Business owners were warned in the 2017 Federal Budget that discussion papers were coming to consider corporate tax planning. But with the release of the Liberal government’s Tax Planning Using Private Corporations proposals on July 18, few advisors dreamed of the level the government would attack small business owners, family businesses, and investors. Not only are there proposals, but, in two cases, draft legislation. With the release of draft legislation at the same time as the proposal papers, this indicates how serious the government is about implementing these changes.
The government has positioned these corporate tax planning changes as cracking down on the wealthy and closing tax loopholes to make the tax system more “fair”. This message is misleading on multiple levels.
“Wealthy” is the new synonym for “small business owner”?
First, these corporate tax planning strategies are employed by the average small business owner, contractor, real estate investor, etc. who is trying to support families, put kids through college or university, and support their employees. Many of them would identify solidly as middle-class people who have an entrepreneurial spirit, and have been willing to take the risks and make the sacrifices common in starting a business plus prudently investing profits for retirement, charities, future business plans, etc. Yes some “wealthy” people will be snagged. However, be careful, when the government calls looking for the elite–they may be your neighbours, friends and colleagues – and you. An article my partner, Brad Berry, prepared discussing how large a group “1%” is illustrates this. While he had some fun with the math, the point is well taken.
Tax laws not loopholes
Second, these are absolutely not loopholes. These corporate tax planning methods are perfectly legal rules that have been set out over years of Income Tax Act legislation (since 1972) and court cases. Far from being secret, these rules are well established and well-known by advisors. Business owners are following the rules set out by the government. They are not evading taxes, or using loopholes. They are being law-abiding citizens.
Fair is a four-letter word
Thirdly, the issue of tax fairness has been represented in this paper in such a way that either the government truly does not understand the reality that business owner’s face, or they just don’t care. Over and over the government provides examples of employees with T4 income, and compares them to the taxes paid by business owners using the tax planning strategies they are attacking. They use these examples to “prove” that the business owner is receiving an unfair tax advantage. Really? They are not comparing apples to apples. In my mind, they are comparing apples to baseballs.
- Business owners often take on a level of risk (including borrowing on personal assets) that an employee does not.
- Business owners do not have access to corporate pension plans. The use of their corporations to hold investments is their equivalent to a pension plan. And, in many cases they are supplying a pension plan to their employees as well.
- Business owners are the employers that pay CPP and EI premiums for employees. Business owners themselves do not have access to EI if their business fails, and significant restrictions exist if they want to take parental leave.
- Small businesses are family businesses which often involve all family members (many times unpaid) as crucial support for the business.
- It appears to me that having one spouse spend considerable time with the business while the other is spending more time raising the family, then telling the spouse raising the family that their value to the business is essentially zilch, despite the family house being on the line and likely guaranteeing various business and personal borrowings, is grotesquely unfair. Traditionally, although this is changing gradually, it is the woman spending time at the house. So essentially the government is saying that the value of women is considerably less than men in the areas valued by governments.
- The government is concerned with dividend sprinkling for a business owner’s children between 18 and 24. It is obvious that these dividends are being used by business owners to fund their children’s education. This allows them to build the future of the country by funding post-secondary education for their children. In many family businesses, these children will usually provide succession to the parents to allow the business to carry on to the next generation. Failing to support education has far greater long-term economic concerns for the country.
It’s worth noting that the government, for a variety of good reasons, subsidizes various groups of people and types of organizations through the tax system to promote activities and growth. They support teachers, volunteer firefighters, technology development, natural resource companies, farmers, fishermen, senior citizens, union members, northern residents, and more. Why not support through the tax system for small businesses and their owners as well?
An Industry Canada study concluded that 30 per cent of small businesses won’t survive longer than two years, and only half make it to five years. Business owners, real estate investors, and entrepreneurs are generally smart people – they know they are taking a big risk and they take it with their eyes open, and often with the families along for support in both monetary and on-monetary ways. But, no safety net exists for the business owner, or his or her family. If the business fails, unlike an employee, they can lose their homes, their life savings, and put their children’s education, and their retirement in jeopardy. They know this going in – they have the spirit to take the risk. This is why small businesses are the engine of the economy. 48% of Canada’s total workforce works for a small business. I fail to understand why the Liberal government is attacking them in such a way and believe they can directly compare their activities with those of employees in the eyes of fairness.
Complex and costly – a bad tax
When Conservative Finance Minister Sir Thomas White introduced Canada’s first income tax act 100 years ago today, July 25, 1917, he stated, “if the cost of administration of a tax is disproportionately heavy, it is not a good tax”. The corporate tax planning proposals as put forth by the Liberal government are complex, costly for small business, and will definitely involve more red tape. By introducing “reasonability” tests into the process for dividend sprinkling, for example, you have set up a two-sided battle in which the business owner and their advisors will be arguing with CRA over what is reasonable. Based on how far off the mark this paper is on understanding the realities of Canadian small business owners, and my dealings with CRA auditors over the years, I have little confidence that their view of reasonableness is going to regularly square with the reality of running a business. This doesn’t even consider the rules on passive investing in corporations, a proposal that was abandoned in 1972 for being too complex to track and manage. With modern business realities even more complex today, and the proposals as they are set forth, I foresee only chaos and cost for businesses to meet these requirements. Introducing more red tape into a complex business environment will only increase costs for business owners, and increase costs for the CRA to enforce these proposed rule changes.
Impact of corporate tax planning proposals – common examples
How will these corporate tax planning proposals affect business owners, besides the obvious economic issues of driving away business owners and investors? (See “Proposed Tax Changes Would Shake the Small Business World”, The Globe and Mail.)
BDO Canada has provided an overview of the changes, and a webinar outlining them in more depth. However, we’ve provided some common impacts below.
The government is proposing to severely limit the ability to split income more tax effectively among family members. For example:
- One spouse is running a business and the other spouse is staying home with the kids, together working as a team. Under the old rules, the income from the business could be split between both spouses (if properly structured), so that the spouse with the lower income could receive income at lower tax rates. If the proposals are enacted, this possibility will be severely limited.
- A business owner has planned to provide money to her college or university age children in the form a dividend from her company to help them pay tuition. The government proposals would also severely limit this ability, starting in 2018. This leaves businesses who had counted on using this form of planning to help offset education costs effectively stranded, particularly those who had foregone RESPs during those years of getting a business off the ground.
Multiplication of capital gains exemption
For many years qualifying owners of corporations could sell the shares of the business and all or a portion could be sold tax free. Where the shares were owned by multiple family members, each may be eligible for this treatment thus creating the possibility of increased tax savings. Typical users of these strategies over the years include family farms, fishermen and family businesses. In many cases this provides for the retirement funds the family would not otherwise have since they wouldn’t have an employer-sponsored pension to rely on. Such planning is now at risk.
Holding passive investments inside a private corporation
In this case, the government is proposing taxing investments in private corporations at different rates depending on the source of the investments. If the money goes back into the business in certain forms, they deem this fine. But if the company is a family business and they choose to invest profits in passive investments such as stocks, mutual funds, real estate, etc., as compared to higher wages or machinery, the government deems this to be inappropriate. Heaven forbid families save for retirement, education, invest for charities, create legacies, etc.
The government has a 75-day consultation period on these corporate tax planning proposals. However the fact that they have draft legislation already drawn up on two of the three main proposals is concerning. What should business owners do?
- If these changes impact you – and if you have a corporation they absolutely will – talk to your MPs and encourage your colleagues and team members to do the same. We have posted my letter to my elected officials, and a sample letter you can customize as well. The changes will affect far more than what I expect most people would consider the “wealthy”. The politicians and media need to understand that these proposed changes go far beyond taxing the “wealthy”, and are actually harmful to business and the economy.
- Ensure you are talking with your tax and accounting advisors to set up strategies to mitigate the impact of these corporate tax planning changes. Keep in mind that the legislation has not been finalized and not all of it has been issued in draft format yet. Planning is of course challenging when we are not aware of all the rules we have to play with. But the time to start preparing is now.
- The government is accepting submissions on these proposals. You can send the submissions as outlined at this link: http://www.fin.gc.ca/activty/consult/tppc-pfsp-eng.asp
George E. Dube, CPA, CA
Tax Partner, BDO Canada
Real estate accountant, real estate investor, speaker, author