For those in the real estate and construction industries, it’s what wasn’t in the 2017 Federal Budget that should give pause for concern. While money for a national housing strategy is a plus, the potential attacks on key tax planning tools for business owners is worrisome. In contrast to the prior two budgets, this budget avoided (or deferred?) major tax changes. Yes, a number of relatively minor changes were proposed that are detailed in BDO’s 2017 Federal Budget Report. But, for business owners in the real estate and construction industries, there were some warning shots across the bow that they need to be wary of right now.
Infrastructure spending & the smart city positives for real estate and construction
First, the potential good for real estate and construction, although the actual details are scarce which provides some pause. The government’s 10 year plan to improve Canada’s infrastructure, and build smarter cities, was a theme of the budget, although without specifics. And, the announcement in the budget for $11 billion to support a national housing strategy, represents a major commitment to real estate and construction. Obviously this type of spending will have an impact on real estate investors, and the construction industries, but as we have seen announcements, and re-announcements before, until we have “shovels” in the ground, we need wait to see where the greatest opportunities will be.
For more details: Budget 2017: Building Smart Cities
Focus on the “middle class” or attack on the “wealthy?
In the budget, the Liberals state “The government remains concerned about income inequality…” The budget advertised itself as focused on the “middle class”, although some of the tax changes actually took items back from the middle class, such as transit credits. However, the flip side of this is the implied, and explicit, attack on the “wealthy”. While this may play well, “the wealthy should pay their fair share”, it becomes more problematic when you look at the wide net that covers the term “wealthy”. The “wealthy” may mean you as a small business owner or investor.
For instance, according to 2014 CRA statistics, the top 1% of tax return filers pay just over 21% of Canada’s personal taxes (ignoring what their corporations may be paying), the top 3% cover about 34%, top 11% cover 59%, while the top 50% cover 96% of all personal taxes paid. The theoretical ideal can be debated as to exactly which percentage various brackets of income earners should be paying, but it already seems like a pretty progressive tax system, as it should be in my opinion, where essentially half of tax payers contribute very little, and the top 10% cover the majority.
Tax changes targeted at investors and business owners using corporations
The government declared that they were concerned with tax reduction strategies commonly used by business owners. To quote them: “Initial steps have also been taken to prevent wealthy individuals from using private corporations to inappropriately reduce their tax payable.” The problem with this statement is that the three specific rules being reviewed through discussion papers and consultations are commonly used by small business owners and real estate investors:
1. “Sprinkling” income by using companies to distribute funds to different family members through the payment of dividends and capital gains
We have very few clients where we don’t do this. Not many families want us to pay all of the profits to the individual with the highest income. While not strictly based on taxes, unquestionably a component of the remuneration strategies we use include analyzing the family’s corporate and personal situation to see how the family can earn more income in a tax efficient manner. The government appears to want to block planning that has widely been accepted in the past.
2. Holding a passive investment portfolio inside a company to take advantage of tax planning opportunities
First, to be very clear the government taxes passive income at a quite high rate until the income is passed along to the personal owners. They seem to be concerned with people accumulating a portfolio of investments, which presumably includes stock-based investments and real estate. While undoubtedly there are many tax advantages to using companies, there are many non-tax reasons for using companies as well, such as liability concerns. There’s nothing preventing Canadians from setting up corporations for themselves at relatively modest costs. Given the language used during the election campaign, perhaps the target will expand to include small business owners (aka the “middle class”) who provide services or sell goods, but employ 3 or fewer individuals. During the election campaign it was noted that the Liberal government would consider implementing a series of rules that have been implemented in Quebec where, with some minor exceptions, businesses were forced to employ more than 3 full-time employees to qualify for the small business tax rate. Regardless of the thought process, the government is looking at people who invest using corporations.
3. Converting a corporation’s normal income into capital gains and flowing this to the owners instead of salaries or dividends
Admittedly there can be some aggressive planning here, but there’s also the need to treat individuals fairly where they have incurred capital gains in a company and are seeking to pass it along to the owners at tax rates similar to if they earned the income personally.
The review of these situations may come back without any further changes, particularly given the perceived pressure on tax reform in the United States, and the need to remain competitive. However, the aggressive wording and focus on tax strategies used by the majority of small business owners should be worrisome.
Reviewing the use of trusts
Separately, the government will conduct a different study on the use of trusts where beneficial ownership is obtained by someone other than the legal owner. While it seems that this may be more of a hunt for criminal activities, it appears to characterize people who use these trusts as people who are doing something wrong. Note that a healthy percentage of real estate investors use trusts to own real estate or bare trusts to acquire real estate for their companies. I believe it is appropriate to be concerned with what the collateral damage may be in making changes to trusts, especially given the prior two federal budgets.
Tax auditors and enforcement
Continuing a trend which was prevalent with the current and past governments, more funds are being allocated to hire auditors. Considering the scrutiny that the real estate and construction industries currently feel by the CRA, this can only mean more.
Ecological gifts of land
Additional restrictions and administrative measures are being added by creating a 50% tax to prevent recipients of donated ecologically sensitive property from changing the use of the property or selling the property after the fact in a manner not approved by the government. Further, to address some concerns with the wealthy who may use a private foundation to benefit charities, the government proposes to eliminate the ability of a private foundation to receive ecogifts.
What to do next?
The 2017 Federal Budget may not seem as though there were many changes, however, the consultations and studies announced on some fairly common tax planning measures used by small business owners is worrisome. What should you do next? It’s time to talk with your BDO advisors now to see how you can shore up your tax planning and make defensive changes. It’s also time to talk with your political representatives to let them know how these changes will impact you and your family.
George E. Dube, CPA, CA
Tax Partner, BDO Canada
Real estate accountant, real estate investor, speaker, author