On December 7, 2015, the Department of Finance released a Notice of Ways and Means Motion (NWMM) that contains many of the income tax measures proposed by the new Federal Liberal government. This then became Bill C-2, which received First Reading in Parliament on December 9.
Some of these measures were summarized in our December 2015 Letter. These and other measures are discussed below. Unless otherwise noted, all changes are effective as of January 1, 2016.
Middle rate tax cut
The second federal tax bracket – for 2016, covering taxable income from $45,283 to $90,563 – is reduced from 22% to 20.5%. The bracket, along with all other tax brackets, is indexed each year to inflation.
Highest tax rate increased
Taxable income of individuals in excess of $200,000 (indexed after 2016) will be subject to a 33% federal tax rate, up from the previous 29% rate. (These rates are all before counting provincial tax, of course.)
Trusts, both intervivos (created during one’s lifetime) and testamentary (created upon death), will be subject to a 33% flat tax on all taxable income. An exception will be made for graduated rate estates (basically, a deceased’s estate for the first 36 months after death) and qualified disability trusts, which will be subject to the graduated tax rates that apply to other individuals.
Similarly, the federal flat tax that applies to the split income of a minor child (sometimes called the “kiddie tax”) will be increased from 29% to 33%. The split income of a minor child includes items such as dividends and shareholder benefits from private corporations.
Donation credit change
Currently, the first $200 of charitable gifts made by an individual per year are eligible for a 15% federal credit and any excess donations are eligible for a 29% credit.
Due to the increased top tax rate of 33%, the credit will be amended for individuals with taxable income over $200,000. Basically, for annual donations in excess of $200, an individual will continue to claim a 29% credit rate, except that, a 33% credit will apply to the extent the individual’s taxable income exceeds $200,000. In other words, the credit will be similar to deducting the donation from income, for federal tax purposes.
The Department of Finance provided the following example:
- If a taxpayer has $220,000 in taxable income and donates $10,000, a 33% credit rate applies to all donations above the first $200 (i.e., $9,800).
- If the same taxpayer donates $30,000 over the year, the 33% rate will apply to $20,000 of the donations (still 15% on the first $200, and 29% would apply to the remaining $9,800).
TFSA Limits
Beginning in 2009, the annual contribution limit for a TFSA (tax-free savings account) was $5,000, indexed for inflation and rounded to the nearest $500. For 2013 and 2014, the limit had been increased to $5,500 owing to inflation. Then the Conservative government increased the 2015 TFSA limit to $10,000.
The new legislation brings the annual limit back to the former $5,000 amount on an indexed basis, so it will be $5,500 for 2016 and indexed thereafter. The $10,000 limit for 2015 has not been reversed.
Furthermore, any unused TFSA room from 2015, based on the $10,000 limit for that year, can be carried forward. For example, if you had made maximum TFSA contributions as of 2014 and then contributed $6,000 in 2015, the extra $4,000 contribution room can be carried forward to 2016 or later.
Tax on investment income of private corporations
In order to prevent individuals from holding their investments in privately-held corporations and deferring tax, a higher corporate tax rate applies to the investment income of such corporations relative to business income.
Investment income other than intercorporate dividends
Basically, before 2016, a Canadian-controlled private corporation’s “aggregate investment income” (net taxable capital gains and other income from property, other than most dividends received from other corporations) was subject to a federal corporate tax rate of 34.67%.
However, in order to maintain some integration between the corporate and individual tax systems (i.e. to prevent excessive double taxation), a Canadian-controlled private corporation (CCPC) was entitled to a refund of tax if it paid out dividends to its shareholders, generally equal to the lesser of ⅓ of dividends paid and 26.67% of its aggregate investment income.
Due to the new top marginal tax rate of 33%, the NWMM increases the federal corporate tax rate on aggregate investment income for CCPCs by 4 percentage points to 38.67%. In turn, the refund for CCPCs is increased, generally to the lesser of 38.33% of dividends paid by the CCPC and 30.67% of its aggregate investment income.
Dividends received by private corporations
Most inter-corporate dividends flow between corporations without regular “Part I” tax under the Income Tax Act. In particular, if your corporation receives a dividend from another corporation, it is normally deductible in computing taxable income so that your corporation is not subject to tax on the dividend.
However, if your private corporation receives a dividend from another corporation that is not “connected” to it (sometimes called “portfolio dividends” since these are typically investments in the public market), it must pay a special refundable Part IV tax. The other corporation will not be connected generally if your corporation does not control the other corporation and does not hold more than 10% of the shares or votes in the other corporation.
Before 2016, the Part IV tax was 33.33% of dividends received by a private corporation. The tax was refundable when the corporation in turn paid out dividends, generally $1 for every $3 of dividends paid by the private corporation to its shareholders.
Beginning in 2016, the NWMM increases the Part IV tax to 38.33% of dividends received by a private corporation. The tax is refundable at a rate of 38.33% of dividends paid by the private corporation to its shareholders.