One hundred years ago in July 1917, Finance Minister Sir Thomas White shocked the nation by tabling a resolution in parliament calling for temporary income taxes, at very low rates, as a “war measure”. On July 18, 2017, one hundred years later, the current Finance Minister Bill Morneau dropped another tax-related bomb; this one directed at all Canadian controlled private corporations.
It’s been labelled as a tax fairness package, comparing employment income to owner-managed business and professional corporations, indicating that the use of corporations is a tax loophole and a tax shelter for the rich. Throughout the sixty-three pages of proposals there are numerous references to the comparison of owner-managed business and professional corporations with middle class employment income. The proposed changes are premised on the notion that the use of private corporations provides “advantages to the select few” and that this is unfair to middle-class Canadians. However, in this country there is nothing to prevent any employee from starting their own business and taking all the risks that ownermanaged and professional corporations face daily.
The proposals consist of putting a stop to income sprinkling amongst family members, a significant increase in tax rates for investment income earned in a corporation and distributed by way of dividends to the shareholder, and finally double taxation on your estate when you die. Calculations show a 72% tax rate on dollars earned in a corporation, invested and accumulated for your retirement. Essentially, upon your death, the payment of 72% of your corporate assets amounts to confiscation of your estate to pay ongoing Federal deficits. If these proposals are approved in Parliament no one will ever want to set up a small business corporation in Canada. Goodbye entrepreneurs, innovators and job creators. Let’s take a closer look at the proposals:
Finance clearly dislikes the payment of dividends to family members. Their proposal is to tax non-active shareholders of the corporation at top marginal tax rates allowing dividend treatment for only those who can prove they are totally engaged in the business. Generally in my practice, dividend sprinkling is associated with getting your 18-year-old children through a four-year university program at $20,000 per child per year. I’ll compare the cases of Dr. Joe, and Jim and Jane. Dr. Joe is a dentist employing five people in his practice. He is 45 and has just paid off his $300,000 in student loans and has partially paid off the $1,000,000 loan he took out to buy his dental practice so he could provide these valuable services to the public. He has two children starting university with anticipated dividends of $20,000 per year per child. Under the current tax regime his tax advantage over the four years through dividend sprinkling would be $61,600 ($160,000 x 38.5% = $61,600) or $15,400 per year. Under the proposed Tax Fairness Plan he realizes no tax savings, therefore, has to come up with another $15,400 per year. So he anticipates working some evenings and weekends to generate another $82,795 in fees per year which after he pays 60% overhead and the 53.5% personal tax leaves him with the $15,400 net each year after tax.
Now let’s look at Jim and Jane, a middle class family with two younger children who are anticipating saving for the children’s future education. They get the new non-taxable Canada Child Benefit each year for say five years:
All the above money is coming from the one and only taxpayer. Where is the fairness in this? Dr. Joe’s taxes are increased by $61,600 so he has to open up on evenings and weekends to finance his two children’s university costs while Jim and Jane do nothing more and the taxpayers finance $114,000 of their children’s university costs.
Fairness requires a look at the income transfers. Dividends are income from property and not related to employment income. The Neuman case which took years to go through the courts, resulting in a Supreme Court of Canada decision that varying amounts of dividends could be paid on different classes of shares, is the current law of the land.
Finance also intends to charge top marginal tax rates on capital gains on small business shares where the vendor is not active in the business. Once again, this compares the ownership of property to employment, which is new territory for everyone including the Courts.
The tax fairness paper devotes twenty-two pages to examining the tax shelter impact of using business income taxed at 15% rate for investment purposes. It makes a number of proposals including a further 35% non-refundable tax on investment income and taxing capital gains at 100% with no ability to pay out a tax-free capital dividend. None of this makes any sense.
The bureaucrats also don’t realize that the accounting and legal fees on investment companies for things like eligible and noneligible dividends, capital dividend elections, preparing T5’s and the more complicated corporate tax return, eat away at investment income. If we assume that the individual pays $100 more per year to get his tax return done because of the investments while the corporation pays $1,200 more per year because of complexity, then we are at a level playing field. Based on the example on page 46 of the Tax Fairness Plan the numbers would look like Table 1 over the ten-year period.
As you can see, there is a $363 advantage to the corporation under the existing system while the proposed amendments reduce the net after tax net worth of the corporation by $2,434. How does fairness factor into this? In addition, the compliance costs with the proposed system to be borne by the corporations are undeterminable but mind-boggling!
When the shareholder of a corporation dies (absent the spousal rollover) that taxpayer is deemed to have disposed of his shares of his private corporation at fair market value resulting in capital gains on the final personal tax return. To come up with the money to pay the tax, the cash within the corporation needs to be withdrawn. The current tax system allows for a tax-free withdrawal of these funds using a strategy referred to as the “pipeline”.
The proposed amendments disallow the pipeline and cash needed to pay the final tax bill will be taxed as a dividend. So now we may have double taxation expressed as follows:
So you have paid your fair share of tax all the way along and now CRA wants to confiscate 72.06% of your estate. Does anyone really think this is fair?
Talk to your advisors and:
At TMFD Financial, we consider these proposals to be ill-conceived with crippling consequences to owner-managed business and professional corporations. We completely disagree with the message the Department of Finance is delivering to the “middle class public” – that the use of private corporations is a tax loophole for the very wealthy.
As always, we understand all of your concerns. Please contact us if you’d like to discuss how these proposed changes could affect you.
ROBERT L. SNOWDON, Chartered Accountant, CPA Bob is based out of the TMFD Financial Ottawa office. Bob obtained his Bachelor of Commerce degree in 1973 from Queens University and received his designation as a Chartered Accountant in 1977. He has been in private practice since 1979, consistently providing a high quality level of professional services to a diverse client base. In addition to being a member of the Institute of Chartered Accountants, Bob is a member of the Canadian Tax Foundation, which provides up to date tax planning techniques and information through its conferences and publications.