On November 23, 2005, the Minister of Finance announced the reduction in the income tax rate on certain dividends paid after 2005. This announcement seemed like a simple straightforward adjustment to the tax rate, but its implications are far reaching. The main focus of the announcement was to "level the playing field" between income, trusts and corporations. However, the reduction in the tax rates will significantly affect those advisors who deal with owner/manager clients, as well.
It will also apply to dividends paid by CCPC's to the extent that the CCPC income is:
In the past, capital gains had a significantly lower tax rate than dividends. This changes the preference to dividends over capital gains.
It appears that CCPC's will have to determine whether dividends paid are from investment income, active business income at the small business rate, or high rate active business income. This will mean some kind of new tracking and ordering rules, adding significant complexity for CCPC's and their advisors. It is uncertain at this point whether the tax reduction will apply to dividends paid out of income earned pre-2006.
This change could mean the end of bonusing down to the small business deduction level. In the past, it made sense to bonus down so as to avoid any additional taxes over and above the highest marginal tax rate. This new regime will ensure that a company and its shareholders never pay more than the highest marginal tax rate.
Even though the announcement states that it will apply to dividends paid after 2005, there is no legislation to date. Until the legislation is released, there is significant uncertainty as to how these rules will be implemented. To add a little more uncertainty, there is a federal election which will certainly slow down the process. We must all wait and see what the actual rules will be.
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