New Brunswick decides not to follow federal passive investment rules: what does it mean for your clients?

New Brunswick announced in its 2019 budget that it would not be following the federal government’s passive investment income rules rolled out December 2018. What does that mean for your clients? Jared Burns from Louisbourg Investments breaks it down for us.

On March 19, 2019 New Brunswick’s newly elected Progressive Conservative Party and their finance Minister, the honorable Ernie Steeves, released their 2019-2020 fiscal budget. Like some of the other conservative provincial governments, NB announced in this budget that it would not be following the federal government’s passive investment income rules rolled out December 2018. 

As you probably recall, the federal government introduced the passive income business limit reduction rules that phase-out a CCPC’s small business deduction limit, on a straight-line basis, if the total of the corporation’s adjusted aggregate investment income (AAII) of the CCPC and any other corporation with which it is associated is between $50,000 and $150,000 in the previous taxation year. The changes to the SBD rules are contained in paragraph 125 (5.1)(b) of the federal Income Tax Act (ITA) and will apply for taxation years that begin after 2018.

With the federal changes and if New Brunswick had not opted out of the passive investment income rules, a corporation earning allowable business income (active business income) and that also earned above the new $150,000 in AAII in the previous year would have gone from a rate of 11.5% for income at the small business deduction (SBD) rate to a general combined rate of 29% on its active business income (ABI).  

As shown in table 1, a corporation that is subject to the general rate pays additional taxes today of $87,500 [$500,000*(29%-11.5%)] and loses its small business deferral advantage.  Think of the loss of the $87,500 deferral as cash that you will not have available in your corporation (rather, the government will have it) cash that you could have utilized to grow your business and earn a return on it.   

This is why NB’s decision to not follow the federal passive investment income rules is so important.  As you may have already noticed when looking at table 1 above, within the differential between the SBD rate of 11.5% and the general rate of 29%, 11.5% of the variance is attributable to the provincial increase from the New Brunswick SBD rate of 2.5% all the way up to the New Brunswick’s general rate of 14%.

With the new provincial budget, the provincial tax rate will remain at the small business deduction rate when AAII income surpasses the clawback threshold in the previous tax year, giving us the total tax rate of 17.5% (15% federal general rate and 2.5% provincial SBD rate) on active business income.  So, we no longer have the loss of the full $87,500 deferral when corporations earned greater than $150,000 in AAII from the previous year, the loss of the deferral is now only $30,000 ($500,000*(17.5%-11.5%)). 

That means that New Brunswick corporations under the proposed budget will get back $57,000 ($87,500-30,000) of the deferral they would have lost.  Bottom line, business owners will have access to additional capital of $57,000 to invest in their business and try to earn a return on it immediately.  

Remember Integration?

Now that we have gone over what the passive investment income rules mean for New Brunswick corporations and their tax deferral, we need to discuss how these rules affect the shareholder.  You don’t only cut half your lawn or only cook your supper for half the recommended time.  By New Brunswick not following the federal government’s passive investment income, we are left with an interesting result when it comes to tax integration. Remember, if integration is working then a person should be “tax indifferent” between earning income via a corporation or earning it personally (i.e. T4).  

Our results will be similar in nature as those seen for Ontario, when Ford’s government decided last November that they would be opting out of the federal rules for passive investment income. See, “Ontario Announcement throws a wrench into integration” written by Jay Goodis and Jamie Golombek

To keep the analysis as simple as possible we will start by calculating the integrated tax rate on an additional $100 in active business income for a shareholder (Erin) of a New Brunswick corporation who has had her federal SBD clawed back and therefore does not have access to the federal SBD rate but because of the new NB rules has access to the provincial SBD rate.  

We will then compare that integrated tax rate to the tax rate for an individual (Patrick) who earns employment income directly from his employer.  For both individuals we will assume they are each at the top effective marginal tax rates for NB before they each earn the extra $100.  

Erin is paying a total tax of 6.66% less than Patrick on the same $100 earned at the top effective marginal rates. Why? Well, after Erin’s corporation payed $17.50 in corporate taxes (15% general federal rate and 2.5% SBD provincial rate) she had $82.5 left to be distributed to herself as a shareholder. 

Since the corporation paid the high general rate corporate taxes federally, the corporation should generate GRIP (General Rate Income Pool) at a factor of 0.72 on income taxable at the general corporate rate ($100).  $72 of the $82.50 total dividend can therefore be designated as an eligible dividend (top tax rate on eligible dividends in NB – 33.51%), the other $10.50 will be an ineligible dividend (top tax rate on ineligible dividends in NB – 47.75%). 

Like Ontario, New Brunswick doesn’t have its own independent GRIP balance for provincial taxes, the province relies on the federal balance calculated in subsection 89(1) of the ITA, therefore, even though the corporation paid the lower SBD rate for NB of 2.5% and not 14%, the shareholders can still have most of their dividend as eligible versus non-eligible.   

However, to take advantage of the integration breakdown and get the tax savings of approximately 6.66%, Erin would have to pay out all the $100 and as such would be forgoing any possible deferral advantage on that $100. 

It is important that professional advisors and accountants work with their clients who have New Brunswick corporations that earn both active business income and significant investment income to help them understand possible immediate tax savings/costs, deferral opportunities available/forgone in relation to the total remuneration strategy. 

Remember different effective tax rates will yield different results, so always run the numbers. You must consider also consider factors outside of just taxation; things like the capital needs of the corporation, borrowing covenants on company assets, estate and succession planning etc.

About the Author

Jared Burns, CPA, CA

Manager, Tax and Estate Planning
Jared Burns holds a bachelor’s degree in commerce from Mount Allison University. He obtained his chartered accountant (CA) designation in 2012 and has completed all three parts of the CPA Indepth Taxation curriculum. At Louisbourg Investments, he is the Manager of Tax and Estate Planning where he works with their investment team, clients and other professional service providers to identify tax and estate planning opportunities custom to their unique circumstances and needs. Jared oversees the firm's compliance function and ensures that we consistently abide by the highest industry standards in our regulatory responsibilities helping to ensure maximum investor confidence.