REVISIONS TO TAX PROPOSALS – ROUND TWO
This morning the Finance Minister introduced revisions to his July 18th tax proposals, after setting an insulting “consultation period” of 75 days in the middle of the summer, when Parliament was not in session. It feels like we are heading into the second round of a multi-round boxing match.
He now claims that the Liberals have listened to concerns from taxpayers and advisors across the country. This is disingenuous, since the officials of the Department of Finance has over 21,000 written submissions from taxpayers and tax professionals. Some of the submissions were in excess of 100 pages. Jamie Golombek, Managing Director of Tax & Estate Planning for CIBC calculated, in an article in the Financial Post on October 12th, that if the Department spent just 10 minutes per submission, it would take 465 work days to review all of the submissions.
However, the talented people at Finance have managed to review and consider all of these submissions in only 2 weeks. We are certainly fortunate to have such good people working for us.
It should be noted that the Senate Standing Committee on National Finance is still in the middle of its hearings into the July 18th proposals.
Passive Investment Income
In a very weak reaction to the solid opposition he has received about his proposed treatment of passive income, the Minister has re-affirmed that all accumulated savings, presumably up to December 31st, 2017, in a Canadian controlled private corporation (CCPC) and any earnings generated by those savings will not be subject to the new passive income rules.
It remains to be seen how the legislation will ensure that that happens. Some of us recall June 1982 when the government introduced a 12.5% Part II tax on dividends paid out of low rate active business income. In order to preserve the existing capital base, which could be distributed without Part II tax, we established holding companies to crystallize the amount that could be distributed without the tax. Again, the government has no concept of the trouble and expense to which they are putting small businesses.
In respect of any future accumulations of capital, there will be a limit of $50,000 per year of passive income that will be exempt from the new rules. Presumably, any investment income in excess of this amount will be subject to the new rules, and the tax could be as high as 73%.
The additional problem is one of complexity. The Finance Minister has been told repeatedly that his proposals are too complex. This change in the passive income rules will make the system even more complicated. There could now be multiple regimes of refundable taxes. Refundable taxes have been in place since 1972 and provide for a refund of corporate tax when a CCPC pays taxable dividends to its shareholders.
Now small businesses will have to track pre-2018 capital and the income generated on that base. Presumably the income generated on any re-investment of that capital will be subject to the new rules. Annually the business will have to track its investment income up to $50,000 and any income in excess of this amount. All of these sources of income will be taxed differently, and will likely each be subject to a different regime of refundable taxes. Presumably the accountants will be able to track this, at a cost to small business, but it is certainly beyond my abilities.
The Government indicates that they will continue to examine all matters related to passive investments and will continue to assess the technical aspects. For example, consideration will be given as to the appropriate scope of the new tax regime with respect to capital gains, including whether in certain circumstances the new rules should exclude capital gains realized on the sale of shares of a corporation engaged in an active business.
What about income earned on capital held within an active business company in order to satisfy banking covenants or bonding requirements. Is this capital an active business asset – it would be for capital gains exemption purposes. How is the income generated on this capital to be treated?
There is some good news for the farm community. The proposed changes to passive investment will not apply to income from Agri Invest, which is a self-managed producer-government savings account that allows producers to set money aside which can be used to recover from small income shortfalls, or to make investments to reduce on-farm risks – under the current system, investment income in an Agri Invest account is treated as active business income. The government's intention is to maintain this treatment.
The details of the proposed measures will be released in Budget 2018, including a technical description of how the passive investment income threshold will be applied. This will leave the entire system in turmoil for months to come.
In his Budget Speech on March 22nd, 2017, Finance Minister Morneau stated, “Canadians expect a fair tax system”. How fair can a system be when it becomes too complicated for any, except the tax professional community, to understand?
Morneau also stated, “Mr. Speaker, I have been very fortunate in my life to have had a successful career in business. And I've always paid my fair share of taxes.” One must ask if the average Canadian believes that he has always paid his fair share of taxes when, as the head of Morneau Sheppell, he set up a subsidiary in the Bahamas and registered it in Barbados. Or, whether he paid his fair share when he established an investment holding company in Alberta to hold his shares of Morneau Sheppell, worth as much as $35 Million Dollars, when the ONLY reason to hold the shares in an Alberta company is to take advantage of lower tax rates.
What else do we know?
These issues were dealt with by Morneau on October 17th.
Reduction of corporate tax rate for small business corporations
Stephen Harper’s government had already announced a reduction in the rate of corporate tax paid by a Canadian controlled private corporation (CCPC) on its first $500,000 of active business income. One of the Liberal’s first moves was to cancel this tax reduction.
Morneau’s announcement is simply a reinstatement of the tax cut. It will reduce the tax that a CCPC will pay on its first $500,000 of active business income, gradually, starting in January 2018. The rate will reduce from 11% to 10% in January, 2018, and to 9% in January 2019.
A cynic might observe that the 9% rate will kick in before the next federal election.
This reduction, when fully implemented would amount to a tax saving of $7,500 for a CCPC earning the full $500,000. Most CCPCs do not earn close to that amount, so the benefit to the middle class is marginal at best.
There has been no significant change to these provisions.
The Finance Minister says that they will simplify the administrative burden on the family to prove that a family member has made a “reasonable contribution”. But, if the taxpayer can’t satisfy that burden, they will still tax their dividends at the top personal tax rate.
The only small beneficial change is that they have now referred to contributions as including, “past contributions”.
This will do nothing to reduce the massive volume of tax objections and appeals that we will see.
It will take 10 years before the Supreme Court of Canada determines what is a “reasonable contribution, so the entire tax system will be in a state of uncertainty until then. How is this a fair tax system?
What is clear, is that all CCPCs with “non-active” family members as shareholders will be paying out large dividends before December 31st, 2017 in order to take advantage of existing tax rates.
Lifetime Capital Gains Exemption
They announced that they will not proceed with provisions that would limit access to the Lifetime Capital Gains Exemption.
Hopefully, this will mean that shares owned in a family trust will still qualify for the Lifetime Capital Gains Exemption.
What Don’t We Know?
Inter-family Transfers of Family Farms and Businesses
Morneau said, in his press release on October 17th, that they would work with Canadians to ensure that the tax rules won’t affect the transfer of a family business or family farm to the next generation.
To do this will require amendments to the existing Section 84.1 which makes is more tax efficient to sell your business to an outside party than to your own children. Simply saying that they won’t change the rules related to the Lifetime Capital Gains Exemption is not sufficient to accomplish this goal.
Conversion of Ordinary Income into Capital Gains
Nothing has been said about these provisions. Some of the provisions to which Morneau has referred are in place to eliminate double, and sometimes, triple taxation of the same amounts. The changes to Section 84.1 announced in July can subject a deceased taxpayer and his estate to taxes as high as 93%.
There has also been nothing announced concerning proposed Section 246.1, which has retroactive effect and could, as drafted, eliminate the ability of a CCPC to pay out the untaxed portion of capital gains in the form of tax-free capital dividends. Again, this has been part of our tax system since 1972 and is crucial to ensure integration of personal and corporate taxes without imposing double or triple taxation.
No doubt there will be more releases from Finance, which remind me of the movie Lies My Father Told Me, and much more commentary from me and others as the weeks progress.