Morneau moves forward with revised income sprinkling reform

On the same day a senate report urges original reforms be thrown out, Canada's finance minister announced new rules will take effect in 2018

Finance minister Bill Morneau today unveiled new rules around how small Canadian businesses can sprinkle income among family members – one of several controversial tax changes tabled by the federal government in July.

Used as a mechanism for lowering personal income tax, income sprinkling allows business owners to issue dividend-paying shares to family members who, if they are in a lower income tax bracket, end up paying less income tax on the business's after-tax earnings. 

Starting January 1, 2018, 'simpler rules' will exclude certain individuals from having to meet a previously announced "reasonableness test" to determine whether income received matches the extent of family members' business contributions. This includes, with some conditions:

  • A business owner's spouse aged 65 or over who has "meaningfully contributed" to the business
  • Adults aged 18 and over who have made a "substantial labour contribution" of at least 20 hours per week during the year or during any five previous years
  • Adults aged 25 and over who own at least 10% of a corporation that earns less than 90% of its income from the "provision of services"

Those aged 25 and over who do not meet any of the government's new "bright-line" tests would be subject to a Canada Revenue Agency (CRA) reasonableness test to determine how much income would be subject to the highest marginal tax rate.

The announcement comes on the same day a 50-page senate report urged the federal government to scrap its proposed small business tax reforms, or at the very least delay their implementation, citing concerns that the reforms would constrain business growth, add complexity and inevitably lead to litigation.

On income sprinkling specifically, witnesses in the Standing Senate Committee on National Finance's report expressed concern about the potential subjectivity of a reasonableness test. Many also noted the previously proposed rules failed to "recognize the reality of family contributions to small businesses." Some suggested extending income splitting to adult children between the ages of 18-24.

The report recommended the government undertake a comprehensive review of the country's tax regime before moving forward with the proposed reforms.

The federal government estimates that the revised rules will affect fewer than 45,000 family businesses, or less than 3% of the 1.8 million Canadian-controlled private corporations the government's proposed tax reforms address.