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This article is from the quarterly Canadian Overview, a newsletter produced by the Canadian member firms of Moore Stephens North America. These articles are meant to pursue our mission of being the best partner in your success by keeping you aware of the latest business news.
The rise of e-Commerce created QST collection difficulties for suppliers with no physical or significant presence in Quebec. This situation negatively affected Québec’s supplier competitiveness, and it’s shorting the provincial government necessary revenue. The policy response to this was the Mandatory Registration System (MRS).
About the MRS
In its 2018-2019 budget, the Quebec government introduced the MRS (also known as the “specified registration system”) for non-resident suppliers. The rules require non-resident suppliers to collect and remit the QST on taxable incorporeal movable property and services supplied in Québec to people who live in Québec but who are not registered for the QST. Moreover, Canadian suppliers will be required to collect and remit QST on corporeal movable property supplied in Québec to a Quebec consumer.
To establish residency and location, non-resident suppliers can refer to a customer’s billing address, IP address or banking information. And customers who falsify this information could face stiff penalties.
MRS and eCommerce
Digital property and services distribution platforms (“digital platforms”) are now required to register under the MRS in cases where the digital platform controls the key elements of transactions with specified Québec consumers (billing, transaction terms & conditions and delivery).
Mandatory registration will apply to non-resident suppliers (NRS) when the value of taxable goods and services exchanged in Québec exceeds $30,000 a year. As NRSs registered under the new MRS are not subject to other QST provisions, claiming an input tax reimbursement is not possible. However, an NRS can register under the general QST if it meets registration requirements.
The Québec government’s goal is the make the MRS simple and easy to use. The return must be filed electronically on a quarterly basis and the remittance can be paid in USD and EURO.
The MRS comes into effect on January 1, 2019, for non-resident suppliers outside Canada, and September 1, 2019, for non-resident suppliers located in Canada.
For more information about the MRS, what it means for your business and how it may or may not affect how you do business, book a consult with us and we’ll get you prepared for continued success in Québec.
Contributed by Benoit Vallée from Demers Beaulne. This piece was produced as a part of the quarterly Canadian Overview, a newsletter produced by the Canadian member firms of Moore Stephens North America.
On November 21, 2017 Segal GCSE LLP prepared an update on the tax proposals based on a series of news releases provided by the Liberal government. On December 13, 2017 the government finally provided new draft legislation for the dividend / income sprinkling rules. The purpose of this article is to provide an overview of the new proposed legislation.
These rules will all apply as of January 1, 2018. However, certain rules with regard to share ownership will apply as of December 31, 2018. This means that, in certain situations, there may be ownership planning steps to be undertaken between now and the end of 2018
The general principal is still that any adult family member that is inactive will pay the top rate of tax on split income (TOSI). Split Income includes the following sources:
Fortunately, the government has removed the proposal to apply TOSI to income on income – secondary income. As well, family will no longer include aunts, uncles, nieces and nephews in considering the source of the income.
The TOSI will not be applied to several new circumstances not previously addressed in the old proposals:
One of the key differences to the new proposals is that individuals within specific age ranges are treated differently:
There is a new rule that a shareholder can receive dividend income or incur a taxable capital gain, that would otherwise have been subject to TOSI, and the income or capital gain would be subject graduated tax rates if the shareholder’s spouse is 65 years or older and the shareholder’s spouse was an active shareholder in that corporation.
These rules appear to be aimed at critics who stated that it is unfair that a senior can split income on pensions but can’t receive dividend income from a corporation.
a. Income earned from a “related business” is subject to TOSI. Related business is generally defined to be a company where a related person owns 10% or more. Where the income is from a partnership, a related person need only be a partner. The percentage ownership or allocation of a partnership is not relevant.
b. Income earned from an “excluded business” is NOT subject to TOSI. An excluded business is defined to be a business where the individual taxpayer works on a “regular, continuous and substantial basis in the year” or for five previous years. The Department of Finance has given some guidance that this would mean working an average of 20 hours per week “during the portion of the year in which the business operates”. This means that if the family member works in the business in the year, then TOSI would not apply to dividends in that year. Moreover, if the family member worked in the business for any five previous years (doesn’t have to be consecutively), the family member will never be subject to TOSI on the income paid from that business. How a person would prove they worked 20 hours a week is unclear. For example, if a daughter worked full time in a business from ages 20 to 25 years old, she could receive dividends, for the rest of her life, and not be subject to TOSI.
c. There is a new concept called “safe harbor capital return”. This allows a child in the above age range, to lend funds to the company and earn a rate of return at the prescribed rate (currently 1%) that is not subject to TOSI. There are no rules as to the source of these funds. That is, a father could lend funds to a child (18-24 years old) to make this loan.
d. The last exclusion is what the proposed rules call “a reasonable return” having regard to “arm’s length capital” of the individual. This would allow an individual who has accumulated funds on their own to advance funds to the corporation and earn a reasonable return based on the following:
The funds advanced cannot be from a related party, cannot be borrowed and cannot be from income distributed by a company owned by family members. Though this is meant to be a relieving provision, there are very few circumstances where an 18-24 year-old has accumulated their own funds to lend to their parent’s corporation.
For those family members over 24 years old, the rules related to a “related business” and “excluded business”, noted above in the 18-24 age range, will also apply. That is, if there is income from a related business it is subject to TOSI. If there is income from an excluded business, there will not be TOSI.
For this age group there are two additional exclusions from TOSI:
Excluded shares are a new definition. They have nothing to do with excluded business, but they are part of the definition of excluded amount.
Excluded shares are defined as a corporation that is owned by the taxpayer where the following conditions are met:
If these two tests are met, the next test is whether the individual taxpayer owns 10% or more of the votes and 10% or more of the value of the company.
Lastly, 90% of the income of the corporation must NOT come from other related businesses. There are many issues in this definition.
It appears that the taxpayer must own these shares directly in order to fit into the exclusion. Therefore, to own these shares through a trust would not work. If the excluded share test is not met, TOSI could still be avoided through the excluded business test (discussed above) or reasonable return test (discussed below).
This ownership test (10% of votes and 10% of value) must be met by December 31, 2018 in order to apply for the full 2018 year and onwards. This provides time for taxpayers to change their ownership to give family members, who are older than 24, ownership of 10% of the votes and value. In those situations where a freeze has been done in the past, there could be challenges with transferring 10% of the value on a tax-free basis. Any transactions between parents and children are at fair market value. There are opportunities to transfer frozen shares to a spouse tax free. However, the attribution rules will attribute back any income or gains from the transfer unless the spouse pays fair market value for the shares. This would include an actual cash payment or a note payable with the prescribed interest rate whereby the interest is paid by January 30th after each year. Bottom line, it’s complicated and will only be available in very specific situations.
This is the second test. This test has nothing to do with the first test. That is, a family member can still receive income that is not subject to TOSI if this test is met. This is similar to the test noted above in that the amount paid to the individual that is reasonable having regard to the following factors relating to the relative contributions of the taxpayer.
One big difference from before is that this is no longer an arm’s length analysis. It is an analysis of the relative contribution of the individual. The problem is how does one determine an appropriate amount. It is all subjective (again). The government has added in “other factors” to be considered. At first blush, one would think that this allows taxpayers some leeway with regard to justifying contributions. However, this could be of advantage to CRA when they make their determination of a reasonable amount. That is, they could consider other factors that support their claim that the amount being paid is not reasonable.
Capital gains on the sale of shares or fishing properties that qualify for the Lifetime Capital Gains Exemption (LCGE) are not subject to TOSI. It is not dependent on claiming the LCGE, only that the LCGE could be claimed. In brief terms, the LCGE is available for shares of Canadian Controlled Private Corporations (CCPC) where 90% of the corporate assets are active Canadian business assets at the determination time and 50% of the assets were active Canadian business assets in the preceding 24 months before the determination time.
Where there are gains on shares that don’t qualify for the LCGE, the tax treatment depends on whether the vendor is over 17 years old or under 18 years old. Where the vendor, directly, or through a trust, is over 18 years old, the gain is subject to TOSI and taxed at the top rates. Where the vendor is under 18 years old, the gain is treated as dividend and subject to TOSI at the top rate. The dividend is 100% of the gain and not 50%.
Clearly, it becomes very important to ensure that shares in a CCPC qualify for the LCGE. This means ensuring that non business assets do not accumulate in the company.
In summary, the government has attempted to give a few more situations where TOSI won’t apply. Specifically, to seniors and family members who have worked in the business for a period of time. However, there are still very few situations where a family member would fit into one of the exclusions. The rules are still very complicated and open to subjective determinations. Determining a “reasonable return” will likely take many court cases until there is clearer guidance to both tax practitioners and taxpayers. This is the beginning of the process.
It is important that you speak to your Segal GCSE LLP advisor to determine how these rules affect you and if there are any planning opportunities or changes required in 2018.
The last few months have been a very tumultuous time for Canadian tax practitioners and taxpayers. Proposals were made by the federal Liberal government on July 18, 2017 that had some of the most significant changes to the taxation of Canadian private corporations since the early 1970’s.
The government promoted these changes as “tweaks”, however, as details emerged, they revealed themselves as fundamental changes to how income was taxed for private corporations. There was a dramatic and strong negative reaction to these proposals from tax practitioners, taxpayers and the business community. In response to the mounting concerns directed to Finance Minister Bill Morneau’s proposals, the government has since made pronouncements by news release that will adjust the original proposals.
The original proposals from July 18th, 2017 are summarized below with updates from the most recent news releases from the federal government including discussion of those that are still on the table. For clarity – there has been no new draft legislation since the July 18, 2017 proposals. There remains a great deal of uncertainty as to what the actual rules will be as of January 1, 2018.
The July 18 amendments can be summarized under the following headings:
In the initial proposals, there were rules that would eliminate the ability for family members to claim the capital gains exemption on shares of a private corporation where those family members were not active in the business. By way of news release, these proposed rules have been removed.
There were a number of rules that proposed to re-characterize capital gains into income. As well, they affected the ability to pay out a capital dividend account when assets were sold to a related corporation. Both of these proposed rules have been removed by way of news release.
These rules are some of the most detailed and far ranging rules that we have ever seen.
The goal of these rules is to tax family members at the highest marginal tax rate on dividends or income received from certain private corporations. In the past, dividends to minors were taxed at the highest tax rate. The new proposals are to tax family members up to 24 years old as well as all family members who have not worked in the business or contributed capital to the business.
These new rules propose a “reasonableness” test to determine if the amounts paid to the family members should be taxed at the highest tax rate or not. This concept is called tax on split income (“TOSI”).
If an individual is subject to the TOSI then that individual will pay tax at the highest marginal tax rate and will not be allowed any deductions against that income.
Previously, this tax was only applied to dividends, shareholder benefits, and certain partnership and trust income. The rules are now being expanded to include income from loans to certain corporations, partnerships and trusts and the disposition of shares in private corporations. Moreover, there is now a proposal to tax investment income earned on the initial income that was taxed at the highest tax rate. That is, if an individual earned $100 and was taxed at the highest tax rate and then invested that $100, the income earned on that investment would still be subject to the TOSI rules and be taxed at the highest marginal tax rate.
The notion of reasonability is being proposed to include all sources of income from the corporation to determine if the dividend income or interest income would be reasonable with regard to the entire remuneration. This obviously is very subjective and we have many concerns about how these rules would be applied.
In the draft legislation, these rules were to be effective January 1, 2018. As a result, we are suggesting that clients consider paying larger than usual dividends to any family member that is over 18 years old in order to maximize the funds available to the family members as of December 31, 2017. The actual amount of dividends should be determined in consultation with your Segal tax advisor.
In the past, an active business could accumulate funds after paying corporate tax and invest those funds in whatever manner decided upon by the shareholders. The new rules are proposing to set a limit on the amount of investment income that can be earned using active business income. At present, the government has proposed a $50,000 annual limit. It must be stressed, that there has been no draft legislation on this matter. As well, the government has indicated that they will table the draft legislation in their 2018 budget. The date of this is unknown.
The general concept is that the income on any assets owned before the rules come out would not be subject to these new rules. At this point, there is no clarity from the government on what the cutoff time will be. We are suggesting that clients maximize their retained earnings and assets as of December 31, 2017 to maximize the amount of investment income that can be earned on these assets in the future. This suggestion is in contradiction to the suggestion above of paying larger than normal dividends to family members. An analysis must be done to determine what the actual dividends should be and what the maximum amount of assets that should be retained in the corporation.
The details of how the income will be taxed are not available. The general idea is that if capital has been injected into the company from personal assets, then these rules would not apply. However, if the capital to invest in the business has been accumulated because the company or its subsidiaries engaged in an active business then these rules will apply.
The proposed rules would be that there is a tax of approximately 50% in the corporation and then full personal dividend tax upon payment out of the corporation. The difference between the proposed rules and the current rules is that under the current rules, the corporation would get a refund of a portion of the corporate taxes paid when dividends are paid. The net effect is that an individual taxpayer would be indifferent to earning investment income in a corporation versus personally. Each province has different tax rates and therefore there is not perfect integration. However, under the new rules the effective tax rate in Ontario, would go from 56% to 73% when considering the corporate and personal taxes.
Given the extremely high tax rate noted above, there has been a significant response to the government about changing these rules. However, there is currently no draft legislation and there is no effective date.
As of now we are waiting for the rules on dividend/income splitting in “the fall” from the government. The passive income rules may not be released until March or April 2018.
The federal and the Ontario government have both announced corporate tax rate reductions for small business corporations. The Ontario rate will decrease by 1%, effective January 1, 2018. The federal rate will decrease by 0.5% effective January 1, 2018 and by an additional 1% effective January 1, 2019. Although these tax cuts will benefit small business corporations, they will have a detrimental effect to the shareholders. To maintain integration, there will be a corresponding increase in the personal tax rates on dividend income. Consequently, individual shareholders receiving dividends after 2017 will be facing a higher personal tax rate.
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