Owner-Managers Final 2016 Dividend Tax Savings

Transcription

1 Owner-Managers Final 2016 Dividend Tax Savings December 13, 2016 No If you are a corporate business owner or an individual with an investment portfolio held in a corporation, you should consider the impact of the integration mechanism on your tax planning for the year. You may have opportunities to defer tax or even save tax for 2016, depending on your province, but you ll need to act quickly. The integration mechanism is intended to ensure that income earned in a corporation and distributed to a shareholder as a dividend should attract the same amount of net income tax, both corporate and personal, as if the income was earned directly by an individual taxed at the top personal rate. However, this mechanism does not always work perfectly in every province. Differences in the effective tax rates can create the possibility of tax savings or costs, depending on the province, for earning income in a corporation rather than earning it directly as an individual. What s changed for 2016? While there has been a 4% effective increase in the top personal income tax rate for 2016, changes in provincial and corporate tax rates this year have ensured that overall the integration mechanism for 2016 has remained largely intact. However, depending on your province of residence, there may still be tax benefits resulting from integration. For example, corporate business owners have significant tax deferral opportunities for active business income earned and retained in a corporation for all provinces, due to overall higher 2016 combined personal top marginal tax rates. This deferral is even greater for income subject to the small business rate. Page 1 of 10

2 However, on a full distributed basis, no tax benefit arises from paying either eligible or noneligible dividends from a corporation in 2016 (except a slight tax benefit from non-eligible dividends paid from income subject to the small business tax rate in Saskatchewan and Newfoundland). If you are an individual with an investment portfolio in a corporation, a tax benefit exists in six out of ten provinces (British Columbia, Alberta, Saskatchewan, Manitoba, New Brunswick and Prince Edward Island) for paying out eligible dividends in 2016 to recover refundable dividend tax on hand (RDTOH). No tax benefit arises from paying non-eligible dividends to recover RDTOH in any province in Based on the current income tax rates for 2017, a benefit arises from paying eligible dividends in 2016 versus 2017 only in Newfoundland and from paying non-eligible dividends only in Alberta, New Brunswick and Newfoundland. A slight benefit arises from deferring the payment of an eligible dividend in New Brunswick to In the remaining provinces, no tax benefit exists for paying eligible or non-eligible dividends in 2016 versus You should review any inter-corporate dividends paid through corporations to generate cash for dividend payments to owner-managers to ensure that new anti-avoidance rules do not apply. These rules can recharacterize certain tax-free inter-corporate dividends as capital gains subject to tax. Year-end tax planning opportunities for 2016 If you have an incorporated business or you have incorporated your investments, the following sections of this TaxNewsFlash-Canada take a more detailed look at tax planning ideas that may be available for you in 2016 as you evaluate your year-end planning. For more year-end tax planning ideas, see the following editions of KPMG s TaxNewsFlash-Canada: Owner-Managers Tax Planning Tips for 2016, 2016 Year-End Personal Tax Planning Tips and Making the Most of Your Charitable Gifts for Background Concept of integration The Canadian tax system is designed so that income earned in a corporation and distributed to a shareholder as a dividend should attract the same amount of net income tax, both corporate and personal, as if the income was earned directly by an individual taxed at the top personal rate. As a result, individuals should be indifferent (from an income tax perspective) as to how they decide to organize their business and investment activities. However, this tax concept, known as integration, does not always work perfectly in every province. Differences in the effective tax rates can create the possibility of tax Page 2 of 10

3 savings or costs, depending on the province, for earning income in a corporation rather than earning it directly as an individual. When investment income (interest, dividends, rents, royalties and capital gains) is earned by a Canadian Controlled Private Corporation (CCPC), integration is achieved with a federal refundable tax mechanism. The additional refundable tax paid by a CCPC on its investment income accumulates in a CCPC s RDTOH balance. This amount is refunded to the corporation when it ultimately pays out a taxable dividend to an individual. Dividends paid by a CCPC may be designated as eligible dividends to the extent of the balance in the corporation s general rate income pool (GRIP) at the end of its taxation year in which the dividend has been paid. Generally, GRIP is the accumulation of taxable income that did not benefit from preferential tax treatment such as the small business deduction (i.e., the small business tax rate) and the RDTOH afforded to investment income. Eligible dividends received from public and private companies will also retain their character and form part of the dividend recipient s GRIP balance. Eligible dividends are taxed more favourably to an individual than regular non-eligible dividends. A corporation s capital dividend account ensures that the tax-free half of a capital gain earned by a corporation is preserved so that it can be paid out tax-free to shareholders, provided timely tax elections are made and other legal requirements are met. Federal tax changes in 2016 affect integration results You and your business may be affected by two major federal tax changes for 2016: the 4% hike in the top personal marginal tax rate to 33% (from 29%), and a freezing of the federal low corporate income tax rate for small businesses at 10.5% for 2016 and subsequent years. These measures also triggered significant changes to the federal integration mechanism and surplus factors affecting corporations (e.g., refundable tax on investment income, RDTOH, dividend refund percentage, and the Part IV tax rate). Several of the provinces also changed their tax rates. However, the result of these changes is that integration has remained largely intact. Although integration is generally functioning as intended for 2016, some imperfections in this mechanism may present some planning opportunities. These integration results and analysis assume you are paying tax at the highest marginal personal tax rate on income that is earned and taxed in one province, and that shareholders are resident and taxed in Page 3 of 10

4 that same province in that same year (i.e., corporate earnings are distributed in the same year as earned). Although these tips may be helpful as you finalize year-end planning, they should be considered all year round as well. Tax deferral opportunities for active business income and small business earnings Business owners may benefit from the tax deferral opportunity that exists when active business income of a corporation remains invested in the corporation. The active business income retained in a corporation will not attract personal tax until it is ultimately withdrawn as salary or dividends by the shareholder. The value of this personal tax deferral opportunity depends on how long the active business income can remain invested in the corporation. Small business tax rate and general corporate tax rate What s the difference? The federal government applies a lower corporate income tax rate to the first $500,000 of active business income of a CCPC, provided that the taxable capital of the corporation and associated corporations does not exceed $10 million. This is commonly referred to as the small business tax rate. For corporations and associated corporations with taxable capital between $10 million and $15 million, the active business income eligible for the small business tax rate is reduced proportionately and is eliminated completely once the taxable capital of all the associated corporations exceeds $15 million. Corporations must be resident in Canada and not controlled in any manner by any combination of non-residents or public corporations in order to be considered CCPCs. For 2016, all provinces also have reduced income tax rates for the first $350,000- $500,000 of small business income. The combined federal and provincial small business tax rates range from about 10.5% to 18.5%, depending on the province. Active business income above the $500,000 federal small business threshold is taxed at the higher general corporate tax rate. Active business income above the provincial small business income threshold is similarly taxed at a higher rate. The combined federal and provincial income tax rates on income in excess of the small business threshold range from about 26% to 31%, depending on the province. Increases to both the top federal personal tax rates and to some provincial personal tax rates for 2016 have increased the combined federal and provincial top personal marginal tax rates. As a result, in all of the provinces, significant tax deferral opportunities arise in 2016 when active business income is retained in a corporation. Page 4 of 10

5 For active business income subject to the small business tax rate, tax deferral opportunities range from a low of 34.5% in Alberta to a high of 40.5% in Nova Scotia, as illustrated in Table 1 below. In the case of active business income subject to the general corporate tax rate, the tax deferral opportunity in 2016 ranges from a low of 19.8% in Newfoundland to a high of 27% in Ontario, as illustrated in Table 1 below. Table Tax Deferral Available for Active Business Income Retained in a Corporation Income Taxed at Income Taxed at Small Business Rate General Rate British Columbia 34.7% 21.7% Alberta 34.5% 21.0% Saskatchewan 35.5% 21.0% Manitoba 39.9% 23.4% Ontario 38.5% 27.0% Quebec 34.8% 26.4% New Brunswick 39.3% 24.3% Nova Scotia 40.5% 23.0% Prince Edward Island 36.4% 20.4% Newfoundland 36.3% 19.8% Tax savings (cost) of incorporated active business income Keep in mind, however, that an ultimate tax cost generally arises for retaining active business income in a corporation and distributing it later as either an eligible dividend from income taxed at the general rate or a non-eligible dividend from income taxed at the small business rate, as shown in Table 2 below. Page 5 of 10

6 Table Tax Savings (Cost) When Distributing Active Business Income Out of a Corporation Income Taxed at Small Business Rate (Non-eligible Dividend) Income Taxed at General Rate (Eligible Dividend) British Columbia (0.6%) (1.5%) Alberta (0.3%) (2.2%) Saskatchewan 0.6% (1.1%) Manitoba (1.0%) (4.2%) Ontario 0.0% (1.9%) Quebec (0.9%) (2.7%) New Brunswick (0.1%) 0.0% Nova Scotia (0.1%) (5.7%) Prince Edward Island (0.9%) (3.2%) Newfoundland 0.1% (8.6%) A slight tax savings opportunity exists in Saskatchewan and Newfoundland in 2016 on active business income eligible for the small business tax rate that is earned through a corporation (0.6% in Saskatchewan and 0.1% in Newfoundland) and distributed as a noneligible dividend. In the other eight provinces, a tax cost of up to 1.0% arises when earning active business income subject to the small business tax rate through a corporation, as illustrated in Table 2 above. Generally, due to the overall tax cost of paying taxable dividends from active business income subject to tax at the general rate, no tax benefit arises from paying eligible dividends from a corporation in In fact, a tax cost of up to 8.6% arises in Newfoundland. That being said, the tax deferral opportunities as illustrated in Table 1 are significant and the reinvestment of these deferred amounts in the business operations in 2016 can outweigh the realization of the ultimate tax cost in the future. Business owners will also need to consider many non-tax factors when analyzing tax deferral opportunities in their particular situation. As an owner-manager, you need to determine both your personal cash flow needs required to maintain your personal standard of living and also your retirement objectives to ascertain the amount of active business income that your corporation can realistically retain. For example, to contribute to the Canada Pension Plan or to an RRSP, you must have earned income such as a salary paid from a corporation. To contribute the maximum amount to the Canada Pension Plan in Page 6 of 10

7 2016, you must earn a salary of at least $54,900. To make the maximum possible RRSP contribution of $26,010 in 2017, an earned income of $144,500 is required for Payroll costs and eligibility for scientific research and experimental development incentives may also be factors in determining whether a corporation pays a bonus to the ownermanager or retains the income to be paid out as a dividend in the future. Business owners should also consider the potential negative impact of having excess cash in the corporation because it may prevent the corporation from being a qualified small business corporation for purposes of the lifetime capital gains exemption. Tax deferral opportunities for investment income Investment income of a CCPC is taxed at a higher rate than active business income. The combined federal and provincial rates for this income range from 49.7% to 54.7%, depending on an individual s province of residence. Generally, this higher investment income tax rate significantly reduces any deferral opportunities for investment income as compared to active business income. Tax deferral opportunities for investment income exist in three provinces in 2016 for income retained and reinvested in a corporation, as illustrated in Table 3 below. In Ontario the deferral is 3.4%, in Quebec it is 2.7%, and in New Brunswick, taxpayers can defer a modest 0.6% on investment income earned by a corporation. In these three provinces, a tax deferral opportunity also exists for capital gains earned by a CCPC and retained in the corporation. In the other seven provinces, a tax prepayment cost arises when earning investment income through a corporation. This prepayment cost ranges from a low of 0.3% in Manitoba to a high of 3.9% in Newfoundland, as shown in Table 3 below. Page 7 of 10

8 Table Tax Deferral (Pre-payment) When Retaining Investment Income and Capital Gains in a Corporation Investment Income Capital Gains British Columbia (2.0%) (0.9%) Alberta (2.7%) (1.3%) Saskatchewan (2.7%) (1.3%) Manitoba (0.3%) (0.1%) Ontario 3.4% 1.7% Quebec 2.7% 1.4% New Brunswick 0.6% 0.4% Nova Scotia (0.7%) (0.3%) Prince Edward Island (3.3%) (1.6%) Newfoundland (3.9%) (1.9%) Pay eligible dividends to recover RDTOH In 2016, if a CCPC has both GRIP because it has paid tax at the general corporate rate on business income and RDTOH related to its investment income, a tax benefit exists in six out of ten provinces (British Columbia, Alberta, Saskatchewan, Manitoba, New Brunswick and Prince Edward Island) to paying out eligible dividends to recover this RDTOH, as illustrated in Table 4 below. This benefit exists because, in these provinces, the personal tax rate on eligible dividends is lower than the 38.33% dividend refund rate that the corporation will receive. This benefit ranges from a low of 0.6% in Manitoba to a high of 8% in Saskatchewan. There is no advantage to paying eligible dividends in the remaining four provinces (Ontario, Quebec, Nova Scotia and Newfoundland) because the personal tax rate on eligible dividends is higher than the 38.33% dividend refund rate in those provinces. No benefit to paying non-eligible dividends to recover RDTOH In 2016, no tax benefit arises from paying non-eligible dividends to recover RDTOH in any province (see Table 4 below) because the combined top marginal individual tax rate on non-eligible dividends in all provinces is more than the 38.33% dividend refund rate received by the corporation. Page 8 of 10

9 Table Tax Benefit (Cost) When Paying Dividends to Recover RDTOH Eligible Dividends Non-Eligible Dividends British Columbia 7.0% (2.3%) Alberta 6.6% (1.9%) Saskatchewan 8.0% (1.6%) Manitoba 0.6% (7.4%) Ontario (1.0%) (7.0%) Quebec (1.5%) (5.5%) New Brunswick 4.1% (7.5%) Nova Scotia (3.3%) (8.6%) Prince Edward Island 4.1% (5.5%) Newfoundland (2.2%) (3.5%) Paying dividends in 2016 versus 2017 The 2017 combined top marginal tax rates for eligible dividends will decrease to 33.51% (from 34.20%) in New Brunswick and increase to 42.61% (from 40.54%) in Newfoundland. In all other provinces, the 2017 top tax marginal tax rates for eligible dividends will remain unchanged from The 2017 combined top marginal tax rates for non-eligible dividends will increase to 41.24% (from 40.24%) in Alberta, to 45.96% (from 45.81%) in New Brunswick and to 43.62% (from 41.86%) in Newfoundland. In all other provinces, the 2017 top tax marginal tax rates for non-eligible dividends will remain unchanged from Based on the current income tax rates for 2017, a benefit exists for paying eligible dividends in 2016 only in Newfoundland and for paying non-eligible dividends in Alberta, New Brunswick and Newfoundland. A slight benefit arises from deferring the payment of an eligible dividend in New Brunswick to In the remaining provinces, there is currently no tax benefit to paying eligible or non-eligible dividends in 2016 versus Paying inter-corporate dividends Important reminder If inter-corporate dividends will be paid through a corporate group to provide cash flow to pay dividends to an individual, remember that you should review the change to the antiavoidance rule that re-characterizes certain tax-free inter-corporate dividends as capital gains subject to tax (also known as subsection 55(2) changes). The new rules significantly broaden the circumstances in which the anti-avoidance rule can apply. Despite the CRA s latest guidance, it is still unclear how the expanded rule may Page 9 of 10

10 apply to dividends received by corporations in many common circumstances, including where cash or other assets are moved within a corporate group. As a result, if cash is being moved up a corporate group by way of inter-corporate dividends, you should consider calculating safe income before paying a dividend to determine whether the dividend qualifies for the exception to the anti-avoidance rule for dividends paid out of safe income. For details, see KPMG s TaxNewsFlash-Canada , Paying Inter-Corporate Dividends? Proceed with Caution. We can help General rules of thumb no longer apply when it comes to corporate and personal tax planning for business owners and investors. Your KPMG adviser can help you assess your specific corporate and personal financial needs, and point out the alternatives available to help you reach your objectives. For details on these or other tax planning ideas, contact your KPMG adviser. kpmg.ca Contact Us KPMG in Canada Privacy Policy KPMG On-Line Privacy Policy Legal Information is current to December 12, The information contained in this TaxNewsFlash-Canada is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity. All rights reserved. The KPMG name and logo are registered trademarks or trademarks of KPMG International. Page 10 of 10