September/October 2003: by Darrell Nordstrom

Planning is key for small business to capitalize on tax breaks

Special tax opportunities are available to small business owners and their families. But in many cases, the rules are complex and detailed planning is required to capitalize on them. Following are some of the major tax opportunities for owners of small business corporations to consider, along with recent tax changes.

TABLE 1: Small business deduction limit
2002 - $200,000
2003 - $225,000
2004 - $250,000
2005 - $275,000
2006 and beyond - $300,000

Take advantage of the rising small business tax deduction: The deduction cuts the basic federal corporate tax rate from 23 per cent to 12 per cent for active business income earned by a small Canadian-controlled private corporation, up to a specified limit. A CCPC is a corporation that is resident in Canada, privately owned and not controlled by non-residents or public corporations.

When combined with favorable Saskatchewan tax treatment, income below the small business limit is taxed at less than half the normal corporate rate: 19 per cent vs. 41 per cent. The threshold, frozen at $200,000 since 1982 and significantly devalued by inflation, was increased in the 2003 federal budget as shown in table 1 (rates are prorated for non-calendar years).

As a result, you'll want to look for opportunities to shift income to later years to make full use of the preferential tax rate. Another related strategy is to minimize income subject to the highest corporate tax rates by paying out salary and bonus to owners. This may also allow owners to maximize RRSP contribution room and achieve other benefits. Consider also the tax-deferral opportunities of retaining earnings taxed at the small business rate within the company.

Use the $500,000 super-exemption at first opportunity: Shares of a small business corporation may be eligible for the $500,000 capital gains exemption on disposition, if certain conditions are met. Among the criteria, the business must be a CCPC and:

• at the time of sale, 90 per cent or more of assets must be used in active business mainly in Canada
• you, or a related person, must have held the shares at least 24 months before sale
• during that period, at least 50 per cent of assets must have been used in active business.

You'll need to monitor your business activities to ensure it qualifies and to capture the tax break at the first opportunity. One strategy to maintain the status of the business is to transfer non-active assets to a separate company. Remember also, you don't have to actually sell or give up control of your shares to use the exemption; an accrued capital gain can be ''crystallized'' in other ways. Note that the exemption is available to individuals, but not trusts or corporations.

Plan for the capital gains rollover: Introduced in 2000, the rollover lets you defer tax on a capital gain resulting from the sale of common shares in an eligible small business corporation if you invest the proceeds in another qualifying small business. Entrepreneurs can begin a new venture without having their capital eroded by tax.

The recent federal budget proposed to enhance this opportunity by lifting dollar limits entirely on the amount of capital gain eligible for tax deferral and extending the time restriction for reinvestment in the next business. The eligible deferral is proportionate to the amount of sales proceeds that is reinvested.

For tax purposes, the deferred gain reduces the adjusted cost base of your new investment and may result in a larger gain when you eventually sell down the road. However, the opportunity to pay less tax now and employ additional capital may be substantial. Small business owners are generally advised to use up the $500,000 capital gains exemption before the rollover.

Split business income with family: Owners of small business corporations have unique opportunities to ''split'' income with family members and reduce the overall tax burden. By choosing an optimal share structure or implementing an estate freeze, you may not only multiply the $500,000 exemption among family members but also shift income to a spouse or adult children in a lower tax bracket – and save tax year after year. In fact, shareholders with no other income can receive approximately $23,500 in dividends tax-free! Planning is required to ensure the government's attribution rules don't create unintended results.

The rules around each of these opportunities are complex, and professional advice is required. For optimal planning purposes, it's never too early to seek expert advice. A professional can help you take steps now to organize your affairs for maximum reward in the future - and ensure you don't miss out on new opportunities as they arise.

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About the author
Darrell Nordstrom, CLU, Ch.F.C., CFP, RFP, Senior Financial Advisor, Assante Financial Management Ltd. He can be reached at 1-877-837-3377 or 306-665-3377, or click to email Darrell Nordstrom.

Disclaimer
Please contact a professional advisor to discuss your particular circumstances prior to acting on the information above. The opinions expressed are those of the author and not necessarily those of Assante Financial Management Ltd.

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