Small to medium sized business owners and incorporated professionals are under attack in Canada on many fronts:
- Legal/Regulatory & Environmental compliance
- From Government & Anti-capitalist groups
- Pandemic lockdown/health arrest
It feels as though there has been this Shadow War on small to medium sized Business…Whether by covert or overt means. It really seems to be open warfare on independence and success.
The result is no less than an assault on your freedom, independence and financial legacy.
A recent salvo by the Federal Government was the 2018 budget:
Changes to the Passive Income taxation rules for Canadian-Controlled Private Corporations (“CCPCs”) introduced punitive tax measures that amount to Confiscatory Taxation.
The main points of attack were punitive change to the passive income rules and income splitting.
In the run-up to the budget, Ottawa’s Anti-Capitalist bias was totally exposed when they branded business owners as TAX CHEATS for just following the rules.
The whole thing started in 2004 when the Doctors in Ontario were looking for a pay raise. The Ontario Govt. said, “instead of fee increases, we will allow you to incorporate as a tax shelter,” which brought Ontario in line with the rest of Canada.
So they allowed funds to remain in professional corporations so they could save in a tax free environment for retirement and future cap/ex. This naturally led to passive income in the corporation.
Now, years later, the Federal Government has Broken the deal.
Ottawa took a look at all the funds sitting in corporations, and decided they wanted to tax those funds and have them circulated back into the economy. So, they said:
“You can take it out as either T4 Earnings, Dividends, or Bonus it out, however you will pay the same high rate of confiscatory tax…” under what is called “integration,”
“You can leave it sitting in your corporation; and potentially lose some or all of your small business deduction and pay even higher tax.”
They invoked the concept of “Integration,” which effectively means that whether you take T4 income, dividends or bonus-out your earnings, you will pay about the same amount of tax, so there is no comparative advantage.
On top of this, Ottawa has shut down “income sprinkling” or paying salary or dividends to family members.
Under new Tax on Split Income rules (TOSI) – family members that are not active in your business will be taxed at the top marginal rate on dividend payments.
They are limiting your alternatives and forcing you to make a decision. So you will likely need to take measures beyond the standard RRSP, Spousal RRSP, TSFAs and RESPs in response.
Part of the problem is that Accountants are often primarily focused on the now – occupied with immediate corporate and personal tax savings, preparing financial statements and tax returns and unable to do much proactive tax planning. And you are likely too busy running your business or practice to deal with these issues.
So, you can pay these funds out to yourself, and pay a lot of tax… or you can leave it in your corp. and pay even more tax!
You are being forced to do something or lose this equity.
So what to do to protect yourself? Well, proper planning & corporate structuring is needed.
Three Primary Strategies
There are 3 main strategies to address this situation that could end up deferring and saving you a meaningful amount of tax, so you don’t end up giving away your sweat equity and family wealth.
You may want to look at:
- Individual Pension Plans (IPPs) as a basic core strategy,
- Corporate Owned Life Insurance (COLI), as well as
- Retirement Compensation Arrangements (RCAs)
or some combination of these, along with other proper corporate structuring that might be appropriate, to avoid and/or defer tax.
1) Individual Pension Plans (IPPs)
IPPs – are private defined benefit pension plans, that are set up and registered with the federal government that allow tax deductible contributions to the plan.
The IPP is “the Teachers Pension Plan for Business Owners and Incorporated Professionals” – Including Doctors Lawyers, Dentists, Accountants etc.
The IPP resides with your corporation and allows you to put away significantly more for retirement than an RRSP on a tax deferred basis.
A major bonus is that past service may allow you to contribute a large initial amount of funds to the plan.
These funds are managed or invested in a number of possible vehicles within the plan.
The IPP strategy is now a main, go-to vehicle for tax deferred savings in your corporation.
An IPP may allow you to address the passive income situation and is great if you want:
- Tax deferral
- forced discipline of putting funds away, and
- a guaranteed outcome during retirement!
2) Corporate Owned Life Insurance (COLI),
The next strategy you might want to have a look at is Corporate Owned Life Insurance.
Corporate Owned Life Insurance:
- is one of the last remaining tax sheltered vehicles available
- has the benefit of both risk management and tax deferred investment
- allows corporate wealth to grow in a tax free environment… and you can access capital or pass it on to heirs.
So you might look at corporate owned Life Insurance as a savings/investment vehicle, which allows you to defer* the tax. (as long as you have an insurance need).
Since you’re likely not going to spend it but rather invest it…you might as well save the tax and invest it in a tax exempt insurance vehicle, where it can grow on a tax free basis.
These funds can be accessed once the policy has accumulated a significant cash value, as you can assign the policy as collateral for a third party line of credit and pay out to shareholders.
As well, remaining balances may eventually be paid out as a tax free benefit through your capital dividend account.
3) Retirement Compensation Arrangements (RCAs)
For higher earning business owners, an RCA might be worthwhile. And I will cover RCAs again in-depth at a future date.
I would emphasize that the Federal Government is forcing you to make a decision, so you should seek out professional advice on proper, prudent corporate structuring, tax, trust & estate planning, to see how these, and other possible strategies, might fit your situation.
E. & O. E.