With its filleting knife in hand, the Trudeau government in July 2017 announced changes to income splitting, passive investment and capital gains that had farmers, small business owners, doctors and lawyers howling. The good news is some of the proposed changes won’t happen. The bad news is some of them will – and fast.
“Most witnesses told our committee that the proposed changes should be withdrawn in their entirety,” the Standing Senate Committee on National Finance reports. “We are inclined to agree. We are not convinced that the government has made a good case for its proposals.”
The government’s proposals are inspired by some academic papers and driven by Prime Minister Justin Trudeau’s apparent belief that self-employed people are avoiding taxes by using provisions for business.
Proposals were introduced with only 75 days for feedback. The Senate committee listened from September until the report’s release in December. Tax reform, it said, should begin with really listening to Canadians, then identifying the problems and presenting solutions.
The Senate report proposed that changes not apply until 2019, at very least. Incredibly, Finance Minister Bill Morneau announced, “everything’s a go” for Jan, 1, 2018, because the 2018 taxes won’t be paid until 2019. “They’ll have 12 months to figure that out,” he said. “We think this is entirely appropriate and consistent with past practice.”
That naïve conclusion had already been disproven in September when a tax expert and former finance minister said wealthy Canadians had already moved their money out of the country. A Canadian Federation of Independent Business (CFIB) spokesperson added, “There’s all sorts of business immigration programs that are out there encouraging entrepreneurs to pick up and leave.”
Whether the business community waited or not, the picture of what will soon happen is now more clear.
Let’s begin with income sprinkling. Some family-owned businesses use dividends to sprinkle income to all adult members of the family, preventing high taxes on personal income for the top earners. Canada Revenue Agency will now require recipients to prove their contribution to the business through labour, property or by assuming risks.
Public backlash led exemptions for spouses over 65, those 18 and over who work 20 hours or more per week, or those over 25 who own 10 percent or more of the company. Even so, the Senate report predicts, “The difficulty of understanding and complying with the rules will lead to uncertainty, foster tax appeals and litigation.”
Additionally, the government wants to target passive investment income, a move that the Parliamentary Budget Officer expects will get the government an extra $1 billion annually in the short term and as much as $6 billion annually 20 years from now.
It has always been an advantage for a company to invest the money it retained because the only tax paid on the base amount was the small business tax, not the personal income tax. Proposals from July suggest removing the refundable potential of passive investment taxes, which means a whopping marginal tax rate of 73 percent on passive income.
Following public outcry, the government is allowing the first $50,000 a year of this passive investment income to remain as it was, which leaves 97.5 percent of Canadian businesses untouched by the new rules. But the CFIB says a $250,000 threshold would be less threatening to business growth.
The government also abandoned the concept to keep family members from splitting the lifetime capital gains exemption (LCGE). Now, those couples intending to sell their business to retire can breathe a little easier. However, it’s still more expensive and complicated to sell a business to an owner’s children at 45 percent than to a third party at 26 percent.
These small adjustments leave most of the bad ideas intact.
No one doubts that Canada needs tax reform. But there’s filleting and then there’s butchering.
Lee Harding is a research associate with the Frontier Centre for Public Policy.