After several weeks of insistent rhetoric from Ottawa, entrepreneurs across Canada finally received some good news when the federal government began rolling back proposed tax changes for corporations. Although there is still a lack of detail, at least on the surface, there appears to be some compromise. However, there are still some troubling proposals on the table that require greater clarity, and in the case of the proposed taxation of passive income, should likely be abandoned altogether.
Acknowledging the business community’s discomfort with proposed measures to restrict three tax-planning tools commonly used by corporations–income sprinkling to family members, limiting the ability of business owners to grow passive income portfolios within a private corporation and converting regular corporate income into capital gains–embattled Finance Minister Bill Morneau this week offered a series of tweaks to the government’s proposed tax changes.
Some very good news that Morneau announced, although again with lack of clarity, is that Ottawa will not move forward on a plan to limit the conversion of income into capital gains. The concession came as irate farmers and fishers–not to mention owners of incorporated businesses across industries–argued that the measure would disproportionately impact their ability to transfer a business between generations. Critics pointed out that the change would have made it virtually impossible for entrepreneurs to pass a family business on to their children without incurring a crippling tax burden. In a statement, the Department of Finance (DOF) said that, “The Government will work with family businesses, including farming and fishing businesses, to make it more efficient, or less difficult, to hand down their businesses to the next generation.” I would applaud this move, but in reality the proposed rules shouldn’t have been tabled to begin with, as they were extremely poorly drafted and far too complex to administer in any event.
A day earlier Morneau confirmed that the government would move forward with changes to rules around holding passive investments in a corporation, in what the DOF feels is a more amenable format when compared to the original planned reforms. As outlined by the DOF, the new measures will ensure that:
- All past investments and the income earned from those investments will be protected
- Businesses can continue to save for contingencies or future investments in growth
- A $50,000 threshold on passive income in a year (equivalent to $1 million in savings, based on a nominal 5-per-cent rate of return)–an amount that is exceeded by only about 3 per cent of corporations–is available to provide more flexibility for business owners to hold savings for multiple purposes, including savings that can later be used for personal benefits such as sick-leave, maternity or parental leave, or retirement
- Incentives are in place so that Canada’s venture capital and angel investors can continue to invest in the next generation of Canadian innovation
This is not an ideal compromise. While the DOF claims that the new proposed rules represent a substantial concession that will protect the majority of business owners from unfair levels of taxation, the proposed threshold is not nearly high enough for mid- to large-size organizations that employ several dozen to several hundred employees. Moreover, the proposed rules are still very complex and practically unworkable. They also create a divide for historical wealth and the creation of new wealth, effectively providing a disincentive for those looking to grow and accumulate wealth. Once more, there doesn’t appear to be sufficient evidence to support the claims of a substantial financial advantage for those earning passive income through their corporations. The examples provided by the DOF do not use actual provincial taxation rates. When modelled out using actual provincial rates, there’s no significant advantage. In certain provinces, the exact opposite is the case as passive income is grossly under-integrated, meaning there’s an actual tax cost to earning this passive income. So, although the government seems to be making a compromise, a more prudent and fair approach would be to abandon these rules altogether, as it did with the surplus-stripping proposals.
Lastly, the Liberals made good on a campaign promise to lower the small business tax rate to 9 per cent by January 1, 2019, down from the current 10.5 per cent. Plans were also announced to “simplify the proposal to limit the ability of owners of private corporations to lower their personal income taxes by sprinkling their income to family members. The vast majority of private corporations, including corporations with family members who meaningfully contribute to the business, will not be impacted by the proposed income sprinkling measures,” according to the DOF. Plans to limit access to the Lifetime Capital Gains Exemption were also scrapped.
While the income sprinkling plans are vague and require further clarification, these announcements are a step in the right direction. The Finance Minister will table the Fall Economic Statement tomorrow, at which time the government promises to provide further detail as to how it intends to implement tax changes for corporations. I can only hope these changes will leave us with a workable solution rather than subjective legislation.
While the exact form and function of that new legislation is still hazy, it’s clear that the business community and hard-working entrepreneurs made their voices heard in the debate over how to improve tax fairness in Canada. We can only hope that Morneau and Prime Minister Justin Trudeau continue to heed their concerns.
Armando Iannuzzi, Partner