Administrative hurdles and hoops make it hard for business owners seeking exemptions
While most of the tax proposals advanced by the federal government last summer have been replaced or withdrawn, new rules that address income splitting have been put in force — and are creating a heavy compliance burden for small business owners, according to one tax expert.
“There are pages of new rules that tax dividends from family businesses, and more pages of exemptions from the rules,” said Allan Lanthier, a former chair of the Canadian Tax Foundation and a retired partner of Ernst and Young, in a column on the Financial Post. “There are definitions of ‘source individual’ and ‘specified individual’; of ‘related business’ and ‘excluded business’; of ‘reasonable return’ and ‘safe harbour capital return.’”
All that boils down to, Lanthier said, is that many family members will now have to persuade tax authorities that they’ve provided meaningful enough contributions to justify their receiving dividends without facing punitive taxes.
“Under these rules, if family members are over age 24 and have not worked an average of 20 hours a week in the business, they may have to prove that their contributions to the business are reasonable — in terms of work performed, property contributed, risks assumed and any other ‘relevant factors’ — all as compared with such contributions by their relatives,” he wrote.
Making a decision can be very difficult. He cited an example of a renovation business owned by a husband and wife. The husband works 40 hours a week in the business, while the wife works only 10. When the business started several years ago, the wife, along with her parents, guaranteed a loan that was needed to get it off the ground; it has since been repaid.
“How much [of a dividend] can be paid to [the husband and wife] without running afoul of the new rules?” Lanthier asked.
Aside from comparing their work contributions, arbitrators must put a value on the loan guaranteed by the wife, deciding whether the fact that it’s been repaid should offset its crucial role in starting the business — an exercise that Lanthier called “an absolute nightmare.”
He noted that the new rules do not apply to certain family members, provided (in part) that the company earns less than 90% of its income from a service business. “In fact, the tax authorities recently stated that over 75 per cent of Canadian small businesses are service providers,” he said. “In other words, the government enacted an exemption that most businesses can never access.”
In December, the Senate finance committee recommended that all the private corporation proposals to be withdrawn. Instead, it urged a comprehensive review of Canada’s tax system — something the country needs, Lanthier said, in light of new challenges from tariffs, trade, and increased US tax competitiveness.
“It is time for tax reform in Canada, and a good place to start would be the taxation of corporations and their shareholders,” he said.