The changes to the taxation of eligible dividends have changed the Canadian tax planning landscape dramatically. Old rules of thumb need to be re-examined carefully. One such example will be discussed in this tax tip.
Integration is a concept that is critical to Canadian taxation. Integration is when income earned by a corporation is taxed at the same combined corporate and personal rates as if the income had been earned directly by the individual. Prior to the introduction of these eligible dividend rules, active business income of a Canadian- controlled private corporation (CCPC) in excess of the small business limit was not integrated.
A separate Realty Co (“Realco”) was often set up for creditor-proofing reasons. Any rental payment made from the operating company to the Realco was deemed to be active business income to the Realco (assuming the companies were associated). If the aggregate taxable income of both companies was in excess of the small business limit, such excess income was subject to combined personal and corporate tax rate of approximately 50%-55% depending on the province.
A simple planning solution was to dis-associate these two companies for income tax purposes by having one spouse wholly own the Realco and the other spouse own the operating company. Due to the refundable taxes and dividend refund, the combined corporate and personal rate of tax is roughly the same rate as the highest marginal rate of personal tax. The operating company would be able to utilize fully the small business deduction.
The eligible dividend rules have changed this strategy completely. Planners now want the two companies to be associated. There are two advantages of such a structure. First, the income in excess of the small business limit would be taxed at a lower corporate tax rate in an associated company rather than in a related company. Second, the eligible dividends paid out of high rate income will result in a tax rate that is close to integration. This varies widely among the provinces. This could be done by having the same spouse wholly-own both corporations.
This is but one example where one may wish to associate companies because of the eligible dividend rules whereas in the past disassociation of the two companies would be preferred. Now more than ever consultation with a tax advisor is of paramount importance in the planning stage of any transaction.
TAX TIP OF THE WEEK is provided as a free service to clients and friends of the Tax Specialist Group member firms. The Tax Specialist Group is a national affiliation of firms who specialize in providing tax consulting services to other professionals, businesses and high net worth individuals on Canadian and international tax matters and tax disputes.