After the proposed small business tax changes were met with mixed reviews from residents of Saskatchewan, the federal government has decided to take a new approach.

The federal budget tabled on February 27 proposed to reduce the small business limit from Canadian Controlled Private Corporations and their associated corporations that have significant income from passive investments. 

Tracy O'Donnell, a tax partner at MNP, explains what this new approach is.

"It's another way of reducing the small business limit," she said. "Under this measure, the business limit will be reduced by five dollars for every one dollar of investment income earned in excess of $50,000. The business limit would be eliminated at $150,000."

"An example," O'Donnell said. "Would be if a Canadian Controlled Private Corporation earning $100,000 of investment income would have its federal business limit reduced from $500,000 to $250,000. It is over the $50,000 threshold by $50,000. Therefore, $50,000 multiplied by five, gives a grind to your business limit of $250,000."

O'Donnell adds that if your corporation and your associated corporations earned more than $150,000 of investment income, you would not get the small business deduction rate, which is currently 12% on the first $500,000 of active income earned within a corporation.

"If you have excess income and you invest it into your active operations you're not going to be earning any passive income," she said. "As long as everything is used for active operations and you're not earning any investment income, then these rules don't apply."

O'Donnell talked about what changes were made from the original comments made back in July.

"The original thought was that they (the government) were going to change the taxation on the actual passive income," she said. "However in the most recent budget, the tax to passive income will stay the same. It will just now have an impact on what rate you pay on your active income between your corporation and all of your associated corporations."

She added that the new approach could potentially impact businesses by seeing them pay a higher tax rate on their active income, but she says how much they pay is dependent on what their investment income is.

O'Donnell said these draft proposals are better for small businesses in the southwest than the previous ideas put forth in July.

"These are better then they were in July," she said. "The July comments would have an effective tax rate of about 70 per cent, so these are better than the July comments for sure. The draft proposals that came out on February 27 will be impacting the small business deduction rate. This is better than an effective flow-through rate of approximately 70 per cent."

The changes will not affect business owners this year but will start for any taxation years beginning in 2019.

O'Donnell added business owners should talk to a financial advisor or accountant to see how these changes will affect their business and to see if there is any potential planning that could be done to prepare for the changes coming in 2019.

The federal government is saying that these new changes would affect a small portion of businesses in Canada.

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