), to reduce your business’s income in this fiscal year. Bear in mind that title to the asset must be acquired and the asset must be available for use in the current fiscal year in order to claim CCA this year.
For eligible property acquired after Nov. 20, 2018 and available for use before 2028, the new Accelerated Investment Incentive rules provide for enhanced first-year CCA. Specifically, if such property is available for use before 2024, it’s eligible for a higher rate of CCA. Manufacturing and processing machinery and equipment that falls into Class 53 and clean-energy equipment that falls into classes 43.1 or 43.2 are eligible for a full deduction in the year of acquisition. Other depreciable property is eligible for an increased first-year CCA deduction. Such property purchased after Nov. 20, 2018 and by Dec. 31, 2023, will be eligible for a CCA claim equal to three times the first year CCA that could be claimed if the acquisition had been made prior to Nov. 20, 2018. For more details, see our Tax Alert, Can Your Business Take Advantage of the Proposed Accelerated-depreciation Rules?
The 2019 federal budget introduced a new category of depreciable assets that applies to zero-emission vehicles. Generally, these vehicles must be new vehicles that are fully electric, fully powered by hydrogen, fully powered by a combination of electricity and hydrogen, or plug-in hybrids with a battery capacity of at least 15 kWh.
Purchases of certain zero-emission vehicles on or after March 19, 2019, that become available for use before 2028 are also eligible for enhanced first-year CCA. For eligible vehicles that would otherwise be included in classes 10, 10.1, or 16, and are available for use before 2024, the new rules allow for full write-off in the year of acquisition. Note that there will be a limit of $55,000 (plus sales taxes) on the amount of CCA deductible in respect of each zero-emission passenger vehicle. If you purchase a vehicle that’s eligible for the new federal purchase incentive for zero-emission vehicles (announced in the 2019 federal budget and administered by Transport Canada), you can’t also take advantage of this fast-CCA writeoff.
Accelerating the purchase of capital assets before the end of your fiscal year and claiming the enhanced first-year CCA on the eligible property will allow for faster tax write-off of these investments, provided that the assets will also be available for use prior to your fiscal year-end.
4. Consider delaying the sale of assets with accrued gains until after year-end
If you plan to sell capital assets with accrued gains, you should consider delaying the sale until 2020 (or the start of your business’ next fiscal year). This will allow your business to claim one additional year of CCA and will also postpone the inclusion of any recaptured CCA and capital gains in taxable income by one year. Note that this planning applies to depreciable property, real property that is a capital property, and investments.
5. Recognize the beneficial change to the Scientific Research & Experimental Development program
For federal tax purposes, a corporation can earn a non-refundable investment tax credit (ITC) at a basic rate of 15% on qualified Scientific Research and Experimental Development (SR&ED) expenditures. Since this ITC is non-refundable, it can only be applied to reduce income taxes payable. However, a CCPC may be entitled to earn a refundable ITC at an enhanced rate of 35% on qualified SR&ED expenditures, up to a maximum annual expenditure limit of $3 million. Prior to recent changes, the annual expenditure limit was phased out when taxable income in the previous tax year exceeded $500,000 and was eliminated when an income level of $800,000 was reached. (Taxable income is measured on an associated group basis for this purpose.) However, this taxable income restriction has been removed for taxation years that end on or after March 19, 2019, thereby making access to the enhanced federal ITC less restrictive. Note that there’s another restriction to claiming this enhanced SR&ED ITC. The $3 million expenditure limit is reduced when the taxable capital of an associated group exceeds $10 million and is fully eliminated when taxable capital reaches $50 million. This restriction continues to apply.
This change may affect your remuneration strategies if your company was bonusing taxable income to you to stay within the $500,000/$800,000 limits in order to be able to maximize high-rate refundable SR&ED ITC claims. There are many factors to consider in determining an appropriate owner-manager remuneration strategy, including whether the new passive income rules (discussed above) that restrict the SBD will be a concern if income is now retained in the CCPC. Your BDO advisor can help you to determine your remuneration strategy in light of this change.
If your CCPC was discouraged from participating in the SR&ED program due to the tightening of compliance requirements in recent years, with the removal of the taxable income restriction, now may be a good time to reconsider whether participation in SR&ED programs makes sense. Our Tax Alert, Federal Budget SR&ED Change Could Impact Your Tax Planning provides more details.
This article was written and published by BDO Canada. Baffilk Financial Consulting does not own this article, it has been shared for information and education purposes only.