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David Steinberg is an EY Canada partner and tax leader, private client services.

Do you own a small, medium or large private business in Canada? New tax-planning proposals will affect your passive investments.

On July 18, federal Finance Minister Bill Morneau introduced draft legislation, explanatory notes and a consultation paper proposing to fundamentally overhaul the system of taxation for private companies, their shareholders and family members. These proposals are broad-based and primarily target Canadian-controlled private corporations (CCPC), regardless of sector, industry or economic grouping. The proposals are far reaching and will undoubtedly affect all Canadian private businesses – not just incorporated professionals.

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The release of the proposal documents follow statements made in the Liberal Party election platform and the Trudeau government's 2017 federal budget that it wants to ensure that CCPC status is not used to reduce personal income-tax obligations for high-income earners, rather than supporting small businesses. The draft legislation identified the reinvestment of aftertax corporate earnings in passive investments as a priority tax-planning measure requiring significant change.

For subscribers: Business groups, entrepreneurs mobilize to block tax changes

Related: How much will Morneau's proposed tax changes cost small business? We do the math

The newly proposed tax-planning measures will fundamentally change the way corporate aftertax income reinvested in passive investments will be managed. Here's an overview of the proposed changes:

Overview of passive income in corporations

Currently, corporate business income is taxed at a lower rate than personal income, which leaves corporations more money to invest in their business. If a private corporation doesn't need to reinvest all of its earnings to expand the business and isn't ready to reinvest – perhaps waiting for new machinery to come out or waiting for a new opportunity to buy a building – they may invest those earnings in passive investments. These could consist of numerous different options, including savings accounts, GICs and stock portfolios held within the corporation or a related corporation. These investments allow small businesses to earn a return on their investment while holding the funds for future business needs.

What's the perceived concern?

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The government perceives an unfair tax advantage when earnings are held inside a corporation not to expand the business, but to earn a return in the private corporation. Corporations will still pay the same amount, approximately 50-per-cent tax, on the passive investment income they earn with these aftertax funds. The government perceives there is an unfair tax advantage, as private corporations have more funds to invest given that the tax rate on their business income is less than that of an individual.

What are the proposed changes?

Several proposals have been issued to discourage the holding of passive investments in private corporations by neutralizing tax-assisted financial gains. The government is proposing to eliminate this perceived tax advantage by effectively increasing the tax rate substantially on earnings from corporate aftertax income reinvested in passive investments that are not related to the corporation's active business. For example, aftertax earnings reinvested in a portfolio of dividend-paying stocks would be affected.

In the new proposals, the government outlined possible approaches for increasing the tax on earnings from such passive investments. Although the proposal documents state that the new rules would only apply on a go-forward basis, no details were provided on how passive assets currently owned by corporations would be grandfathered under the existing rules.

What factors are the draft proposals not considering?

The private businesses I know don't set up companies to gain an unfair tax advantage. The majority of private businesses in Canada have been operating as corporations for their entire business life cycle. The current tax system helps supports thousands of private businesses that employ millions of people and add significant value to the economy. Private businesses take risks – from loans to liability and beyond.

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It isn't "fair" to compare a private business with an individual employee and try to equate their overall returns on earned investment income. Private businesses risk all of their wealth to reap the rewards, and sometimes they fail. Employees have access to pension plans and don't risk losing all their wealth every day they go to work.

What happens now?

If you currently earn passive income through a private corporation, the proposed changes to legislation may result in a higher rate of tax on future distributions of this income. It's important for you to understand the financial consequences of the proposals on your bottom line – now, and in the future.

The government has given taxpayers and professionals 75 days (until Oct. 2, 2017) to provide submissions on the proposals. Given the breadth and complexity of the proposals, it is hoped the government considers extending the timeline for submissions. Every private corporation could potentially be affected in some manner by the changes included in the proposal documents.

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