SAV-RBC Presentation- Tax on Split Income and Passive Income Rules V4FDIS

1. RBC Advice Event for Small RBC Advice Event for Small Business Owner Week Business Owner Week Recent Tax changes impacting small business owners Tax on Split Income and Tax impact of passive Income October 18, 2018 RBC – Royal Bank of Canada Yonge and Hollywood Branch 5001 Yonge Street, 2nd Floor North York, Ontario M2N 6P6 SAV Associates Chartered Professional Accountants

2. This material is for educational purposes only. As it deals with technical matters which have broad application, it is not practical to include all situations. As well, the course material and the references contained therein reflect laws and practices which are subject to change. For this reason a particular fact situation should be reviewed by a qualified professional. Disclaimer Although the course material carefully prepared, none of the persons involved in the preparation of the material accepts any legal responsibility for its contents or for any consequences arising from its use. has been

3. Presented by Sanjay Chadha CPA, CA, MBA 647 831 8322 sanjaychadha@savassociates.ca LET OUR EXPERIENCE AND COMMITMENT GET YOU THE VALUE YOU DESERVE CONFIDENTIAL -CONTENT OF THIS PRESENTATION IS NOT AN ADVICE ANDSHOULD TO BE USED FOR EDUCATIONAL PURPOSES ONLY

4. SAV Associates is a Toronto based Chartered Accountant firm serving the needs of Small Business Owners & Entrepreneurs in Toronto, North York and GTA (Greater Toronto Area). Tailor-made Services to Entrepreneurs and small businesses Remaining on the cutting edge of tax law, financial trends and regulatory changes We value efficient, honest service that achieves remarkable results. ACCOUNTING ASSURANCE TAXATION Our goal is to provide our clients with personalized solutions designed to meet their specific needs BUSINESS ADVISORY RISK ADVISORY We are supported by a team of professionals who are nationally and internationally certified and have wealth of experience and can provide true business consulting. CONFIDENTIAL -CONTENT OF THIS PRESENTATION IS NOT AN ADVICE ANDSHOULD TO BE USED FOR EDUCATIONAL PURPOSES ONLY

5. Agenda Passive Income and Small Businesses Tax on Split Income Confidential - Content of this presentation is not an advice and should to be used for educational purposes only

6. Tax on Split Income SAV Associates Charted Professional Accountants

7. Old Rules- Pre 2018 (widely known as Kiddie Tax) • Family members (Canadian resident) under 18 years of age. Had a parent residing in Canada during the year. • Purpose - Splitting income among family members of a Canadian owned corporation • Type of Income – Private company dividends, shareholder loan, partnership income run by a related person, income from Trust that is traced to one of the sources above • Intention – Tax planning arrangement to reducing overall tax paid to the CRA for Income tax purposes Tax on Split Income (TOSI) Result: Income was taxed at the highest marginal rate in recipient individual’s hand (in Ontario upto 53.5%) Confidential - Content of this presentation is not an advice and should to be used for educational purposes only

8. Scenario 1 Tax on Split Income (TOSI)- Old Rules Example One Person Corporation Profit: $100,000 Total Tax Liability: apx 35% Confidential - Content of this presentation is not an advice and should to be used for educational purposes only

9. Scenario 2 A One-Person Corporation Tax on Split Income (TOSI)- Old Rules Example Splitting Income among family members to reduce tax by paying dividend the family members The owner Spouse Child 1 – over 18years old Child 2 – under 18 years old Confidential - Content of this presentation is not an advice and should to be used for educational purposes only

10. Income splitting was accepted by Supreme Court of Canada in Neuman v Queen Decision Tax Rules limiting income splitting • Section 67 – Deduction from income must be reasonable. Current Legislative Limits in ITA – Income Splitting • Sections 56, 74.1 to 75.1 – Income attributed back to transferor. • Sections 15, 246 and subsection 56(2) – Tax benefit conferral • Section 74.4 – Imputes income where attribution done indirectly through corporations. • Sections 74.1 and 60.03 – explicit permission for seniors to split CPP and eligible pension income. • December 13, 2017 proposal significantly expands the scope of the TOSI rules. Confidential - Content of this presentation is not an advice and should to be used for educational purposes only

11. Tax on Split Income(TOSI) Decision Tree Flow Chart Confidential - Content of this presentation is not an advice and should to be used for educational purposes only

12. “specified individual” - Rules expanded to include Canadian resident family members (spouses, minor and adult children, parents and siblings) for split income purposes “related business” - For individuals 18 or over, rules only apply if an amount (i.e. dividend, capital gain or interest) is derived directly or indirectly from a “related business” Tax on Split Income(TOSI) - New Rules as of January 2018 “Source individual” is an individual who at any time in the year is resident in Canada and is related to the specified individual “Related” if individual is your mother, father, spouse, son, daughter, brother, and sister and any of the above as a result of marriage (e.g. son- in-law) For TOSI to apply (at a high level) - the business is operated by a corporation and the source individual owns at least 10% of the total fair market value of the corporation If there is no business, TOSI rules may not apply Confidential - Content of this presentation is not an advice and should to be used for educational purposes only

13. taxable dividends from corporations (non – listed) income derived directly or indirectly from a “related business” – (provided services / property or disposition of interest in business) Tax on Split Income(TOSI) - New Rules as of January 2018 income from the rental of property if a related person is actively engaged on a regular basis in the activities or owns an interest in the partnership or trust interest, if other amounts would be classified as TOSI income capital gains realized on properties the income from which is specified as TOSI income Confidential - Content of this presentation is not an advice and should to be used for educational purposes only

14. Tax on Split Income(TOSI) - New Rules as of January 2018 Section 120.4(2) “Split Income” ITA Where a specified individual earns split income, there will be a tax applied at the top marginal rate Split Income X Top Marginal Tax Rate Confidential - Content of this presentation is not an advice and should to be used for educational purposes only ey.com

15. Tax on Split Income(TOSI) - New Rules Example XYZ Corporation Inc Dividend paid to daughter: $100,000 Only Source of daughter’s Income (over 18years old) Daughter does not work in the business Under older rules: Apx $ 17,000 Under new rules: $ Highest Marginal rate Confidential - Content of this presentation is not an advice and should to be used for educational purposes only

16. Income is considered excluded if one or some of the following conditions are met: • Inheritance Exception (Under 25 years of age) – parent of an individual or any person if individual is full time student • Breakdown of relationship (Divorce) exception • Death exception – taxable capital gain arising as a result of death • Income from excluded business or not related business if 18 or older • Safe harbor capital return exception (between 18 to 24) – reasonable return on arm’s length capital • Reasonable return exception (over 24 years) – work performed, property contribution, risk assumed etc. • Unlimited Income Splitting allowed if Individual with a contributing spouse age 65 or over in the present year OR has died should to be used for educational purposes only Excluded Amounts = No TOSI Confidential - Content of this presentation is not an advice and

17. No TOSI - if business is excluded business and individual is 18 or older Income from Excluded Business = No TOSI • for all amounts other than capital gains, individual must be actively engaged (average 20 hours per week), on a regular, continuous and substantial basis in the year or any 5 previous years • for capital gains, in any 5 previous years – if business sold after 3 years, in business – “Tricky” - may be challenged Confidential - Content of this presentation is not an advice and should to be used for educational purposes only

18. No TOSI - if 24 or older before the year and shares are excluded shares • less than 90% of business income is from services (business income); • corporation is not a professional corporation (accountant, dentist, lawyer, medical doctor, veterinarian or chiropractor); • individual owns 10% or more of votes and value of corporation; and • income of the corporation not derived directly or indirectly from another related business – Probably to prevent business being split into two businesses and letting specified individual own shares in non-service business Income from Excluded Shares = No TOSI For 2018 only, 10% votes and value must be met either before the relevant time or by the end of 2018 Confidential - Content of this presentation is not an advice and should to be used for educational purposes only

19. Possible Consideration to avoid TOSI • Salaries • Consider Capital Gain Exemption crystallizations • Convert professional corporation to a regular CCPC if it is no longer active • Restructure to fit within “excluded shares” definition • TOSI vs Income Attribution (unreasonable salary) • More option when entrepreneur turns 65 Confidential - Content of this presentation is not an advice and should to be used for educational purposes only

20. Passive Investment Income and Its Impact on Small Business Tax Presented by Sanjay Chadha SAV Associates Reduction Charted Professional Accountant

21. Purpose - • To remove perceived advantage of corporations’ ability to invest in passive investment using earnings that were subject to corporate tax rates (as opposed to having to invest with earnings subject to the much higher personal income tax rate). In 2018, tax on small business income at 10 percent federally To be reduced to 9 percent in 2019 Grind on Small Businesses Limit Small business limit $500,000 federally and in most provinces (provided capital employed is less than 10 Million) • Therefore, to promote fairness and neutrality, under the new regime, earning passive income through a corporation or personally should yield the same after- tax return. Under the Proposals, the small business limit will be reduced by $5 for every $1 of investment income above a $50,000 threshold Therefore, the Small Business Deduction Rules (SBD) will be eliminated when investment income reaches $150,000 • Targets private corporations only. Confidential - Content of this presentation is not an advice and should to be used for educational purposes only

22. CRA Rules on Passive Income for Small Businesses The Small Business Deduction Rules (SBD) reduces the corporate income tax that a corporation would otherwise have to pay in a taxation year throughout which it was a Canadian-controlled private corporation (CCPC). A corporation’s SBD for a taxation year is generally calculated by multiplying its SBD rate by the lesser of its: income for the year from an active business carried on in Canada, excluding certain income and exceeding certain losses; taxable income for the year (including associated corporations) business limit for the year (To be tested every year) Confidential - Content of this presentation is not an advice and should to be used for educational purposes only

23. Calculating CCPC’s Passive Business Limit Reduction • A CCPC’s passive income business limit reduction for a particular taxation year will be the amount determined by the formula: • BL/$500,000 x 5 (AAII - $50,000) • where • BL is the CCPC’s business limit otherwise determined for the particular year (i.e., its business limit as described above); and • AAII is the total of all amounts each of which is the adjusted aggregate investment income of the CCPC, or of any corporations with which it is associated at any time in the particular year, for each of their taxation years that ended in the preceding calendar year. • The clawback limit pertains to the amount of investment income, and not on the amount of small business income in the corporation. https://www.canada.ca/en/revenue-agency/programs/about-canada-revenue-agency-cra/federal-government-budgets/budget-2018-equality- growth-strong-middle-class/passive-investment-income/small-business-deduction-rules.html Confidential - Content of this presentation is not an advice and should to be used for educational purposes only

24. Example ABC Company is a CCPC having a December 31, 2020, taxation year end, and is not associated with any other corporations in the year. ABC Company’s adjusted aggregate investment income for its December 31, 2019, taxation year was $75,000. Calculating CCPC’s Passive Business Limit Reduction ABC Company’s passive income business limit reduction for its 2020 taxation year is determined as follows:= $500,000/$500,000 x 5($75,000 - $50,000)= 1 x 5($25,000)=$125,000 If a corporation has $150,000 of business income and $75,000 of investment income, the clawback will be 5 x ($75,000-$50,000), or $125,000. This will reduce the small business limit to $375,000. Since the corporation has only $150,000 of small business income, it will be fully eligible for the small business deduction. Consequently, ABC Company’s business limit for its December 31, 2020, taxation year will be reduced from $500,000 to $375,000 (i.e., $500,000 - $125,000) Confidential - Content of this presentation is not an advice and should to be used for educational purposes only

25. Same facts as Example 1 in last slide, except that ABC Company is associated with XYZ Company, which had $55,000 of adjusted aggregate investment income in its December 31, 2019, taxation year. The entire business limit for the 2020 taxation year was allocated to ABC Company. Example 2 Calculating CCPC’s Passive Business Limit Reduction ABC Company’s passive income business limit reduction for its 2020 taxation year is determined as follows:= $500,000/$500,000 x 5(($75,000+$55,000) - $50,000)= 1 x 5($80,000)=$400,000 Consequently, ABC Company’s business limit for its December 31, 2020, taxation year will be reduced from $500,000 to $100,000 (i.e., $500,000 - $400,000). Confidential - Content of this presentation is not an advice and should to be used for educational purposes only

26. Investment Income measured by Adjusted Aggregate Investment Income Capital gains (and losses) on disposition of property Non active rental income Income earned from savings in a non-exempt life insurance policy Dividend, capital gains and interest received from an investment Excludes: Capital gains - on property used in an active business; disposition of shares to connected CCPC; NCL C/F from other years and Dividends from connected corporations Confidential - Content of this presentation is not an advice and should to be used for educational purposes only

27. 2018 Corporate Income Tax Rates for Active Business Income ey.com Confidential - Content of this presentation is not an advice and should to be used for educational purposes only

28. Q&A HULLMARK CENTRE AT YONGE AND SHEPPARD 3M-4773 YONGE STREET, TORONTO, ON, M2N 0G2 TEL: 647.831.8322 416.822.8570 EMAIL: INFO@SAVASSOCIATES.CA THANK YOU CONFIDENTIAL -CONTENT OF THIS PRESENTATION IS NOT AN ADVICE ANDSHOULD TO BE USED FOR EDUCATIONAL PURPOSES ONLY