Morneau’s “unintended consequences”
Tuesday, October 17th, 2017
The Department of Finance’s Backgrounder issued on October 16, 2017 titled “Income Sprinkling Using Private Corporations” is full of contradictions that you need to know about.
1. The government has not lowered taxes for middle class Canadians (still as yet an undefined class of persons) when you factor in the non-refundable tax credits eliminated by Mr. Morneau in his 2017 Federal Budget (public transit tax credit, children’s fitness credits and children’s art’s credits and the family tax cut.)
2. The OECD reports that Canada’s average wage in 2017 is $50,997. The 2017 tax burden in Ontario on this salary is $8,392 or 16%. The 2015 tax burden in Ontario on this salary was $8,652 prior to the changes in tax rates brought about by the Trudeau Liberals. This $260 advantage was more than wiped out by the loss of the credits cancelled in the 2016 and 2017 Federal Budgets.
3. Mr. Morneau fails to recognize that there are valid reasons for incorporating companies aside from tax planning strategies. Why would Mr. Morneau incorporate 2070689 Ontario Ltd. to own an Alberta based investment holding company in Calgary, 1193536 Alberta Ltd? How about the Florida real estate holdings owned by Mr. Morneau through 2254165 Ontario Inc., 1446977 Ontario Inc., 2135042 Ontario Inc. and 2135041 Ontario Inc. What does his wife own in NCM Holdings Inc.? Another one of his companies owns a villa in France. I suspect these companies have been set up to isolate risk and legal liability not solely for the purpose of tax planning strategies.
4. Mr. Morneau is about to make the problem worse by not addressing the structural problem of high personal tax rates and low corporate tax rates, and in fact cutting the small business rate even further to 9% in 2019 down from 10.5% in 2017. The Federal government encourages income splitting by continuing to increase the spread of tax rates. See my previous article highlighting this issue here.
5. So we are about to have the lowest tax rates in the G7 but almost the highest rates of personal tax in the G7 – there is no celebration here. Only Japan and France have higher personal tax rates (55.7% and 54.0%). Canada’s rate is 53.5% but the threshold for the highest rate to apply occurs at 4.3X the average wage. The highest rates in Japan kick in at 8.7X the average wage and at 14.8X the average wage in France. So we have a regime of low corporate tax rates, and I would argue the highest personal tax rates in the G7.
6. Jeremy, restauranteur in the government’s Backgrounder “Reducing the Small Business Tax Rate” is going to have $450 at his disposal to upgrade his restaurant’s kitchen thanks to the latest Federal tax cuts. I wonder what a $450 kitchen reno will get you these days?
7. How do the Liberals know that only 50,000 family businesses are sprinkling income? How can they extract the data from your annual tax returns that measures labour contributions, capital or equity contributions, financial risks, co-signing of debt and past contributions in respect of previous labour and capital? This is at best a guesstimate.
8. Income Sprinkling – Mr. Morneau’s term not ours – we prefer Income Splitting – has always been subject to the general limitation test in section 67 of the Income Tax Act. A corporation may only deduct an expense that is reasonable. Why do we need a whole new regime of red tape to address an issue that is already subject to a reasonability test? The cuts to the small business rate will cost government coffers $2.9 billion over the next 5 years. The Department of Finance thinks it can raise $250 million a year by curbing income splitting. Is anyone in Finance doing the math here?
9. The examples of Alicia, a single mother of two minors, and Brent his wife and two adult children are laughable. How many 4 person adult families do you know that have only one bread winner? How could you possibly compare that family to the single mom with two children of undisclosed age but under the ages of 18? How do the Department of Finance tax calculations compare a family of two working parents with teens who work summer jobs to save for post-secondary education?
10. Why are we now picking on family members aged 18-24? How can the ill equipped Canada Revenue Agency auditors (I know them – they are in our offices every week) possibly evaluate the reasonableness of the contributions of family members. What is clear and meaningful? How do you measure labour contributions – with a time clock? What is a fair return on capital for an investment in a private business?
Here is the solution:
The last time Canada performed a comprehensive review of tax reform was in 1963. The Carter Commission delivered its findings in 1972 – right 9 years later. Our tax rules have largely not changed in more than 45 years and we are about to make the structural problem of low corporate tax rates and high personal tax rates worse.
It’s time for comprehensive tax reform. It is not time for the public service to wreak havoc on business owners and cause all manner of “unintended consequences.”