The federal government has unveiled its new proposal to curb "income sprinkling" by some small business owners to family members, with substantive changes to a much-criticized initial proposal unveiled in the summer.

But the government still intends to apply the new rules for the 2018 tax year to reduce the illegitimate use of income sprinkling, a tax-planning measure to shift income to family members in a lower tax bracket as a way to reduce taxes owed.

Morneau will speak to reporters about the changes after question period later today. CBCNews.ca will carry his remarks live.

Finance Canada said Wednesday the new changes will ensure legitimate contributors to a small business will still be eligible to receive income from the business. The government has introduced a number of "bright line" tests that will be used to weed out those who stand to benefit financially from business operations but have few day-to-day dealings with the company.

A "reasonableness test" was unveiled last July to determine legitimate contributions, but small business owners and business groups were unhappy with the increase in paperwork.

Now, no reasonableness test will be needed for family members:

  • Over age 65.
  • Over 18 who make a "substantial labour contribution" of at least 20 hours per week.
  • Over 25 who own 10 per cent of more of a business that earns less than 90 per of its income from the "provision of services."

Those who do not meeting these "bright-line" tests will face a reasonableness test review by the Canada Revenue Agency.

The government initially intended to expand an existing "kiddie tax" — which blocks proprietors from transferring income to minors in a lower income bracket — to include adult children and other family members. The kiddie tax levies the highest marginal tax rate on that income, making sprinkling a less desirable measure.

Now, the reasonableness test will be used to determine how much of a family member's income, if any, would be subject to the highest marginal tax rate for those who do not pass one of the "bright-line" tests.

While the new rules go into effect Jan. 1, Finance Department officials pointed out Wednesday that businesses have until Dec. 31, 2018 to adjust to the changes before filing their 2018 taxes.

Initial changes sparked outrage

Earlier this fall, after weeks of criticism about both his proposals and his own personal wealth management, Morneau announced changes to the initial tax change proposals he put forward in July, but also said proposed changes to income sprinkling would kick in on New Year's Day.

At the time, the finance minister promised the details would come later this fall.

With time running out, business group and opposition politicians have been, once again, critical of Morneau.

"First he ruined summer, and now he is ruining Christmas for small business owners," Conservative deputy leader Lisa Raitt said on Tuesday.

Morneau has been attempting to downplay the impact of the changes.

"We are going to announce, for those three per cent of small businesses that split revenue to other family members, how they can do this very simply," he said Tuesday.

Senators want changes scrapped or delayed

Wednesday's announcement comes a day after the Senate's national finance committee issued a report — after a months-long cross-country fact-finding investigation on the proposed changes — demanding the government scrap the proposals or, at the very least, delay implementation until Jan. 1, 2019, a year later than planned.

"This is not some exercise to embarrass the government, indeed Minister Morneau endorsed our investigation at the outset," Sen. Percy Mockler, the Conservative chair of the committee, told reporters. "We believe there is too much confusion for the government to proceed on the timeline it has suggested."

The 50-page report documents a host of witnesses demanding senators urge the government to withdraw the proposed changes entirely. "We are inclined to agree. We are not convinced that the government has made a good case for its proposals," the report states.

The committee said it was particularly troubled by plans for the so-called "reasonableness test" for income sprinkling, warning it could lead to arbitrary decisions by Revenue Canada bureaucrats. "The difficulty of understanding and complying with the rules will lead to uncertainty, foster tax appeals and litigation," the report reads.

Beyond the specific changes to the small business tax regime, the Senate said the government should immediately begin a comprehensive review of the entire tax code — something that has not be done since the 1960s, when the government of the day launched a royal commission on the matter.

Sen. Elizabeth Marshall, a Tory member of the committee from Newfoundland and Labrador, said the tax system has become a "ponderous and unwieldy monster" after years of haphazard additions. "An independent review should take place regardless if the government moves forward with its proposed changes," she said.

Not one of the Trudeau-appointed Independent senators were present for Wednesday's press conference, leading to questions as to whether the critical report was rammed through by Conservative appointees. Mockler insisted a majority of the committee — comprising five Conservatives, five Independents and two Senate Liberals — backed the report.

with a file from The Canadian Press