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This article was published 30/9/2017 (877 days ago), so information in it may no longer be current.
Taxes are a tricky subject for politicians.
Lowering taxes usually scores points. At the same time this creates another problem: less revenue for our mounting public expenses. Hiking taxes can also put political points on the board when new taxes are aimed at those familiar pariahs — smokers, boozers, gas guzzlers and… the wealthy.
But taxation also is a political porcupine.
Politicians — at least those holding the purse strings — are going to get a few, or a lot of, quills stuck in their hides along the way.
This has been true regarding proposed changes to taxation for Canadian-controlled private corporations — generally incorporated small businesses. Making good on a campaign promise, the Liberal government aims to end some tax preferences — to some, "loopholes" — that it argues some of Canada’s wealthiest are using to reduce their taxes unfairly through the use of corporations.
Yet what might have seemed like an easy score has turned into political wildfire with various business and professional associations claiming these changes are unfair and strip away compensation intrepid entrepreneurs should receive for taking risks and creating jobs.
Essentially, three broad changes are being proposed. One deals with income sprinkling, mainly paying dividends to adult family members such as a spouse. One involves taxation of money from income invested inside the corporation. The third and seemingly least controversial proposal has to do with converting dividend income to capital gains, which is taxed more favourably.
Other changes are pending too, including how the lifetime capital gains tax exemption on the sale of the business may or may not apply to shareholders who happen to be adult family members (a spouse, for example).
Overall, the changes are a kind of Rorschach test for Canadians. If you have a small business, the ink splat of proposed legislation may appear unnerving — or uncertain, at least. And if you’re a wage-earner, it might seem more fair than foul.
Wealth adviser Doug Nelson, a small business owner, says the proposed changes indeed paint a pretty grim picture, and he’s been a vocal critic as a result.
"There’s this assumption that entrepreneurs are gaming the system in some way when that’s not the truth at all," said Nelson, of Nelson Financial Consultants in Winnipeg.
"My conclusion to these changes is if you have a private corporation and you have a family member, who is a shareholder or working for the business, you will be impacted (negatively)."
For the most part, an entrepreneur could be facing a higher tax bill… under certain circumstances.
This particularly applies to the first measure aiming to rein in what Finance Minister Bill Morneau has referred to as income sprinkling.
According to an example set out in a Department of Finance discussion paper, professionals or entrepreneurs who own a private corporation and earn income at the top tax bracket — $202,800 — would pay about $79,000 in taxes if they take home the money as salary (a little less tax if it was paid as dividends). But under the existing rules, those owners could split $100,000 of this money with their spouses, for example, and pay about $35,000 less in tax.
Naturally, tax-advised high-income earners with the ability to set up a corporation are wise to do so under the existing rules if they have a spouse or an adult child earning significantly less income, or no income at all. Michael Wolfson, a researcher whose work provided some foundation for the proposed change, says by no means is this a tax dodge. But it’s a costly tax preference for the government coffers.
"The most succinct takeaway is the federal government could be forgoing on the order of half a billion dollars a year in income tax revenue," said Wolfson, an adviser with the Centre for Health Law, Policy and Ethics at the University of Ottawa.
Still, critics argue entrepreneurs need this kind of flexibility to properly compensate, for example, a spouse who as a shareholder assumes risk and liability related to ownership of the corporation. Moreover, the test for determining whether the shareholder assumes risk or does work worthy of compensation leaves a lot of questions unanswered and is likely to lead to unintended outcomes, Nelson said.
Equally unsettling in his opinion is proposal No. 2 — how invested income is taxed. He and other critics, including leading national accounting firms, have raised concerns this measure may hurt the ability of a small businesses to save for rainy days and, just as importantly, retirement (given entrepreneurs don’t have pension plans — though some do).
"If you are fortunate enough to have your company grow to a level where you are consistently earning more than you’re spending, then yes, you should have an opportunity within your corporate structure to accumulate retirement savings," Nelson said.
The likely changes, however, should not affect how a business saves for the future, the government paper states. The tax on income inside the business remains the same — about 50 per cent regardless of whether it’s interest, capital gains or dividend income.
The difference would be when those savings are paid out as dividends. They would no longer be eligible for the credit — at least that’s one measure under consideration.
According to the Department of Finance’s paper, the basis for this move is corporate income for a small business is taxed at 10.5 per cent (in Manitoba, small business income up to $450,000 is tax-exempt). That leaves a small business with almost 90 cents on the dollar to invest, as opposed to a wage-earner who has — at the top marginal rate — a little less than 50 cents left to invest in a non-registered account. (With an RRSP, by the way, both employees and entrepreneurs — taking a salary — can invest to similar benefit.)
From a wider perspective, the proposed changes are unlikely to affect small businesses much in situations where entrepreneurs are earning income taxed at less than the highest marginal rate, said Andrew Jackson, senior policy adviser with the Broadbent Institute. (In fact, a recent report by another left-of-centre think tank — the Canadian Centre for Policy Alternatives — estimates only one in eight small businesses would be affected by restrictions on income sprinkling.)
Rather, the proposals target the most those who are earning above the $202,800-a-year bracket and use the current system to reduce the taxes they pay legally, Jackson said.
"You can’t blame people for using to their advantage provisions in the tax system, so I don’t think it’s appropriate to call people tax cheats."
But the use of the rules has "become excessive and is not really justifiable," he added.
That’s why the Liberal government argues it’s trying to level the playing field.
Still, those who stand to be negatively affected view it differently, saying the field will be tilted against them.
"Small businesses are tax-generating machines," Nelson said. "We’re advocates of the government to create more wealth for government, so why would you want to kill your salesperson?"