Legal Updates

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Update

Thursday, January 14, 2016

The federal Liberal government has followed through on its previously promised changes to federal income tax rates. Effective January 1, 2016, there is a tax cut for individuals in the second-lowest tax bracket and an increase in the tax rate for those earning more than $200,000 of taxable income per year. There has also been a corresponding increase to the tax rate on investment income and Canadian source dividends earned by Canadian-controlled private corporations (“CCPCs”). The resulting proposed amendments to the Income Tax Act (Canada) (the “ITA”) also include a reduction in the Tax Free Savings Account (“TFSA”) annual contribution limit.

Personal Tax Rates

For 2016, the top marginal federal income tax rate increases from 29% to 33% for taxable income over $200,000. The tax rate for taxable income between $45,282 and $90,563 is reduced from 22% to 20.5%. The new 20.5% rate results in a maximum 2016 tax benefit of $679 for an individual.

The maximum tax rates for Ontario residents in 2016 are as follows:

  1. 53.53% for regular income;
  2. 26.76% for capital gains;
  3. 39.34% for “eligible dividends” (for example dividends from public Canadian corporations); and
  4. 45.5% for other dividends from Canadian corporations.

Federal Donation Tax Credit

The tax credit for donations increases to 33% to the extent the donor’s taxable income exceeds $200,000. The following is an example of how the rules will work:

Assume an individual whose taxable income in 2016 is $240,000 makes $60,000 in charitable donations. The 15% rate on the first $200 of donations will remain the same. The 33% rate will apply to $40,000, being the amount of the individual’s taxable income over $200,000. The 29% rate still applies to the remaining $19,800 of donations.

Trust Tax Rate

As a result of the increase in the top marginal income tax rate, federal income tax payable by all trusts and estates, except “graduated rate estates” and “qualified disability trusts” (as such terms are defined in the ITA), increases from 29% to 33%.

Income Splitting (Kiddie Tax)

The “kiddie tax” applies on certain types of income (“split income”) received by a non-arm’s length minor. Federal income tax on such split income for 2016 has correspondingly been increased from 29% to 33%. 

Tax Free Savings Accounts

The amendments enacted by the current Liberal government include a reduction of the annual TFSA contribution limit from $10,000 to $5,500, which will be indexed for inflation. As a result, the annual TFSA contribution limit for 2016 is $5,500. Since this change applies on a going forward basis, it will not affect an individual’s cumulative contribution limit that resulted from the increase to $10,000 in 2015.

Changes in Taxation of Canadian Controlled Private Corporations

Corresponding to the increase in the top marginal tax rate, the tax rate for a CCPC’s investment income also has increased. These rules apply to CCPCs whose taxation year ends in 2016. The increases are prorated for taxation years that include days in 2015 and 2016. The tax rate for investment income earned by a CCPC, such as interest, foreign dividends, rent and taxable capital gains, increases from 46.2% to 50.2% for CCPCs taxed solely in Ontario. The tax rate for CCPCs on Canadian source dividends increases from 33.33% to 38.33%.

CCPCs are required to include in a refundable tax account a percentage of their investment income to provide for what the government refers to as integration. The addition to the refundable tax account increases from 26.67% to 30.67% for investment income and from 33.33% to 38.33% for Canadian source dividends. The refundable portion of both investment income and Canadian source dividends is triggered by the payment of a dividend to shareholders. Prior to the changes, refundable tax was recovered on the basis of $1 of recovery for every $3 of dividends paid. The rate of recovery now is $1 of tax recovered for every $2.6089 of dividends paid. Again, the refundable tax rates are prorated for corporations whose taxation year straddles December 31, 2015. 

Due to changes in the taxation of dividends received by individuals, investment income earned through a CCPC has become less attractive. While there is an immediate income tax advantage to earning investment income through a corporation as opposed to directly (contrast 1 and 2, below), the aggregate tax cost increases where the investment income then is distributed to the shareholder (contrast 1 and 3, below), assuming the individual shareholder pays tax at the maximum marginal rate. The following illustrates the contrast in tax rates with respect to $100,000 of investment income:

Tax Payable on $100,000 of Investment Income (Ontario)

 

2016

2015

1)      Individual tax at top marginal rate (earned directly)

$53,530

$49,530

2)      Corporate tax (prior to distribution of net corporate profit to shareholder)

$50,200

$46,200

3)      Corporate tax and individual tax at top marginal rate (on distribution of net corporate profit to shareholder as ineligible dividend)

$56,150

$51,830

 

If you would like further information regarding the issues discussed in this update or if you wish to discuss any aspect of this commentary, please feel free to contact us.This update is intended as a summary only and should not be regarded or relied upon as advice to any specific client or regarding any specific situation.