January 2016 Newsletter

 On December 7, 2015, the Department of Finance released a Notice of Ways and Means Motion (NWMM) that contains many of the income tax measures proposed by the new Federal Liberal government. This then became Bill C-2, which received First Reading in Parliament on December 9.

Some of these measures were summarized in our December 2015 Letter. These and other measures are discussed below. Unless otherwise noted, all changes are effective as of January 1, 2016.

Certain spousal (or common-law partner) trusts and joint spousal (or common-law partner) trusts enjoy special tax treatment under the Income Tax Act. In most cases, property can be transferred into the trust on a tax-deferred basis, either during your lifetime, or upon your death (for a spousal trust). A spousal trust will have your spouse as beneficiary, and a joint spousal trust will have you and your spouse as beneficiaries (certain other conditions must be met).

As a typical example, you could set up a testamentary spousal trust under your will. On your death, property passing to the spousal trust would do so on a tax-free basis, without triggering capital gains (other property upon your death is normally subject to a deemed disposition at fair market value).

Overview

Often, when you transfer property to a non-arm’s length person such as a corporation that you control, you have a deemed disposition of the property for proceeds equal to the fair market value (FMV) of the property. Assuming the FMV exceeds the cost of the property, the transfer can trigger capital gains or ordinary income.

However, a special election under the Income Tax Act (a "section 85" election) allows you to transfer property on a tax-free or partially tax-free basis to a corporation if you receive at least one share of the corporation as consideration for the transfer. The election allows you to incorporate your business or investments on a tax-deferred basis.

A private corporation can elect to pay a “capital dividend” to its shareholder(s). The benefit of the election is that the dividend is not included in the shareholder’s income, assuming the shareholder is a Canadian resident (withholding tax will apply if the shareholder is non-resident). Public corporations cannot make the election.

In general terms, a capital dividend reflects certain amounts that are tax-free to the private corporation, and that should be allowed to pass tax-free to the shareholders. For example, one-half of net capital gains are not taxed and therefore form part of the capital dividend. More specifically, the capital dividend will reflect the corporation’s “capital dividend account” (CDA), which includes items such as:

Mini-storage business not eligible for small business deduction

The small business deduction reduces the federal tax rate for the first $500,000 of active business of a Canadian-controlled private corporation to 11% (for 2015). The rate is reduced further to 10.5% for 2016 and another 0.5% per year until 2019, when it will be 9%.

Active business income includes most business income, but it does not include a “specified investment business”, which is a business the principal purpose of which is to earn income from property (such as rent). An exception to the specified investment business rule applies if the corporation employs more than five full-time employees throughout the year.