To Sprinkle or Not to Sprinkle? The End-of-2017 Question

This article was originally published on the Canadian Tax Foundation site and is reproduced with permission.

The effective date of the income-sprinkling proposals—January 1, 2018—is fast approaching, and many small business owners will want to take steps to mitigate the impact of these proposals before the end of 2017. Specifically, many may consider paying larger than usual dividends to family members in 2017 in order to maximize the benefit of income sprinkling without having to contend with the reasonableness test. While this idea certainly has merit, other factors could limit the effectiveness of such a plan. Those factors remain relevant following the changes announced from October 16 to October 19, 2017.

Assume that a family member is actively involved in the business. The family member will be able to continue receiving dividends in 2018 and later years to the extent that the amount he or she receives is "reasonable." It is important to note that the reasonableness test does not reset in each taxation year, but rather looks at all historical contributions by the family member, as well as all consideration that was previously paid to him or her. Therefore, if an excess dividend is paid in 2017, it may impair the ability to pay a dividend to that family member in 2018 and later years.

It is also important to consider the interaction between the income-sprinkling and passive-income proposals. While the matter is not certain, the government has stated that it will endeavour to grandfather existing pools of passive assets: it has said that any passive assets that exist at the transition date, as well as future income earned on those assets, will not be subject to the passive-income proposals. It is therefore in the best interest of taxpayers to accumulate the largest pool of passive assets possible prior to the implementation of these proposals in order to maximize the future earnings that will not be subject to them.

Thus, for corporations that have passive assets, there are opposing goals in planning for these two proposals. To mitigate the impact of the income-sprinkling proposals, it benefits taxpayers to distribute additional funds in 2017; to mitigate the impact of the passive-income proposals, it benefits taxpayers to keep assets in the corporation so that they are subject to grandfathering. These opposing goals must be weighed against each other to determine the optimal course of action for each taxpayer.

Passive income generated from new assets acquired after the transition date will not be subject to the proposals to the extent that it does not exceed $50,000. Thus, if the corporation is expected to stay below this threshold far into the future, having the maximum pool of passive assets on the transition date may not be a concern.

Contact Nick Korhonen, Senior Manager, Tax Services, at 613.691.4245 or [email protected]

The online article can be read here.