Suggestions for Morneau’s tax changes

TheStar.com – Opinion/Commentary – If enacted, the federal finance minister’s tax measures will have a significant detrimental effect on small business and the Canadian economy.
Sept. 26, 2017.   By

In my 36 years as a tax lawyer, I have never seen proposed amendments to the Income Tax Act cause more discussion, concern and anger than the proposals released by Minister Bill Morneau on July 18. If enacted, these measures will have a significant detrimental effect on small business and the Canadian economy.

The proposed rules will limit income sprinkling, restrict the ability of a shareholder of a private company to convert dividend income into capital gains, limit capital gains exemptions of family members and impose a new non-refundable tax on investment income earned by private companies.

These proposals will result in a massive tax increase, primarily from one amendment that has not received much attention. This is the increase in the tax on death because of the elimination of the “pipeline strategy:” The tax payable following the death of an individual who owns shares of a private company increased by 20 percentage points or more. This is likely the largest tax grab in the last 35 years.

So, how do we appease this anger, move forward in a sensible manner, protect the Canadian economy and put an end to the rhetoric surrounding the so-called “loopholes?” Here’s what I would do:

1. Spouses owning shares of a private company should be taxed on dividends from the company in the same way. Let’s not call it income sprinkling. Instead, let’s just say the family owns a business and both spouses own shares. If that provides the family with the ability to income split, so be it. Consider permitting other Canadians to split income with their spouse to some degree. Income splitting between spouses is already permitted to the approximately 30 per cent of Canadians who receive a pension.

2. Provide that any family member who has worked for at least two years full-time for the family company should be taxed at their marginal rate on dividends from the company. Other family members can be taxed at the top-rate on dividends unless they have made a meaningful contribution. This will make the rules easier to understand and straight forward for the Canada Revenue Agency to administer.

3. The proposed rules on the multiplication of the capital gains exemption are too complicated. The exemption should only be available to both spouses and any family members working full-time in the business at the time of sale. This will make the rules simple to understand and easy for the Canada Revenue Agency to apply.

4. Before imposing an additional punitive tax on private company investment income, Finance should consider how all companies are taxed on investment income arising from retained earnings not utilized in the business. Currently, investment income earned by public companies is taxed at 26.5 per cent in Ontario. Canadian-controlled private companies pay tax on investment income at 50.17 per cent and receive a partial tax refund when dividends are distributed.

To even the playing field, eliminate the small business deduction for any private company that earns more than a certain amount of investment income in a year. If the proposed tax on investment income becomes law, private companies will stop making risky investments, which will greatly reduce the tax revenue generated. Why would a private company invest in a risky venture where a sizable portion of any gain has to be paid to the government?

5. Finance must rethink the rules on changing the tax rate payable when a taxpayer dies. Dying is not a matter of choice and taxes are accelerated as a result of death. To almost double the tax on death without any grandfathering is incredibly unfair. To apply double tax on families where parents pass away is cruel. Many taxpayers have made plans to fund the tax on death by buying life insurance. Many may now be unable to buy additional life insurance to fund the additional tax since they may no longer be insurable. Selling the company to a third party instead of keeping the business in the family may save tax.

6. I am sure that when the Liberals raised the top marginal rate for individuals to 53.53 per cent in Ontario, they thought they would collect more tax revenue from the wealthy. I suspect that this did not happen. Studies have shown that increasing the tax rate over 50 per cent does not generate any additional revenue. Lower the top rate and the number of corporations will decrease without collecting a nickel less tax from the wealthy.

David Malach is a partner at Aird & Berlis LLP in Toronto. He is a senior member of the firm’s tax group and co-chair of the tax litigation team.

https://www.thestar.com/opinion/commentary/2017/09/26/suggestions-for-morneaus-tax-plan.html

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