Peter Weissman CPA, CA, TEP is a partner at Cadesky and Associates LLP.
Despite all the unprecedented opposition to its July 18, 2017, proposed tax changes, the federal government is still trying to sell the proposals as "tweaks" that only target "the rich." These proposals are, in fact, the most significant and irresponsible I have seen in almost 29 years as a tax specialist, and their release in the middle of the summer, with only a 75-day consultation period, speak volumes about the government's motives.
The proposals have been criticized in the media by owners of all sizes of business, and to MPs from across the country who have fielded a flurry of concerns. Federal Finance Minister Bill Morneau is adamant that the proposals are not retroactive and will only affect "the rich." This statement is simply not true.
I implore Mr. Morneau to acknowledge the reality. The proposals overshoot the mark, and are horribly complicated. In fact, the government's stated policy objectives could be achieved with simpler, more efficient proposals, but those of us who deal with tax rules day in and day out are being ignored when, in fact, we can help.
What is the reality? As written, the proposals will have significant adverse consequences for all family businesses (large and small), their employees and the Canadian economy They will add significant costs and uncertainty to family businesses already grappling with higher minimum wages, carbon taxes, North American free-trade agreement renegotiations and increased personal taxes. Increasing tax burden and complexities for Canadian business owners will prompt more of them to consider moving themselves and their business out of Canada. Since these proposals were announced, I have received many such inquiries.
The following is a summary of three of the most problematic proposals.
The government is concerned that business owners can pay dividends to their children and spouses who are at lower tax rates (income "sprinkling"). Current tax rules already eliminate much of this planning through clear, objective, understandable and easily audited rules. The few scenarios in which the current rules allow for income splitting are also clear. You would think, therefore, that the proposals would address these few remaining legal income-splitting options.
Instead, the new rules are not targeted, and are unnecessarily complicated and unpredictable. They include subjective "reasonableness" tests that cannot be audited or planned for with any certainty. There is no way to define reasonability and, in tax matters, you are guilty unless you can prove your innocence. This reality and the lack of accountability for mistakes within the Canada Revenue Agency means the subjectivity in the proposed rules will create chaos and increased tax litigation. Bottom line: These proposals are poorly thought out. There are much easier, objective ways to address income splitting.
This term refers to stripping excess cash (surplus) out of a company, currently at capital-gains tax rates of about 25 per cent instead of dividend tax rates of 40 per cent to 45 per cent. The idea of curbing this type of planning may be sound, but the proposed rules, unnecessarily, will produce terrible collateral damage. For example, many family businesses will be sold to outsiders instead of the next generation because the latter will be taxed at 40 per cent to 45 per cent instead of 25 per cent. I can't believe it is the government's intention to tell a family farmer or any family-business owner that it is better to sell to a neighbour than to children. If you inherit a family business, you may pay tax on gains that your predecessors already paid tax on. This amounts to retroactive double taxation (as if double taxation was not bad enough).
These proposals will also result in double or triple taxation after an owner dies because they eliminate an accepted strategy that deals with this flaw in our tax rules. Many taxpayers have used this strategy with preapproval from the CRA. This approval seems meaningless now, since the proposed rules are retroactive and replace the rules the CRA's approval was based on.
Despite Mr. Morneau's repeated protestations, these rules affect the estates of people who died prior to July 18, 2017. That is retroactive treatment. No ifs, ands or buts.
Taxation of passive income
When a business makes a profit (never a given), it will pay tax of 15.5 per cent (in Ontario) on the first $500,000 of taxable income and 26.5 per cent on all business income above that. These rates are lower than what would be paid if the business profits were earned personally and make Canada an attractive place to run a business.
The difference between the lower corporate tax rates and the higher personal tax rates is equalized when the corporate profits are paid to the shareholders who then pay dividend taxes. This mechanism is known as "integration" and is a cornerstone of our tax system as it prevents double taxation. Owners use this deferred dividend tax to reinvest in their business, invest in a new business, offset prior losses or save for retirement. This reinvestment drives economic growth. The government says it wants to eliminate the deferral if funds aren't reinvested in the business, but, again, has proposed a totally impractical approach that will apply to all businesses, not just the professional corporations the government says it is targeting.
Funds not reinvested in the business or paid to shareholders are usually invested in "passive investments" such as mutual funds, bonds, stocks, etc., that are taxed at high rates, sometimes higher than the shareholder's tax rate. However, the investments provide security to business owners since they do not have financial safety nets such as employment insurance, low-cost pension plans and other items that many employees and, of course, civil servants have.
Not only will the new rules reduce a businessperson's ability to save for economic losses, life events and retirement, but they blow integration and fairness out of the water, are unwieldy and apply to a much broader base than the government would have us believe. Investment income in a private business will ultimately be taxed at more than 70 per cent by the time the shareholder receives the funds personally. This level of taxation is unheard of and cannot be what the government intended. Simpler solutions exist, such as a surtax on these types of corporations. The government has asked for input with respect to this one area.
I urge the government to slow down and implement responsible, workable and fair changes. It is misleading Canadians and attempting to implement some of the most sweeping tax changes in decades too quickly. The proposals are not tax "tweaks." They are nothing short of tax reform that was not developed with open and collaborative consultation, announced strategically in the middle of summer, when Parliament was in recess, with only 75 days for consultation. Worse, the proposals will not even achieve what the government claims they will.
Developing tax changes after only consulting theorists and academics, as the government has done, is irresponsible. Changes that meet the government's actual goals are only possible with open and honest dialogue between the government, business owners of all sizes and tax professionals. Take the time to do this right, be fair, avoid retroactive and double taxation – not compromise the ability for families to pass their business onto the next generation. Develop rules that have objective, auditable criteria. Canadians deserve this and should not settle for anything less.