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. Continue Reading…
I thought it might be of use to prepare a brief review of where we stand with regards to Bill Morneau’ s infamous July 18, 2017 tax proposals.
As you are aware, attempting a profound degree of subterfuge, Mr. Morneau announced some “minor” tax changes aimed at bringing “fairness” to the taxation of Canadian Controlled Private Corporations (CCPC). What he in fact brought forward was the most fundamental change to corporate taxation since the introduction of the current Income Tax Act in 1972. This was coupled by a paltry 75-day consultation period, most of which coincided with summer vacations and harvest.
Despite his attempted strategic deception, a robust group of stakeholders representing a wide cross section of the Canadian economy mobilized to challenge these proposals and carry the message to Canadians that what was being proposed was fundamentally at odds with any rational conception of fairness, but instead a punitive attack on small business, professionals and family farms. The government was inundated with over 21,000 submissions. Last week we saw what I believe will be the first of several stages of government retreat from these proposals.
Few of the proposals will end in legislation
It is my contention that given the profound opposition that these proposals have engendered, both within the Federal Liberal caucus and from many sectors of the Canadian economy that little, if any of the proposals will actually find their way into legislation. Even the revised proposals create such layers of byzantine complexity that they are largely unworkable, elevate the roll of a CRA auditor well beyond their current capability and increase compliance costs exponentially for most Canadian economic enterprises.
If I may I would like to review the proposals and revised positions:
I) Surplus Stripping
The initial proposals called for an expansion of the ill-conceived section 84.1 of the Act. This is the infamous section that resulted in it being more advantageous from a tax perspective to sell your business to your next door neighbour rather than to your children. The proposals had called for restrictions on sale beyond simply spouse or children to include extended family members. It also placed the power of determination of defining “arm’s length” to a CRA auditor. The proposals also introduced a new omnibus anti-avoidance measure, section 246(1) that would have eliminated the ability to implement a common post mortem strategy, commonly referred to as “pipeline.” It would have made redemption strategies the only acceptable means of undertaking post mortem tax planning, threatened retroactivity and potentially exposed business owners (and their estates) to taxation rates in excess of 70%.
Mr. Morneau fully retreated from this proposal on Thursday of last week. There has been guidance provided by the Department of Finance that section 84.1 will now be substantively reformed to remove or reduce impediments to inter-family succession.
Whether this will be restricted to farm and fishing corporations, or be a general provision applying to all CCPC’s remains to be seen. I am hopeful that the Department of Finance will actually survey the tax planning community for guidance on what is prudent an efficient.
The conclusions regarding the retreat from the earlier proposals are as follows:
The cancellation of s. 246(1) restores traditional planning including “pipeline” and maintains that estate freezes are still relevant and prudent planning option.
Attacks on potential Capital Dividend Account (CDA) credits have been terminated. The use of corporately owned life insurance is still a preferred planning method.
II) Capital Gains
The proposals, both directly and through the Taxation of Split Income (TOSI) proposed a radical curtailment of the ability to claim the Lifetime Capital Gains Exemption (LCGE). The LCGE would have been restricted to individuals over the age of 18. It also would have eliminated the ability to claim the LCGE where shares are owned by a trust. This is of course a common planning technique with both tax and non-tax rationale. The ability to income split, creditor protect corporately held assets and insurance and multiply the LCGE all require a family trust as a central element of any freeze transaction or other selected reorganization strategies.
The proposed changes to the Income Tax Act that the Minister of Finance, the Honourable Bill Morneau, has released have real-world implications. The consultation period ends October 2, 2017, so now is the time to make your voice heard. Call or email your member of Parliament, or Minister Morneau directly.
I recently had a meeting with a high-tech entrepreneur in an internet-based business. He is very conservative and has not carried out any tax planning. His wife helps him but he does not do any income splitting with her. He has about $1 million in his corporate bank account for possible business use, but has not invested it and just earns minimal bank interest. The hype about the proposals has caused him to take notice of his tax affairs and meet with me.
I told him that under the new proposals income splitting with his wife, other than a fair salary for services performed, will be prohibited. His wife will probably not be able to participate in the lifetime capital gains exemption. If he decides to invest his retained earnings, there may be an additional tax on his income. He is now thinking about lifestyle and whether he wants to leave the country. I fully expect to prepare a memo for him about becoming non-resident.
Minister Morneau’s proposed tax changes will have the effect of causing an exodus of Canadian entrepreneurs for more business-friendly jurisdictions.
I had lunch with accountants a few days ago and they reported the same types of conversations with high-tech clients. They are considering leaving the country. Now, some won’t because of the education of their children, to be close to aging parents, adult children,or because they like their Canadian lifestyle. Others will decide it’s more important to maximize after-tax income and that it makes sense to move offshore.
70% of Canadians work for firms with 100 or fewer employees
Remember, statistics show that the vast majority of Canadians — 70 per cent — who are the economic engine of this country, work for companies with between 1 and 100 employees: the very targets of these new measures, and who are able in many cases to pack up and leave.
This is not just the view of tax professionals. Ryan Holmes, the CEO of social media internet company Hootsuite, was reported as saying on Sept 14, 2017 that the proposals are causing a lot of concern to business owners and that “I think you need to be very favourable at the small end of the market.”
I was recently contacted by a Liberal MP who is very opposed to what his government is doing. He has an entrepreneurial background and he realizes the impact of these proposals.
Prime Minister Justin Trudeau, in his dogged defense of what are the most fundamental tax proposals made since the report of the Carter Commission (which gave us our modern Income Tax system) claimed last Thursday that it is wrong that someone earning $50,000 a year as salary pays more in tax than someone earning $300,000 in their corporation.
Many tax professionals have dissected this ridiculous statement and could in considerable detail discuss where Mr. Trudeau was in error. In simple terms Mr. Trudeau would have you believe that the corporate shareholder lives in a different world where they are not affected by personal taxation.
According to the Ernst & Young tax Calculator an Ontario resident earning $50,000 would pay just under 30% on their income or $8,311 in taxation. The Ernst & Young Tax Calculator can’t factor in the value of a company or government funded health benefits program or pension plan.
If we turn to the corporate tax result, an active business earning $300,000 of profit in Ontario would be subject to taxation at 15%. We don’t need a sophisticated tax calculator to determine that this equates to $45,000. One should be baffled.
Corporate income also attracts personal taxation
Mr. Trudeau also is comparing apples and oranges. Does the entrepreneur who owns the business pay themselves anything? Regardless of whether they take income as salary or dividends it will attract personal taxation. Let’s say that they took a salary of $50,000, the same as Mr. Trudeau’s downtrodden employee. They would also have paid $8,311 in tax.
They might have had to pay themselves considerably more in order to afford an RRSP contribution, as it is highly unlikely they have a pension plan in place. If they decided to invest that $300,000 in their corporation any income or growth on that asset would be taxed almost at the same rate as an individual and when they withdraw the money as a dividend they would pay tax at the rate of 45.3%.
Perhaps the shareholder is as malevolent as Mr. Trudeau and “Red” Billy Morneau believe and they are deducting all of their lifestyle costs, including mortgage, food, transportation, vacations, toothpaste, etc. as a corporate expense. They would be guilty of tax evasion and the Criminal Code has provisions for dealing with that.
“We see these approaches to managing people’s affairs through a private corporation as creating an unfair playing field … We’re trying to tighten these loopholes to make sure that it’s fair.”
Doesn’t sound like taxes for small business owners are going down, does it? The above is from federal finance minister Bill Morneau’s July 18 announcement outlining some of the measures the government is proposing to help level what they perceive to be an unfair playing field.
Since the announcement we’ve been thinking about the potential implications of these changes and digesting comments from a variety of different tax experts. We agree with one expert who opined that “fairness is subject to personal interpretation.”
Unfortunately adhering to these proposed changes won’t be subject to personal interpretation so the bottom line is that we encourage all small business owners, especially those using private corporations in conjunction with saving for retirement or for the benefit of their families as a whole, to seek expert tax advice ahead of these changes coming into effect.
How did this come about?
Taking a step back, the reason that small businesses were given preferential tax treatment in the first place was to encourage them to reinvest in growth opportunities, employ more people, contribute to the Canadian economy in a more meaningful way and that would be good for Canada – hard to argue with that.
Of course all rules, especially tax rules, end up with unintended consequences. The current government feels many small business owners and their families have been taking advantage of opportunities (loopholes) in the legislation that allow for further savings when it comes to their personal taxes. Furthermore, they seem to be particularly concerned about the increased “corporatization” of certain professions that has taken place over the last 10 to 15 years in order to reduce tax bills. As not everyone is a small business owner, the tax advantages are deemed to be unfair to those who aren’t.
What are the specific areas that are deemed to be unfair?
1.) Income sprinkling
Income sprinkling is a strategy where a business owner looks to save tax by distributing income, dividends and capital gains to other members of his or her family in order to take advantage of multiple sets of graduated tax rates (i.e. pay other family members who are in a lower tax bracket) or exemptions, in order to lower the overall family tax bill. Continue Reading…
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By Robert G. Kepes
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