New exclusions made to proposed income sprinkling rules

The federal finance department recently announced simplification to the new proposed income sprinkling rules that begin to apply in 2018.

It has provided clear guidelines (“bright line tests”) for when these rules will no longer apply to a taxpayer. The changes appear to provide relief for a majority of structures that farms may have in place.

However, it is important to understand these tests because the rules continue to be very complicated, especially if you do not fall into the “bright line tests.”

To provide some background, the premise of income sprinkling is paying income to a family member in a lower tax bracket rather than to a family member in a higher tax bracket to take advantage of lower tax rates.

One example of this under the current rules is a farming corporation paying family members older than 17 a dividend as a way to use their lower personal tax rates. In the past, this was possible as long as they were a shareholder, regardless of how active they were on the farm.

The proposed changes look to take away the advantage of paying dividends to non-contributing non-arm’s length individuals.

To do this, the government proposed reasonability tests based on labour and capital contributions and risks assumed. If the amount is deemed to be unreasonable, the dividends will be taxed at the highest marginal tax rates. In 2018 this could be the difference of paying tax at 15 and 42 percent on dividends.

The finance department has now released these “bright line tests” in addition to its proposed income sprinkling rules. These tests exclude certain individuals from even having to apply the reasonability tests for income sprinkling:

  • A farmer’s spouse if aged 65 years or older (as part of an effort to “better align” the income sprinkling rules with the pension income sprinkling rules).
  • Adults 18 and older who were engaged on a regular, continuous and substantial basis in the activities of the farm (generally an average of at least 20 hours per week) during the year, or during any five previous years.
  • Adults 25 and older who own at least 10 percent of the votes and value of a farm corporation.
  • Individuals who realize taxable capital gains from the disposition of qualified farm corporation shares or qualified farm or fishing property.

The finance department also provided relief for farms due to the more seasonal nature. It has declared that the 20 hours per week labour contribution requirement may apply only to the busy parts of the year. This may provide relief for paying those children who come home for seeding and harvest and attend college or university or work off the farm in the winter months.

Furthermore, it was confirmed that the finance department will not move forward on its proposed measures to limit access to the lifetime capital gains exemption. This allows for farms to continue to use many of the planning strategies available.

For further advice on how these new exclusions may affect your farming operation, be sure to contact a tax professional.

Thank you to Riley Honess and Steve Scott of KPMG for their assistance with writing this article.

Colin Miller is a chartered accountant and partner with KPMG’s tax practice in Lethbridge. Contact: colinmiller@kpmg.ca.

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