|
Proposed Federal Tax Changes May Impact
How You Should Pay Yourself
Recent proposed tax changes, if
passed, will have a significant impact
on planning strategies related to the
retention or distribution of corporate
profits.
On November 14, 2005, Finance Minister
Ralph Goodale presented the
government’s economic and financial
update, or “mini-budget.” In the update,
the government proposed to reinstate
two tax measures that were announced
in the 2005 federal budget but which
failed to make the final budget legislation.
Both the 2 per cent corporate tax rate
reduction and the elimination of the
federal surtax were reintroduced in the
mini-budget. New measures announced
in the mini-budget include an acceleration
of the elimination of the federal capital
tax, a 1 per cent reduction in the personal
tax rate applicable to taxable income
under $115,739 and an increase to the
taxable income level at which the top
federal tax bracket of 29 per cent applies
($200,000).
On November 23, the government issued
a press release ending its consultations
on income trusts. As discussed in the Fall
2005 Business Adviser, the government
commenced the consultations in
September 2005 to deal with the risk of
federal revenue loss due to the increase
in the number of income trusts. As a
result of these consultations, the
government proposed to level the playing
field by making the tax paid on dividends
received by individuals from corporations
more comparable to the tax paid on
distributions from income trusts. This
will be achieved by eliminating the
element of double taxation that currently
exists when corporate profits that are
taxed at the high corporate tax rate are
distributed to individual shareholders. It
is important to note that comparability
will be obtained only if the provinces
follow suit and similarly reduce the
provincial personal tax rates on dividend
income. At the time of writing, not all
provinces had responded to the federal
proposal.
The tax changes are set to be phased in
at various dates commencing in 2005 and
ending in 2010. The changes to eliminate
the double taxation of dividends will apply
to dividends paid after 2005. The
corporate tax rate reductions, totalling
3.12 per cent, will not be in full effect until
2010. At this time the details related to
the taxation of dividends have not yet
been released and there are many
questions related to how the measure will
be implemented.
It is quite possible that the tax proposals
discussed will not be implemented given
the recent change in government.
However, should they be implemented,
the changes may create a shift in the
optimal salary/dividend mix for private
companies. Currently many Canadiancontrolled
private companies bonus out
corporate income in excess of $300,000
in order to avoid the double taxation that
occurs when corporate income that is
subject to tax at the top corporate rate is
distributed as dividends. This double
taxation used to range from 5 per cent to
13 per cent, depending on the provincial rate of taxation. Generally this bonus
strategy made sense if the earnings were
to be paid out to shareholders in a short
period of time.
The proposed changes may alter the
optimal salary/dividend mix, commencing
in 2006. Bonuses paid solely to reduce
corporate income to the small business
limit of $300,000 need to be rethought.
The ability to take advantage of the
corporate tax deferral may provide cash
flow benefits to corporations and their
shareholders.
Generally speaking, salary levels for 2006
should be established based on after-tax
cash flow requirements. At a minimum,
owner-managers should receive salary of
approximately $106,000 to help ensure
they maximize their RRSP and or RPP
contribution limits. Income requirements
in excess of this amount could be met
with either taxable dividends or bonuses.
In provinces that levy payroll taxes, such
as Ontario, it may make more sense to
distribute all income needs in excess of
$106,000 as dividends in an effort to
minimize payroll taxes payable.
The proposed tax changes, if passed,
will be a welcome change for private
companies. However, due to the
uncertainty related to their passage,
2006 planning should be kept as flexible
as possible.
|
