How a salary cut could help a brokerage owner

Before breaking for the holidays, broker-owners should consider “holding off” on paying large salaries to themselves, below new federal tax law takes effect, so they can take advantage of existing tax advantage that could end Jan. 1, an Ernst & Young expert advises.

Finance Minister Bill Morneau proposed this past July to change the rules on how companies’ “passive income,” which can include interest and property income, is taxed.

Passive income earned before the changes take effect, probably on Jan. 1, “is not going to be subject to the new rules,” David Steinberg, EY Canadian tax leader, private client services, said Tuesday in an interview. Legislation stipulating the new rules has not been tabled yet.

The Senate Committee on National Finance said Wednesday that Morneau “should scrap or at least delay plans” to make tax law changes originally announced July 18. The Senate finance committee said Wednesday it held 30 public meetings and heard from 138 witnesses on Morneau’s proposed tax changes. Witnesses pointed out that passive business income could in the future be subject to marginal tax rates of 73%.

Corporate income tax is generally lower than personal income tax. How much tax a business or an individual pays depends on several factors, including province. Depending on the situation, there can be an advantage for business owners to hold investments inside the company rather than personally, the senate finance committee said in a report released Dec. 14.

Steinberg advises small business owners to consider holding off on paying large salaries. By keeping the money in the company – instead of paying the owner – the money is taxed at the corporate tax rate, which varies by province.

“Instead of stripping out a lot of money – whether that be a large salary to the active shareholder – it might be more beneficial to build up equity in the business,” Steinberg said.

Charging brokerages more tax on passive investments “penalizes those who have already been re-investing in their business with an eye to the long haul,” Brooke Hunter, chief executive officer of commercial brokerage Hunters International Insurance and former president of the Toronto Insurance Conference, told Canadian Underwriter earlier.

Morneau’s intent in proposing to change the tax rules on passive corporate income is to take away “any tax benefit in retaining the funds within the private corporation,” law firm Aird Berlis noted. The feds’ proposals “are quite complicated,” Aird Berlis added.

The new rules will only apply to passive corporate assets that generate income of more than $50,000 a year.

Steinberg predicts the government will table legislation in the spring of 2018 when it tables its budget for the fiscal year ending March 31, 2019.