Government Attacks Entrepreneurs

On July 18, 2017, Finance Minister Morneau tabled a consultation paper and draft legislation that proposes to significantly change how private corporations and their shareholders are taxed. The tax burden on both an individual shareholder and private corporations will suffer major increases.

For the last 43 years, Canada has taxed private corporations and their shareholders based on the concept of integration. Integration means that the after tax income received by the shareholder would be the same whether income was earned directly or earned in a company and paid out as a dividend to the shareholder.

In BC, the lowest rate of corporate income tax is 13.5% on qualifying income under $500,000 annually. Active income that does not qualify for the low rate is taxed at 26%. Investment income is taxed at about 50%. When earnings that have already been taxed as active income in the corporation are further distributed to shareholders or individuals, additional income tax is paid personally so that the total rate is about 50%. When investment income is paid out as a dividend, the shareholders pay tax and the company gets a refund so that there is essentially no additional tax.

At the end of day, under the current rules and through the concept of integration, an individual should pay the same amount of tax whether the income is earned personally or whether that income was first earned corporately and subsequently flowed out to the individual as dividends. That said, an individual who first earns active business income corporately receives a “tax deferral” until the time that the funds are withdrawn from the corporation. It is this deferral that is the cause of concerns outlined in the consultation paper released by the Department of Finance.

There are three major areas that the consultation paper addresses:

A. Income Splitting
B. Passive Income in Private Corporation
C. Converting Income into Capital Gains

A. Income Splitting
There are already provisions to discourage income splitting with children younger than 18 years old. Income splitting is a strategy to have income taxed in the hands of lower rate individuals. This proposal would extend the additional tax on ‘sprinkled’ income to related individuals under 24. The proposal goes further to include adult individuals who cannot demonstrate that they contributed a reasonable amount of service or cost of share acquisition to justify the income received. Draft legislation would implement these provisions in 2018.

B. Passive Income in Private Corporations
The proposals in this area seem to be based on a concept that the shareholders of private corporations should not receive preferential tax treatment over salaried employees. The Department of Finance has forgotten the entrepreneurial risk that shareholders take on and the fact that about half of economic activity and job creation is generated by private businesses. Even salaried employees should be concerned that these proposals will prove to have a severely negative impact on the Canadian economy. The proposals made by the Department of Finance include the following:

  1. A tax deferral should only apply when funds are reinvested in an active business.
  2. There should be no advantage to private corporate shareholders over salaried employees in terms of after tax results and tax strategies. Planning that has been well used for a generation will no longer be viable.
  3. Integration may no longer apply and the overall combination of corporate and individual rates could exceed 70%.
  4. The proposed rules make it more difficult for business owners to retain and accumulate funds in a company for future investment and for better banking arrangements.
  5. Public companies will not be subject to the changes.

C. Converting Income into Capital Gains
These proposals are technical in nature and apply to fewer individuals. Proposals to restrict multiplying capital gains exemption also have more limited application.


 

Contacting Your Representative

These discussion proposals will proceed unless an overwhelming response is received from Canadians who are either private corporation shareholders or individuals who realize that the implementation of these proposals could be disastrous for the Canadian economy.

We are suggesting that you write to your Member of Parliament and/or Minister of Finance Bill Morneau to communicate your concerns about the proposed changes.

The Honourable Bill Morneau
House of Commons
Ottawa, Ontario K1A 0A6

Telephone: 613-992-1377 Fax: 613-992-1383
Email: Bill.Morneau@parl.gc.ca

Your comments might mention that:

  • The contribution of private businesses accounts for almost 50% of economic activity and job creation.
  • In comparison to the taxation of salaried employees, entrepreneurs need to be encouraged by the tax system to create economic activity.
  • The importance of continuing tax integration and that the long hold concept of integration is not a “loop hole”.
  • Overall fairness and fairness in comparison with public companies.

Please let us know if you have any questions or comments.

Mark A. Zlotnik CPA, CA, CLU
Garry M. Zlotnik FCPA FCA CFP CLU ChFC

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