What Happened on July 18?
On July 18, 2017 the Liberal Government released a “Discussion Paper” and related “draft” tax legislative proposals (“Proposals”) which fundamentally changes (and dramatically increases in many cases) the taxation of family business corporations in Canada.
Under the cloak of “fairness” (as defined by this Government; not surprising, “fairness” is a term found nowhere in Canada’s Income Tax Act), the undercurrent of this legislation and the accompanying “Discussion Paper” is anything but fair, and is hostile in its tone and effect in an unprecedented manner.
What will be the Results of the Proposals?
The Proposals alter the established risk-reward equation for starting or growing a family business in Canada; they do nothing for “risk” and seek to tax away substantially more “reward”, if there is success.
Here will be the results of the Proposals:
1. The Proposals will make the after tax economics of starting or growing a family business in Canada less attractive. (This Government’s statement that Canada is “open” for business is becoming increasingly meaningless and disingenuous, especially for family businesses.)
2. The Proposals will, in a degree and magnitude not addressed in the Discussion Paper, result in less investment and employment in Canada, with family businesses, as practicable and desirable, exploring alternate opportunities to invest and grow employment outside of Canada.
3. The Proposals, in concert with other significant tax increases, make us uncompetitive (i.e., effective tax rates substantially over 50%) vis-a-vis other jurisdictions for individuals and families to start and grow family businesses, including the US with upcoming tax reforms.
Are these the results the Government intend the Proposals to accomplish?
Proposals are Hostile in both Tone and Effect
The Proposals are (i) incredibly complex, (ii) will not be properly understood by either business owners or their general accounting or legal advisors, and (iii) will require the expense of tax specialists (which may or may not be affordable for family business owners) in order to try to navigate through numerous snares and traps embedded in the Proposals resulting in ridiculous tax rates well in excess of 50% and double taxation, along with residual uncertainties resulting in more tax disputes with the CRA.
Why are the Proposals so Hostile?
In tax law, details matter; the authors of the Proposals are unaccountable Government Bureaucrats at the Department of Finance who were tasked by this Government to draft their legislative priorities.
In drafting the Proposals, these Bureaucrats made deliberate choices to adopt, unnecessarily, harsh approaches to legislate these priorities with retroactive effects (i.e., rewrite the tax implications for historical transactions), over the top resultant tax rates, and double tax traps. Why did these Bureaucrats make those deliberate, hostile, over-the-top drafting choices?
Was Justin Trudeau or Bill Morneau aware of these “details” when they released the Proposals on July 18, or was there a rush to go on summer vacations?
Family Business Owners vs. Government Bureaucrats, who is treated more “Fair”?
The Proposals target three areas: income splitting, reinvesting family business profits for retirement savings, and capital gains from family businesses.
Not surprisingly, the “Discussion Paper” uses self-serving examples to justify the changes. To illustrate the unfairness of the Proposals, we will not use the examples favored by the Discussion Paper, and will instead contrast the changes between two families, Mr. and Mrs. Retailer, and Mr. and Mrs. Government Bureaucrat working at the Department of Finance.
Mr. and Mrs. Retailer are not rich. They own a retail store in a private corporation in Ottawa which employs other Canadians. Mr. Retailer works all the time in the business; Mrs. Retailer stays at home and looks after their minor children. Before paying themselves anything, we will assume their corporation makes $220,000 in net income. Mr. Retailer pays himself a salary of $110,000 and pays Mrs. Retailer a dividend of the remainder after paying applicable corporate income taxes.
As a comparison, Mr. and Mrs. Bureaucrat work in Ottawa with the Department of Finance, have no children, both make $110,000 in salary ($220,000 in total household income), weeks of paid vacation and banked sick time, both have a taxpayer funded, risk free defined benefit pension plans which, as per the Canadian Federation of Independent Business, Mr. and Mrs. Bureaucrat contribute to about only 50% of its estimated costs (and prior to 2017, only about 37%), with the majority balance paid for by taxpayers, including Mr. and Mrs. Retailer.
Income Splitting Attack – Top Rate Tax and Retroactive Tax Effect
There are numerous complex and punitive attacks under the income splitting Proposals, but the most common attack will be on the spouses and common law partners of active family business owners who are not paying their “fair share”.
Prior to the Proposals, the families of Mr. and Mrs. Retailer and Mr. and Mrs. Bureaucrat would have similar after tax family incomes on their similar before tax family incomes. That is fair.
The Proposals change that result. Under the Proposals, all of dividend to be paid to Mrs. Retailer, whether paid to Mrs. Retailer, or redirected to Mr. Retailer, will result in their family paying well in excess of $10,000 of additional tax each year versus Mr. and Mrs. Bureaucrat’s family on the same $220,000 total of family earnings. Is this fair? It appears this Government thinks so.
Ironically, the Discussion Paper refers to a “gender based analysis”; the value of a spouse or partner who stays at home to care for the children (usually the female) to support the efforts of the active spouse or partner in the family business (usually the male) receives zero recognition under the Proposals. Is that fair? Not according to Canadian matrimonial law.
The Proposals are retroactive in effect. They not only apply the punitive tax rate to future earnings of the family business but also past retained profits in the family business. If Mr. Retailer retires in 2018 and wants to pay a dividend to Mrs. Retailer out of retained profits during their retirement years which were earned over a period of prior decades prior to the Proposals; the punitive top rate on the dividend will apply on that income also, an indirect way of imposing a retroactive tax on earnings retained in a corporation under a different set of rules and expectations! Is that fair?
Statistically Mr. and Mrs. Bureaucrat will retire sooner than Mr. and Mrs. Retailer. As it relates to the taxpayer funded pensions of Mr. and Mrs. Bureaucrat, the Proposals do not address their ability to income split with each other if one of them has higher pension income than the other or none. No proposed changes here – nothing at all. Is “selective fairness”, fair?
If this Government was sincere in its confessed aim in “making sure that we all pay our fair share of taxes – with no exceptions” the Proposals would level the playing field for all taxpayers by allowing all taxpayers, business owners or employees, the choice to file joint tax returns with their spouses or common law partners thereby availing tax efficiencies for all taxpayers instead of selectively taking it away for some and letting it remain for others. That would be most fair, even better than status quo.
Other nations have adopted this superior, “fair” approach, such as the United States; allowing for joint tax returns respects couples’ individual choices as to their agreed upon work and family priorities.
Retirement Savings Attack – Tax Rates > 70%
Mr. and Mrs. Retailer do not have the guaranteed, generous Government pension plan of Mr. and Mrs. Bureaucrat. Like many owners of family businesses, they compensate by risking a portion of their business after tax profits to earn non business income to fund their retirements. However, there is a significant cost to doing so; corporate non-business income is taxed at a higher, ultimate tax rate (over 50%) than if earned directly.
By way of contrast, those non business earnings are at risk, not guaranteed, and do not accumulate tax free, as in the case of the pensions of Mr. and Mrs. Bureaucrat. Moreover, 50% or more of the ultimate payouts from the corporation of Mr. and Mrs. Retailer are not subsidized by the taxpayers of Canada, as in the case of the Government pensions of Mr. and Mrs. Bureaucrat.
While nowhere near as advantageous as Mr. and Mrs. Bureaucrat’s pensions, the Proposals attack the perceived unfair advantage that these corporations have because they start with higher amounts to invest because of lower corporate tax rates on business income versus if it was earned personally.
Unfortunately, the concept of corporate tax integration, including tax rates of over 50% on investment income, is not understood by the general population and the Government has decided to take advantage of this misinformation to squash the modest advantage of using a family business corporation as a substitute pension vehicle. For whatever reason, a 50% or more tax rate is not enough and the Proposals would result in effective taxes well in excess of 70% on such earnings. Is that fair? What rational person would ever invest in those circumstances?
Implicit in applicable tax rates in excess of 70%, do our provincial and federal Governments think they are more entitled to Canadians’ income than the Canadians who earned it?
In this toxic environment, the Proposals will drive away significant investment by family businesses, where capital is becoming increasingly important because of the growing exodus of foreign investment, resulting in harmful consequences to the Canadian economy. Is that what this Government wants?
Capital Gains Attack - Double Tax with a Retroactive Tax Effect
Canadian taxpayers have witnessed dramatic income tax increases over the past few years. For example, in Alberta the top marginal tax rate has increased from 39% to 48% in just a couple of years and in other provinces, top marginal rates now exceed 50%! However, with a 50% inclusion rate, capital gain tax rate increases have been more insulated from other tax increases, including on dividends.
The Proposals seek to eliminate opportunities to benefit from this lower tax rate, whether intentionally or unintentionally (including due to ridiculously complex and overly broad changes to the intercorporate dividend rules by the Department of Finance) in a private corporation context. The Proposals will impose a double tax in such circumstances, and seek to impose retroactive tax on transactions that occurred in the past under a different set of rules! Is that fair?
What Can You Do?
This Government and the Bureaucrats at the Department of Finance appear to have forgotten that without a private sector (most of which is directly or indirectly attributable to family businesses) there is no money to pay for the public sector, including the salaries and pensions of Mr. and Mrs. Bureaucrat.
Even if one holds to a belief that the Proposals are “fair”, if the ultimate impact of the Proposals is to diminish Canadian family businesses, the largest private employer and direct and indirect contributor of tax revenues in Canada, is this wise Government policy? Do we want to encourage successful family businesses, with tax revenues and employment that accompany them? Is it prudent to pile on more cumulative disincentives for risk taking, growing and employing in these challenging times? Who will be causing harm to Canadian employees –family businesses providing these employees with livelihoods, or reckless Government Proposals which diminish, and in some cases, will take away those livelihoods?
This Government has an opportunity to make meaningful, long term positive tax policy changes to address concerns and improve economic competitiveness; however these hostile and destructive Proposals with a disingenuous 75 day “consultation” process started during the middle of the summer do not make the cut. Humility will be required to make the required course correction.
Canadians should be concerned about the destructive, direct and indirect, short and long term, economic impacts which will occur under the Proposals and emphatically and sincerely inform our local Government representatives, as well as the Department of Finance ([email protected]), Bill Morneau ([email protected]), and Justin Trudeau ([email protected]) of our concerns.
Hopefully goodwill and common sense will prevail.
- Jason Stephan
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