In light of amended rules, Cindy David suggests allocating a portion of corporate investment assets to a permanent insurance plan for tax sheltering
Restricted access to small-business deductions affects retirement savings
The release of the 2018 budget in February saw the federal government introduce amended rules on how passive investment income for Canadian-controlled private corporations (CCPCs) would be taxed. And while they are an improvement over the punitive tax rates proposed a year prior, Ottawa’s scheme to restrict access to the small business deduction if the passive income of a corporation exceeds $50,000 is still a major blow to the business community, says Cindy David, president and estate planning adviseer for Cindy David Financial Group Ltd.
David says of the amended rules that will take effect next year: “Finance wants tax fairness between business owners and salaried employees. But that ignores the fact that business owners take risks in creating their businesses, as well as the inequality in the ability to fund their own retirement plans.”
She adds: “The government estimates less than three percent of the total businesses will be affected. While this is based on past tax returns, it doesn’t contemplate the many businesses that are only now approaching the threshold that will be affected. The worst blow is the loss of grandfathering for businesses that have already saved well for retirement. This is a move that clearly punishes those business owners who saved diligently under the old rules and I believe it is something worth fighting for.”
Under the amended rules, the amount of business income that qualifies for the combined small business tax rate of 12 percent will be reduced depending on how much annual passive income is declared above $50,000 — and eliminated completely once passive income rises above $150,000 (thus obliging a company to be taxed at the regular corporate tax rate of 27 percent). Assuming a five-percent return, $50,000 in passive income requires $1 million in investment assets, while $150,000 requires $3 million in assets.
The million-dollar question is: how can business owners best save for retirement in this new taxation landscape? David suggests the time to act is now. “If you’re newly incorporated, then just keep saving towards your first $1 million,” she says. “Also, take advantage of triggering capital gains within your investment portfolio for 2018 on existing investments and remove whatever income you can this year, in order to prepare for next year’s anticipated higher taxes.”
David acknowledges that business owners may be inclined to assume more aggressive financial behaviour to combat the new rules. “But you should stick to the integrity of your own risk tolerances. There are planning options that are widely accepted to avoid the passive-income rules, such as taking retained earnings and investing them in a permanent insurance plan, but the plan must be appropriate and suitable to your needs.”
David has a simple rule of thumb. “I target 30 percent of non-registered investments as an allocation to an insurance tax shelter,” she says, adding that “30 percent is enough to make a meaningful difference on your tax return, while leaving a majority of your funds available for shorter term use” since insurance is not like a bank account.
Many other issues about the new taxation that can impact retirement and succession planning must be considered by business people, but David says the key is not to panic. “Instead, seek sound advice for the long term from your professional advisory team.”
Disclaimer: Cindy David is the President of Cindy David Financial Group and Senior Estate Planning Advisor representing Raymond James Financial Planning Ltd. (RJFP). This article expresses the opinions of the author and not necessarily those of RJFP. It is for information purposes only. It is furnished on the basis and understanding that RJFP is to be under no liability whatsoever in respect thereof. It is provided as a general source of information and should not be construed as an offer or solicitation for the sale or purchase of any product. As with all planning strategies, you should seek the advice of a qualified tax advisor.