An Update on the 2017 Corporate Tax Proposals

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By Robert G. Kepes

Special to the Financial Independence Hub

You have probably seen that ad on CNN with an apple and chattering teeth sliding in front of it. The voiceover says one is an apple and the other is a distraction. The ad concludes: “But it will never change the fact that this is an apple.”

The ad is a not-too-discreet dig at shenanigans currently taking place in Washington, D.C., and may also have some traction on this side of the border, especially where it concerns the federal government’s tax proposals.

Back on July 18, 2017, the federal government released its first take on tax proposals involving tax-planning strategies of private corporations, including many professional corporations. The feds announced a period of consultations to discuss proposed policy changes involving the taxation of corporate passive investment income, such as interest or dividends.

Income sprinkling a key focus

The government’s wish, which actually went back to the federal Budget released in March, 2017, was to close alleged tax loopholes, bring fairness back to the tax system, and end tax-planning strategies in which the rich may take unfair advantage. The strategy also looked at income sprinkling among family members using private corporations. Income sprinkling  allows the corporation to pay dividend income to the founder’s spouse and children, in lieu of the founder paying tax at the highest rate on all his/her income earned. Overall tax savings for the family is achieved through a combination of the founder’s top tax-rate salary, and low-tax dividends to the spouse and children.

The benefits of income splitting with minor children were eliminated in the 1999 federal budget. It introduced the Tax on Split Income (TOSI) as a flat tax equal to the top marginal rate on certain ‘split income’ earned by individuals under age 18, including dividends from a private corporation. Spouses and adult children were not subject to the tax. The government’s July, 2017 proposals seek to extend the TOSI to ‘split income’ of spouses and adult children.

Response by small business led to two proposals being dropped

On October 18, 2017 – after a relentless, nation-wide attack against these proposals by much of the country’s tax community, but especially by small business – the feds changed their approach. They dropped two of the proposals.  The government said it is no longer proceeding with measures that limit access to the lifetime capital gain exemption (LCGE). These would have denied the LCGE to a trust or minor, or to capital gains subject to TOSI (i.e., the shareholder made no contribution to the business).

Also being shelved were measures relating to conversion of income into capital gains (i.e., surplus stripping). This was welcome news because the collateral damage of eliminating post-mortem pipelines was significant; estates of deceased shareholders would have faced a potential double tax, or paying tax at 40% instead of 25%.

But tax on passive income still a concern

The most controversial proposal was arguably the tax on passive income earned by private corporations. Bill Morneau, Minister of Finance, said those proposed changes to passive income taxation would not apply to existing assets, future income arising from existing assets, or investment income below a threshold of $50,000. In addition, he said the government would draft legislation for these changes as part of the federal Budget in 2018. But people are still concerned, and should be.

Spokespersons for the federal government, including Finance Minister Morneau and Prime Minister Justin Trudeau, have said that those who earn a certain amount as a business owner pay less tax than an employee who makes the same amount in salary. But, as anyone in business knows, such a concept is absurd.

Enter the analogy of the apple and the chattering teeth. The federal government would have you believe that these two people are not paying the same tax even though they both may earn $150,000 a year. The issue, we are told, is that current rules don’t recognize that the shareholder has more capital to invest through the corporation than the employed individual.  The proposal is to impose a penalty tax to equalize the two.

However, one of those people is an apple and the other is a distraction because the current integration of corporate and personal tax rates means they eventually pay the same tax. The equalization comes when the owner pays tax on a dividend from the private company.

Then we are told that the proposal will only affect a small number of private corporations, and the intention is to shake up the ‘dead money’ within them. The penalty tax is an incentive to spend the money on the business.

Dead money brought to life in federal coffers

On October 18, 2017, the Parliamentary Budget Office reported that, indeed, only 3% of private companies would be affected by these changes. That is the distraction. Now comes the apple. The apple is that the long-term result would be an additional $6 billion in annual tax revenue for the Government of Canada. Thus, the ‘dead money’ is brought to life in federal coffers.

A business owner has likely taken a certain amount of risk to build that business. He or she may not have drawn a salary at all the first few years. They may have had to mortgage their house. They may have taken a loss, maybe a huge loss, to get the business off the ground. And let’s not forget that this person has no benefits. And, needless to say, there is no pension.

The Standing Senate Committee on National Finance held its own hearings on the government’s tax proposals. On December 13, 2017, the Committee released its report. It recommended the following:

  • The federal government should abandon the passive-income proposal altogether.
  • If the government wishes to proceed with the proposed changes, then the implementation should be delayed until no sooner than January, 2019. This will allow it to undertake consultations of the draft legislation and thoroughly analyze any impact on the economy, gender-based implications, and the healthcare system.

The federal government roundly dismissed the Committee’s report. That could be a cue for chattering teeth.

Robert G. Kepes is a partner with Morris Kepes Winters LLP, a leading tax boutique law firm.

 

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