Tax expert explains how government is closing tax "loophole" around dividends
Business owners should clear their portfolio surplus by paying out dividends before the year end or miss out on the preferential tax recovery rate.
This year’s budget closed the “loophole” that allows private companies to pay out eligible dividends at a personal tax rate of 40%, with about 38% of that refundable.
From January 1, 2019, the only way you can recover that 38% is via an ineligible dividend, which will be subject to 46% personal tax, eventually set to increase to 49% in 2019. This means there will be about a 10% additional cost to do this going forward.
Eddy Burello, tax partner, MLP, said it was the Liberal government’s platform that private corporations and their owners were abusing the system but that private company owners had actually simply been “following the law”.
He said: “For people who had dual businesses, like dentists and doctors that had passive income as well as active businesses, this was a great planning opportunity.
“You could pay out an eligible dividend taxed personally at the lowest rate and yet recover almost the same, dollar for dollar, in the corporation so you are almost neutral.
“The government was well aware of this opportunity and have now changed the rules commencing January 1, 2019, technically for taxation years after 2018, but if people can make a mental note it’s 2019.”
He added: “So what we advised many of our clients, especially if they’ve found themselves in a co-mingled pool, earning passive income in their business, with active business, is they should really seriously be thinking about paying out dividends this year to recover the 38% tax that’s sitting in their corporation and only pay 40% personal tax.
“The cost to doing that is only 1-1.5% and that advantage will only remain until December 31.”
This relates to company’s Refundable Dividend Tax on Hand (RDTOH) and General Rate Income Pool (GRIP) and Burello said the planning opportunity brought about by the original legislation is closing up fast.
He said: “This anomaly was actually caused by the government, which is why I find it ironic that they closed the loophole. When this legislation first came in about eligible and ineligible dividends, what they failed to do in the original legislation was stream the income that gave rise to the eligible and ineligible dividends.
“In other words, if you earned active business income, the only type of dividend you should make from active business is an eligible dividend and if you’re earning passive income, the only type of dividend they should be able to pay is an ineligible dividend. That streaming never happened in the original legislation, which is why we had the anomaly and this budget corrects that problem.”