Budget 2018: Pixie Dust

By Trevor Parry

Special to the Financial Independence Hub

While Bill Morneau’ s second federal budget can be described as a punt, this third foray can best be described as a “fart in the wind;” however,  given that this is a Justin Trudeau government, the term “pixie dust” seems far more appropriate.

The Budget included two major tax measures, one relatively substantial and the other curative.  The latter was a tweaking of the rules surrounding Refundable Dividend Tax on Hand (RDTOH) , dividing the pools into eligible and ineligible pools, thus corresponding with their according dividend. The more substantive measure was to introduce a measure that reduces the ability of a corporation (or its related entities) to claim the Small Business Deduction where “substantial” income has been earned of invested after tax profits.

The new rule would see a company’s SBD eroded by 5 dollars for each 1 dollar of passive income earned in excess of $50,000 each year.  If the company earns $150,000 per year in passive income it loses the entire SBD and is subject to General Rate taxation, effectively 26%.  The government claims that this will affect about 3% of businesses.  In the cases where the full SBD is lost the company will end up paying about $55,000 in additional corporate tax.  The same company would also be paying out eligible dividends, which will be taxed at lower personal rates by the shareholder.

Finance’s pragmatic policy wonks prevailed with the Small Business Deduction

I actually think that the more pragmatic policy wonks in the Department of Finance prevailed with regard to this measure.  The SBD was introduced to provide a tax incentive for small businesses to save and invest and by this process graduate to a medium sized or growing business.  The problem of course is that tax planners have for decades sought to freeze the status of a small business in place.  This can still be achieved by paying out shareholder bonuses, but given confiscatory personal rates in most of the provinces it is likely that trusted advisors will still the ability of a corporation to defer taxation and recommend that earnings continue to be retained.   The approach the government has taken is a more comprehensive approach to total corporate earnings.  It explicitly says to business owners and incorporated professionals that you can use your corporation as a retirement vehicle, or rainy day fund but you will be taxed as a more mature business.

There are of course planning measures that can be taken to avoid this new measure.  Permanent life insurance remains the last game in town with regard to significant tax deferral possibilities.  Given that the Department of Finance engaged in meaningful consultation in fashioning the substantive update of the “exempt test” rules in 2016 that no wholesale assault on life insurance is in the offing.

Instead, I think the Department will continue to observe the golden rule — “Pigs get fat and hogs get slaughtered” — in deciding what action is necessary.  Like the 10/8 strategy before, there are strategies being implemented today that clearly drift into the aggressive category.   The diversion of loan proceeds to a shareholder in an Immediate Finance Arrangement, or the rebating of commissions without their appropriate declaration of status as taxable income come to mind.

Individual Pension Plans only temporary remedy for new rules

Some might also trumpet the use of Individual Pension Plans.  IPP’s in the right instance are wonderful planning tools.  They are particularly useful for incorporated physicians who cannot plan retirement on the basis of an eventual sale of their professional corporations and who too often suffer from a lack of savings discipline.  They are however not a comprehensive solution to the new passive income rules.  If one‘s business is substantially affected by the new rules the IPP is at best a temporary remedy.  The tax relief associated with large past service contributions will likely offset the application of GRIP rate taxation for a year or two, but in later years the annual contribution, though larger than those available to a RRSP, will not be sufficient to take up significant retained earnings.  IPP’s should be considered and undertaken because they make good retirement planning sense.

Other than those tax measures the Budget document had all the economic substance of one of Justin Trudeau’s contrived “town halls,” or one of Sophie Trudeau’s poems.  The document continues to create unaffordable deficits, particularly galling when the government claims the Canadian economy continues to enjoy robust growth.  Perhaps Mr. Morneau, when he isn’t busy responding to ongoing ethics and conflict of interest charges can undertake some remedial reading of John Maynard Keynes.  Keynes, the economic guru that this government pretends to follow, called for deficit spending in challenging economic times and constrained spending in robust periods.

There is no mention of returning to fiscal sanity.  Balanced Budgets are a phantom of a bygone age; remembered from the dark and controlling days of perpetual boogeyman Stephen Harper (let’s not mention Paul Martin and Jean Chretien).  We are told that Canada’s debt to GDP number is enough to placate the masses in to believing the myth that all is well in our fiscal house.  The simple fact is that the so called “boom” is entirely founded on growth in the public sector and hyper inflated real estate values in a few Canadian cities needs not be considered.

Little fiscal sanity among Trudeaupian platitudes

The document includes the typical Trudeaupian platitudes.  We shall now conduct budget making through a gender lens.  Measures are to be taken to enforce equity.  The fact that these measures affect Federally regulated corporations which constitute less than 10% of incorporated businesses in Canada renders this “progressive” measure as irrelevant.

Of course, keeping with the myth that Canada’s history is one of oppression, the signature message behind Justin’s “Canada 150” spend-a-thon, there is talk of reconciliation with indigenous people.  No one argues that the current system is broken, but a sensible approach would see fundamental reform and deployment of assets after a thorough analysis devoid of emotional and politically driven claims of victimhood.  Profligate spending without any accountability is pure vote buying and a recipe for perpetuating the problem.  One needs only to see the utter failure of federal transfers to the provinces as an example of how to perpetuate  an economic morass.

This Budget, devoid for the most part of substance belies something else, a sense of foreboding, and  a real and tangible fear.  Mr. Morneau is not Mr. Trudeau.  He does not live in Never Never Land, characterized by lavish tax payer funded family vacations, selfies by the second, town halls for quislings or a very occasional visit to work (House of Commons).  Mr. Morneau sees the reality of the emerging American industrial renaissance.  Capital remains agnostic, as evidenced by the large scale withdrawal of capital from Canada, particularly in the capital intensive resource sector.  Given punitive personal tax rates intellectual capital will follow.

South of the border, Donald Trump and the GOP have introduced the most substantive tax reform package since the Reagan years.  The result is massive repatriation of capital, a growth of the industrial base, increased profitability and increasing wages.

The cupboard is bare

Mr. Morneau knows that the Canadian cupboard is bare.  The fiscal sanity and treasure created by previous Liberal and Conservative governments has been squandered in an orgy of political pandering.  Mr. Morneau knows that to address the situation he must discard the kumbaya mantra of his apparent political master and return to bare-knuckled economic common sense.

That common sense does not exist in Justinland.  Barring a St. Paul moment on the road to Damascus I don’t think Mr. Morneau is about to cross the floor or discard Keynes for Hayek.  Instead he will quietly withdraw from the political arena, returning to his French chateau and while he samples a decent vintage, planning his own apology tour, to the Canadian economy and the men and women who drive it.

Trevor Parry, M.A. LL.B LL.M (Tax) CLU TEP, is the President of the TRP Strategy Group, specializing in owner manager tax and compensation planning, executive compensation, philanthropic strategies, enhanced retirement planning and professional corporation planning.  Trevor was formerly the National Sales Director of GBL, a boutique actuarial consulting firm.  In addition to his practice he speaks and writes extensively on financial strategy, planning and tax issues.  

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