Response to Consultation paper on Tax Planning Using Private Corporations
This is the letter that I've submitted to the Honourable Minister of Finance as my response to the consultation paper on Tax Planning Using Private Corporations dated July 18, 2017:
Minister of Finance
The Honourable William Francis Morneau
Department of Finance Canada
90 Elgin Street
Dear Honourable Mr. Morneau, Minister of Finance;
I operate a Chartered Professional Accounting firm and provide corporate and personal tax and financial advice to my clients, the vast majority (~80%) of whom are corporate small business owners. I operate out of my home office, as a sole proprietorship, so these requests for changes are not coming from me benefiting myself. They are coming strictly from a perspective of trying to look out for my clients.
Although I respect the motivations of the federal government trying to make the "perceived rich" pay what they feel is their "fair" share, you’re not taking the time to consider what the repercussions are going to be on those that operate their businesses in the same structure as those that they believe are "taking advantage" of "loopholes".
I also agree that changes to the current system need to be made in order to simplify the system, but I do not believe that these changes will be simpler to understand, nor simpler to administer.
All of my current clients fall under the small business deduction for their net income, therefore they are all considered “small” businesses that you have determined will be unaffected by these changes, however, the unintended consequences will reach them.
When you create such a wide-spread solution for what has been named as a targeted problem, there is bound to be collateral damage.
Also, it seems that these proposals are coming as a response to the creation of an environment of preferred incorporation by the changes that have already been made in the last few years of tax legislation. An increase on the rate of tax paid by the highest income earners motivated them to incorporate. A decrease on the small business corporate tax rate motivated small partnerships and sole proprietors to incorporate. Then there was a significant increase in the number of incorporations of CCPCs (Canadian Controlled Private Corporations). It seems reasonable that sole proprietors and partnerships would then incorporate to save taxes in order to be able to reasonably be able to reinvest in the growth of their businesses, rather than be taxed on every dollar earned in the business at a personal rate.
Implementing the reasonableness test to determine the distribution of funds from the corporation will become arduous and the documentation completely unworkable. It’s the creation of a situation where a small business owner that has worked in his/her small privately owned corporation for many years is now ready to retire based on their corporate structure and resulting estate freeze that has been in place since long before July 18, 2017. They’ve likely taken as little money out of the corporation as possible to fund their private lives, but now, instead of being able to reasonably retire based on the careful planning of their investment in their corporation and therefore, in themselves, they now will have less than half of what they had planned and therefore will be able to fund less than half of their retirement. This is effectively raising taxes, especially on those that cannot reasonably afford it.
Also, when corporations are struggling, shareholders typically seek investment from family members (either loan or investment) as many do not qualify for commercial or small business financing. These “angel” investors will now also be captured under the income sprinkling reasonability test which effectively tells all corporate shareholders’ family members that investing in un-related corporations is a smarter investment than supporting the family member in their endeavour. This is in contrast to the Liberal government’s comments that you’re trying to increase the investment within the small business/middle-class market.
The ability to invest corporate money into passive investments is a smart business decision in order to help smooth out earnings in a corporation and get through rough economic times. Many corporations make investments, ranging in size, to assist with cash flow when revenues are not able to cover payroll, rent, overhead, etc. More often than not, during these times the corporate shareholders take little to no distribution for themselves to ensure that their payroll and other required expenses are covered. These investments are not made for personal gain; they are made to ensure that the corporation is able to withstand bankruptcy when navigating through years such as 2014 – 2016 in Alberta.
Again, tracking of the distribution from the corporations between active business income and the passive investments held within the corporation is going to be a time-consuming and demanding task that will be up to the already over-burdened CRA to administer and audit.
I agree that there corporate shareholders that are using the pipeline planning specifically for the purposes of decreasing the amount of tax paid on dividends from their corporations. However, with the proposals set up currently, this also captures any transition of corporations to the younger generation or the distribution from corporations of deceased shareholders to their estate and beneficiaries. Ultimately, the way the proposals are written creates a situation where transitioning the corporately-owned family farm to a family member will be so costly that it is more beneficial to sell to a non-arms’ length party or foreign entity. I cannot believe that this was the intention of the proposal, and yet, as written, it captures estate and succession planning in addition to the intended individuals stripping dividends as capital gains. This proposal definitely needs some rework to ensure that the targets are met and the collateral damage is minimized.
We all grew up in a country where our parents urged us to get a job, go to school, learn and eventually work for ourselves so that we could control our own destiny. However, the message that is being delivered is that to be an employee is preferable to being a small business owner because you’ll have access to benefits, social programs and retirement programs and paying whatever marginal tax rate is required of you based on your earnings as an employee. As a small business owner, instead we have no holidays, work hours of overtime with no pay, can only qualify for EI as long as we’ve opted into it and pay both portions for ourselves, in addition to our employees, we do not qualify for RRSP contributions unless we can afford to pay ourselves a salary, which based on fluctuating revenues is always difficult to manage which is why we pay dividends (which do not qualify for RRSPs), invest our own personal resources and put up personal collateral for business loans (when we can get them), re-invest back into the economy by paying our employees (and their EI and CPP), creating taxable income and expanding our businesses; and yes, we bring income into the household for both us and our spouses (because we feel that all family members contribute to the earnings of the business in one way or another).
But these two are not comparable; they are mutually exclusive and for the benefit of the Canadian society as a whole must remain so. Our country needs our small businesses and we need our public servants and our small businesses and large businesses need employees to be able to run properly.
I urge you to consider that the collateral damage may not cripple the small business economy in Canada, because, we are, after all, resilient, but there will be great damage and many small businesses will crumble under the pressure. As a result, not only will those small business owners now be jobless and seeking employment, but all of their employees will be as well.
Robin Mitchell, CPA, CA, CAFM
RAM Accounting & Consulting