Liberal small business tax reform plan: what does it mean for you?

The Canadian government is moving forward with plans to close certain tax loopholes that have reportedly enabled high-income business owners including dentists looking to list a dental practice for sale to reduce their tax obligations. According to Finance Minister Bill Morneau, these proposed reforms are intended to improve fairness within the tax system, rather than to increase government revenue.

An overview of the Liberals’ proposed tax changes:

In July, Morneau introduced measures aimed at addressing tax strategies that the government believes have allowed dentists and other high earners to avoid higher tax rates. One key focus is on “income sprinkling,” a method used to distribute income among family members, regardless of their involvement in the business. The government also plans to revise how income is converted into dividends and capital gains, while placing limits on the taxation advantages of passive business income. It is suggested that dentists earning $150,000 or more including those considering a dental office for sale in Ontario may feel the greatest impact from these changes.

Re-evaluating income sprinkling practices

Income sprinkling enables dentists to allocate portions of their income to family members in lower tax brackets by paying them salaries, wages, or dividends—even if they do not actively contribute to the business. This approach reduces the overall tax burden for the family.

Under the proposed changes, the government intends to introduce a "reasonableness test" similar in concept to a Dental Practice Appraisal to assess whether a spouse or adult child genuinely contributes to the business. This evaluation would include determining the level of their involvement in business activities. Compensation may be deemed unreasonable if it exceeds what an unrelated third party would receive for similar work and responsibilities.

Potential challenges for retirement planning

Capital gains refer to profits made from selling assets such as stocks, securities, or property for more than their purchase price. The government argues that converting corporate income into capital gains provides an “unfair opportunity” to lower taxes, due to the preferential tax treatment of capital gains.

If these changes are implemented, accessing such funds could trigger immediate taxation. Critics suggest this could create obstacles for business growth and make retirement planning more difficult.

Concerns around passive investment income

Passive income is generated from investments rather than from actively running a business. The Department of Finance has indicated that some individuals benefit unfairly by holding passive investments within their corporations, as these are taxed at lower corporate rates.

The department explains, “This becomes an issue when funds are kept within a corporation not for business expansion, but to avoid higher personal tax rates.”

Alan Rustom