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Tax Tip: A New Tax Credit for Infirm Children

Last week we discussed a new Canada Caregiver’s Credit (CCC) for spouses and eligible dependants who can be claimed as “equivalent to spouse.” But did you know that you can now make a new claim if you are a caregiver of a dependent minor or adult child who is infirm? It’s possible under the revamped Canada Caregiver Credit.

Quick recall: the Canada Caregiver Credit comes with two parts:

  • A “Mini” CCC of $2,150, which must be claimed for an infirm minor child or someone for whom you are claiming a spousal amount. Remember that the term spousal amount also includes an “eligible dependant” or a someone you are claiming as “equivalent to spouse.”
  • A “Maxi” CCC of $6,883, or a portion thereof, may be claimed if you are supporting a spouse or eligible dependant whose net income is over $11,635. But, you may also claim this amount for infirm adult dependants. However, this larger credit, is never claimed for a minor child.

Infirm children. The claim is $2,150* for each infirm child under age 18. Children under 18 will be considered to be “infirm” only if they are likely to continue to be, for an indefinite period, dependant on others in attending to their personal needs significantly more than when compared to children of the same age. Only one claim may be made for an infirm child by one parent. But if that parent does not need the full amount, the unused amount may be transferred to their spouse. This is done using Schedule 2 on the personal tax return.

New Essential Tax Facts. Book by Evelyn JacksThe Canada Caregiver Credit may not be claimed by a taxpayer who is required to pay a support amount for the dependant. However, in the year of a change in marital status, the taxpayer has the option of claiming the credit or the support payments. In the case of a child, where both parents must make support payments, only one parent can make the CCC claim and the parties will need to agree on who that is.

Other Infirm dependants age 18 and over. In this case, claim $6,883* minus the dependant’s net income over $16,163. You will get a full claim if net income is under $16,163, a partial claim if it is between $16,163 and $23,046 and nothing when income is over that.

Your dependant can be your or your spouse’s parents/grandparents, brothers/sisters, aunts/uncles, nieces/nephews. Only one claim will be allowed for the Canada Caregiver Amount for this class of dependant, although the claim could be shared amongst two or more taxpayers, as long as the total amount claimed does not exceed the allowable claim.

Evelyn Jacks is President of Knowledge Bureau and author of the New Essential Tax Facts: How to Make the Right Tax Moves and Be Audit-Proof, Too, available in February. Pre-orders accepted now. Follow Evelyn on twitter @evelynjacks.

 


US Tax Reforms Could Attract Top Canadian Talent

In its first major tax reform in over 30 years, the United States is considering a package of tax changes that if passed into law, could significantly impact Canada’s ability to keep top talent and business ventures from moving across the border.

While Canadian high-income earners have faced various federal and provincial tax hikes since 2016, and private businesses are fighting this summer’s controversial high-tax  reforms, the federal tax proposals in the U.S. are much friendlier to several taxpayer profiles:

  • For low-income earners the standard deduction will increase from $6350 to $12,000 (slightly more than Canada’s current basic personal amount of $11, 635).  For those filing jointly, the amount would rise from $12,700 to $24,000.
  • Above the standard deduction, the number of tax rates will be reduced from 7 to 4 ranging from:  12 percent (on incomes up to $45,000), to 25 percent (incomes between $45,001 to $200,000) and 35 percent (incomes between $200,001 to $500,000).  A high rate of 39.6 percent will be applied to incomes above $500,000.  The bracket amounts double for joint filers.
    • It’s at income levels between $142,354 and $202,800 that American taxpayers have the most favorable tax rates, saving 4% over Canadian rates. The next most advantageous tax rates occur on incomes up to $45,000, where Americans would save 3% over Canadian rates.
  • A new Family Credit would enhance the current Child Tax Credit, increasing it from $1,000 to $1,600.  In addition, a $300 credit will be provided to each parent and adult dependant.
  • The Estate Tax exemption would double immediately; and be repealed entirely after six years.
  • The corporate tax rate would be reduced to 20 percent from 35 percent. The tax rate for active small business income would be 25 percent.    For small businesses, a rate of 9 percent for incomes under $75,000 is proposed, with the rate phasing out as incomes exceed $150,000 with a full phase out at $225,000 of income.
    • It’s interesting to note that Canada’s small business tax rate is proposed to drop to 9% by 2019 – a hasty announcement made last month by Finance Minister Morneau, who has been under attack for trying to substantively change the landscape for business owners with exorbitant taxes on family members who don’t meet “reasonableness” tests and passive investment income in the corporation.
  • Business could immediately write off the full cost of new equipment.
  • It would become easier for American business to repatriate foreign earnings; incentives to move overseas would be eliminated.
  • Mortgage interest rate deductibility will continue, but only for existing mortgages and on the cost of newly acquired homes up to $500,000.
  • The Alternative Minimum Tax would be repealed.

Canadians have already expressed concerns about some of these proposals and their effect on our economy.  Writing in the Financial Post, tax expert Jamie Golombek noted that in combination with Florida’s zero tax rates, the Trump tax reductions at the top end of the income scale,  would make the U.S. more attractive for Canada’s highly skilled people and professionals.  Using the example of a medical professional paying tax at 53.5% on income above $220,000 in Ontario, accepting an offer to move to Florida would mean “. . .not only could she be paid in U.S. dollars but that income would be subject to tax at a top rate of 33 per cent – that’s more than 20 per cent lower than her current, combined federal/Ontario rate.”

Speaking to the Canadian Press last December, Dr. Jack Mintz,  President’s Fellow of the School of Public Policy,  also worried about the potential brain drain through tax competitiveness:   “We don’t look particularly competitive in attracting talent when you have both a low dollar and, now, a really high marginal tax rate cutting in at a relatively low income level. I think the government needs to worry about attracting talent.”

Craig Alexander, chief economist for the Conference Board of Canada, agreed, noting that “businesses and individuals often make decisions based on after-tax incomes . . .so, if America cuts its corporate and personal income-tax rates significantly, it could create a competitive challenge for Canada.”

More recently, Dr. Mintz opined on what Canada must do if the tough NAFTA negotiations it is in with the U.S. fail:  “Like the U.K. following its Brexit experience, we will need to pursue more vigorously new avenues for trade and create a better business environment with better regulations and growth-oriented tax system.”

Combined with the recent tax proposals, which are going in the opposite direction, and new CPP tax hikes on the horizon, it could be a very bumpy road ahead for Canadian business and their government, and by extension, the taxpayers who work for them.

To weigh in with your view, participate in the Canadian Federal Budget consultations at this link:     http://www.fin.gc.ca/n17/17-113-eng.asp

Evelyn Jacks is Founder and President of Knowledge Bureau and author of 52 books on tax preparation, planning and family wealth management. Follow her @evelynjacks.

Additional Educational Resources:  CE Summits, November 21 in Winnipeg, November 22 in Calgary, November 23 in Vancouver and November 28 in Toronto, and Cross Border Taxation Course.

©2017 Knowledge Bureau Inc. All Rights Reserved.


The Paradise Papers, Pre-Budget Consultations and The Real Tax Gap

This week brought more controversial tax news to Canadians: the Paradise Papers and a new tax “consultation”; this time in advance of the 2018 Federal budget. The elephant in the room in both these stories is the unfinished “consultation” on the massive tax changes proposed for private businesses.

Small business owners are still reeling from the potentially exorbitant tax hikes on the incomes from their invested capital in private corporations within Canada, even as they hear about potential tax erosion from the Paradise Papers story. It appears that CRA is unable to tap into the “tax gap” left from the movement of assets offshore by prominent, wealthy Canadians, according to CBC reports.

Speaking from the Distinguished Advisor Conference being held in Kelowna, Evelyn Jacks, President of Knowledge Bureau, said, “There are many troubling aspects to this story starting with a key ingredient required for a fair taxation system: confidentiality. The burden of proof for accurate tax filings is always on the taxpayer, but in return the taxpayer has rights to the confidentiality of his or her taxation records, and impartiality. This is in fact enshrined in the sixteen Taxpayer’s Bill of Rights.”

This Taxpayer’s Bill of Rights is worth the read. For example, did you know:

“You have the right to receive entitlements and to pay no more and no less than what is required by law.” To make sure that all taxpayers pay only the correct amount of tax, the law must be simple and transparent and from a compliance point of view, it cannot be applied retroactively and punitively for people who don’t understand their rights.

For small business, the Taxpayer’s Bill of Rights says this:   “CRA is committed to administering the tax system in a way that minimizes the costs of compliance for small businesses.” This makes a compelling case for dropping the onerous “reasonableness tests” and the mind-numbing complexity proposed for the tracking of sources of capital used for passive investments in private corporations.

In other words, there must be reciprocity in a self assessment system: if taxpayers must bear the burden of proof, there must be an equal obligation for the tax department to ensure all efforts are made to help Canadians mitigate their tax costs by communicating in a simple, understandable and effective manner what the law is, how people can comply with it and several appeal rights that allow people to get it right.

International tax law is very complex. It’s difficult for taxpayers and CRA alike to understand. While CRA needs to enforce the obligations people have when they move their assets offshore; these taxpayers also have taxpayer rights. Those who try to comply with the law are not tax cheats, if they took all steps to ensure they met their obligations to Canada are met.

These include the following requirements, which all taxpayers should take note of:

  • If you are a resident in Canada at any time of the year you must file a tax return in Canada and report world income in Canadian dollars. This includes the income from offshore trusts and pensions. You must also declare on Form T1135, the cost of certain foreign assets over $100,000.
  • Residents of Canada can be actual, factual or deemed. Certain deemed residents qualify for special tax credits in Canada. Therefore, you can still be tied to your tax obligations in Canada even if you or your money resides offshore.
  • Canadian residents who hold foreign investment properties or who transfer or loan money to offshore trusts will be subject to Canadian taxation and complex annual reporting rules.
  • Those who immigrate or emigrate are considered to be part-year residents of Canada, but may still have reporting obligations in Canada.
  • Upon emigration from Canada, departure taxes must be paid on accrued gains on many assets held at that time. Professional help should be sought to understand which assets require reporting, how capital losses are identified and scheduled and what obligations may arise in both countries, if any, after departure.  For example, those who are non-residents may still be required to file a tax return in Canada if they earn employment or self-employment income in Canada or sell taxable Canadian property.
  • Taxes paid in other countries on the same world income reported in Canada will be the subject of a foreign tax credit to provide tax relief from double taxation. In other cases, tax treaties will provide relief.

Most Canadians pay their taxes willingly and on time. It’s possible that the Paradise Papers story underscores just what happens when the fundamental principles of an effective tax regime – fairness, equity, simplicity and compliance – break down: people with means leave the country with their assets and their income, leaving burdensome tax obligations on lower income earners. That’s the real tax gap we have to fix.

Knowledge Bureau’s EverGreen Explanatory Notes and Cross Border Taxation course provide detailed information on the rules and implications of holding offshore assets. However, taxpayers who are in doubt about their compliance requirements when assets are held offshore should immediately seek advice from a qualified tax specialist and correct their situation before CRA comes knocking.

Evelyn Jacks is President of Knowledge Bureau, Canada’s leading educator in the tax and financial services, and author of 52 books on family tax preparation and planning.

©2017 Knowledge Bureau Inc. All Rights Reserved.


Which Employee Benefits Are Taxable?

A couple of weeks ago, the financial news of the day involved a controversy about the taxation of employee benefits. CRA was enforcing its interpretation of the law in relation to the taxation of the benefit of receiving employee discounts at work. After a political outcry, CRA backed down, leaving several question marks.

That’s regrettable because tax law must be certain – up front – in order for employers to properly fill out T4 slips and communicate the net after-tax value of employee remuneration.  It’s not possible to try to anticipate how CRA is going to interpret a law afterwards, and it’s unfair for employees to face unintended consequences in an audit many years later.

Based on where the law stands today, here’s a list of a dozen and a half taxable and tax-free benefits to consider in determining compensation for employees for 2017, excerpted from Family Tax Essentials. Business owners should discuss these and other perks of employment with their tax and bookkeeping specialists as part of their year end planning meetings:

Perks of Employment

Taxable Benefits*:

  • Personal use of employer’s vehicle
  • Gifts in cash or those that exceed $500
  • Value of holidays, prizes and awards
  • Merchandise discounts – below cost
  • Premiums for a provincial health or hospital plan
  • Tuition paid for courses for personal benefit
  • Interest-free and low-interest loans
  • Group sickness, accident or life plans
  • Gains and income under employee stock-option plans

Tax-Free Benefits:

  • Recreational facilities, including social or athletic club memberships
  • Non-cash gifts under $500;
  • $500 or more for birthdays, anniversaries. Annual $1000 total.
  • Employee counselling services for health, retirement or re-employment
  • Merchandise discounts – above cost
  • Premiums for a private health plan or lump-sum wage-loss replacement plan
  • Tuition paid for courses for the employer’s benefit
  • Certain moving expenses if required by the employer
  • Employer’s required contribution to provincial health and medical plans
  • Employer-paid costs of attendant for disabled employees or to cover away-from-home education due to work in remote worksites

* If these amounts include GST/HST, employees who are allowed to claim employment expenses may be able to claim a rebate on Line 457 by filing form GST370. If you receive this rebate, claim it as income in the following tax year on Line 104.

Evelyn Jacks is Founder and President of Knowledge Bureau and author of 52 books on the subject of tax planning, preparation and family wealth management.

Additional educational resources: Advanced Family Tax Preparation Course, CE Summits


Disability Tax Credits Change Highlights Audit-Proofing

Audit-proofing strategies must be implemented by tax professionals and their diabetic clients receiving disability tax credits in light of the CRA’s new interpretation of the rules.

CRA has changed their position on allowing diabetics to claim disability tax credits in certain cases; a national news controversy that is leaving taxpayers uncertain about claims specific to important life sustaining therapies for their loved ones.  So exactly what are the rules and why is CRA changing their interpretation in retrospect?

Criteria for claiming the DTC (Disability Tax Credit).  If you become disabled, you may be able to claim the disability amount on Line 316 of your return. You’ll need to have a medical practitioner (the government now allows nurse practitioners as authorities) complete Form T2201, Disability Tax Credit Certificate. If you do not require the full disability amount to reduce your federal taxes to zero, you may transfer the unused portion of the credit to a supporting person. In the case of spouses, that transfer is made on Schedule 2 and on Line 326 of the tax return.

Taxpayers with “a severe and prolonged impairment in mental or physical functions” may claim it. Here is what that means:

  • A prolonged impairment is one that has lasted or is expected to last for a continuous period of at least 12 months.
  • A severe impairment in physical or mental functions must restrict the patient all or substantially all of the time, which is another way of saying 90% of the time or more.

You will be considered markedly or in some cases significantly restricted if all or substantially all of the time you have difficulty performing one or more of the basic daily living activities listed below, even with the appropriate therapy, medication, and devices:

  • speaking
  • hearing
  • walking
  • elimination (bowel or bladder functions)
  • feeding
  • dressing
  • mental functions necessary for everyday life

When it comes to life-sustaining therapies, the disability tax credit can be claimed if the therapy is required to support a vital function and the therapy is needed at least 3 times per week, for an average of at least 14 hours per week. This includes the daily adjusting of medication and the time spent by a primary caregiver performing and supervising activities for a disabled child.

According to the Revenue Minister, advances in technology, such as portable insulin pumps, have reduced the amount of time that diabetics require for life-sustaining therapies and this has resulted in them no longer qualifying for the credit.  What’s important is that the burden of proof is on the taxpayer – keeping a log of life sustaining treatments is required to justify claims.

The claim is lucrative. The maximum claim is $8113 per adult dependant in 2017. As a non-refundable credit, the disability amount reduces the taxpayer’s tax bill by $8113 x 15% = $1216.95 regardless of income. In addition, each province has a provincial disability amount which varies by province, and will increase this claim.

Disability Tax Credits for children who require this assistance also qualify. For those supporting a disabled minor, this amount is enhanced by an indexed supplement of $4,732 (for 2017). This amount is reduced by amounts claimed under Child Care Expenses on Line 214 and the Disability Supports Deduction on Line 215 in excess of $2,772 (for 2017).

Additional Educational Resources:  Contact your DFA-Tax Services Specialist for help in working with CRA’s audits, or consider taking this important online designation program to help others.

Evelyn Jacks is President of Knowledge Bureau and author of 52 books on personal tax preparation, tax planning and family wealth management.  Follow her on twitter @evelynjacks.

©2017 Knowledge Bureau Inc. All Rights Reserved.


How To Grow Your Business Through Influential Leadership

No doubt about it: leadership is challenging these days. Whether you are raising a child, coaching someone else’s child, directing a team to reach a common goal, or leading your clients towards their financial goals and objectives, the skills you need to navigate change – a leader’s, primary role – are themselves changing. Your business and career growth, in fact, may depend on your ability to embrace new leadership requirements.

Although often rewarding and challenging, leadership is rarely easy. It requires commitment; resourcefulness; a relentless passion for self-improvement; together with the ability to listen, learn and earn the trust of the team and others who rely on it – consistently and continuously.

As most seasoned managers know, leadership is actually not about you. It’s about the people you lead and whether they choose to follow you, or simply to do what you tell them to do. These are two entirely different matters, and they will have different outcomes. Your success as a leader depends on the choice the people you lead make.

A large part of that choice is driven by whether you are seen as authentic; that is, confident in your vision and your skills and comfortable in your own skin.  For most leaders who are really effective with their teams, the courage to be authentic is the key to forging accountable results not just once, but on an ongoing basis, because it drives both strategy and culture. . .and you need both to get the results required.

Leadership requires a focused, accountable effort to persuade and compel others to work willingly with you towards objectives and goals that may be in flux.  That’s the problem in times of great change.  Most people don’t like change, but you have considerable influence on your team’s ability to embrace it.

Truly inspirational leaders can motivate their teams to accomplish the impossible.  Whether that’s in encouraging people to embrace new technology or subject matter expertise, change their habits or understand their new roles in the organization, it’s important for the leader to passionately – and often firmly – convey that the status quo isn’t going to cut it.

Conversely, leader less committed to change can negatively affect the new outcomes his or her team is responsible for.   In fact, whether your team respects or disrespects your vision will directly influence the success or failure of the goals you need to achieve.

Growing Your Business:  Will your leadership skills produce a positive or negative influence?  It’s a really difficult question to ask of oneself, and requires a special kind of courageous introspection.   Great leaders do that, and it matters, because there are essentially two ways to get results:  in the short term and in the longer term.  That’s the subject of next month’s Growing Your Business leadership challenge:  Compliance vs Culture.

Please be sure to let us know your opinion, as authentic, influential business leadership in times of great change this is the subject of our discussion this month in the Executive Business Builder Network.

Evelyn Jacks is Founder and President of Knowledge Bureau. She has twice been named one of the Top 25 Women of Influence in Canada, and has won the prestigious Rotman School of Business Canadian Woman Entrepreneur of the Year Award. Evelyn is the creator of the Executive Business Builder Program, which helps small businesses acquire new skills required to grow their enterprises, and is the co-author of Get Your People to Work Like They Mean It.

©2017 Knowledge Bureau Inc. All Rights Reserved.


Changes to Corporate Income-Splitting Rules Could Hurt Women and Families

Finance Canada’s controversial proposals on the taxation of private corporations, which require comments on the changes by October 2, will potentially affect business people of all income levels, from all walks of life, who serve and employ Canadians in their hometowns across Canada. However, they will also affect families and, in particular, women.

According to the background information accompanying the proposals, entrepreneurship is alive and well in Canada. The number of incorporated self-employed individuals almost doubled between 2000 and 2016. Canadian Controlled Private Corporations (CCPCs) now account for more than twice the share of taxable active business income (relative to GDP) than they did in the early 2000s.

The tax data also shows that men own and control most of these corporations in Canada, reporting 74 per cent of the net capital gains from dispositions of qualified (private) small business corporation shares and receiving 66 per cent of non-eligible dividends received by the shareholders of CCPCs in 2014.

Males also represent the 70 per cent of higher-income earners who initiate the income-splitting strategies targeted in the proposed tax reforms, distributing some of the dividends from the corporation to their spouse and children. That’s a good thing, as the fruits of labour from the business trickle down to the family. However, some perceive this strategy as being unfair, when compared to the taxation of income earned by a single salaried employee who can’t reduce tax with family income splitting, except in certain instances — pension income splitting being one of them.

Finance Canada has proposed exceedingly complex rules to crush the income-splitting opportunity for CCPCs, but in the process has introduced new distortions to tax fairness; this time tipped against the middle income family that derives its household income from self-employment.

By Finance Canada’s own admission, “the extent to which benefits [of income splitting] are currently shared with members of. . .families may be difficult to measure with available data. . .It is likely that existing tax benefits are shared with family members — the owner’s spouse and children — or in the case of the sprinkling of income, that family members are participants to the tax planning strategy.”

On closer look, despite income sprinkling from their partner’s CCPC, women do not get equal amounts of dividend income. They receive less income from this source than men do. Neither do they get equal income distributions from trusts and partnerships. Given the lack of information Finance Canada has on the matter, it makes one wonder just how serious the tax leakage is from income splitting through the family business.

Given the gender stats, these proposed reforms, in their current form, could significantly affect women, who may need to pick up the slack in the proposed reductions in family income.

The changes may also affect the community. If integrated personal/corporate tax rates run into the 60-70 per cent range for some of those families, especially high-net-worth families, volunteer and philanthropic work done by stay-at-home spouses may be threatened; it’s possible the size of charitable donations could also be affected.

The proposals promise to take gender inequities into account in the final design of tax rules for private corporations. This should raise eyebrows. How will this be done? What affect will this have on family economic decision-making? In assigning tax attributes to income sources, should one gender be favoured over another?

Against the backdrop of such dramatic change, these tax reform proposals are an excellent opportunity to improve tax literacy and discuss tax fairness for families as a whole. Given that we don’t actually know the financial impact of the proposals on women and children, consulting well with all stakeholders and with sufficient time to review concerns, would seem to be worth it.

Be sure to take in several opportunities to do so:

Proposals on Taxation of Private Corporations

Distinguished Advisor Conference: DAC addresses today’s key technical trends and business issues from an academic perspective. Its delegates and speakers reflect on the outcomes of change in private sector forecasting, domestic and international tax law and economic policy making, as well as the regulations that affect the work that professional advisors do.

November CE Summits: Learn about the most recent advanced updates from CRA, Finance Canada and Statistics Canada, as well as strategies for applying new rules and interpretations to compliance and planning scenarios for clients using cutting-edge technology.

Evelyn Jacks, MFA, DFA-Tax Services Specialist, is President of Knowledge Bureau, a national educational institute, and the author of 52 books on personal tax preparation and planning and family wealth management.


7 Factors for Classifying Your Side-Gig Income with the CRA

About 32 per cent of workers are starting their own businesses on the side for a variety of reasons — including 25 per cent of those who earn more than $75,000 and 19 per cent of those with income over $100,000. For tax purposes, it’s critical to know the difference between someone who is employed and someone who is considered self-employed.

The research conducted in the U.S. by CareerBuilder.com also confirms that self-employment is embraced more frequently by women and by those in the leisure/hospitality, transportation and health care sectors. The statistics are similar in Canada.

According to Finance Canada’s most controversial proposals on the taxation of private corporations, released on July 18, 2017, the proportion of incorporated self-employed individuals almost doubled between 2000 and 2016. “CCPCs now account for more than twice the share of taxable active business income (relative to GDP) that they did in the early 2000s.”

This brings an opportunity for tax and financial advisors to embellish on their value propositions by engaging taxpayers who are creating their own side-gigs in year end tax planning.

The Canada Revenue Agency provides guidelines in its publication 4110. There are seven factors to consider:

1. Equity: Responsibility for investment and management of resources.

2. Control: The right of the payor to exercise control over the activities of the work and influence over workers, especially related to outcomes and methodology. Who has the final word?

3. Assets: Who has the responsibilities and contractual control over the tools and equipment used in the business?

4. HR: Ability to hire and subcontract human resources: Who does this and pays for the expenses, and has control over hiring and firing?

5. Financial risk: Who is responsible when contractual obligations are not completed or met? Who is reimbursed for expenses and fixed costs? In this case, the payer is the self-employed person.

6. Opportunity for profit: Control over revenues, expenses and realization of profits.

7. Written contracts: The nature of the individual contracts, and who pays source deductions is considered.

At year-end, numerous tax planning considerations come into play for both employers and employees. In this era, in which one taxpayer may dabble in each profile, understanding the rights and obligations of each is more important than ever.

Additional Educational Resource:
T1 Professional Tax Preparation for Proprietorships

Evelyn Jacks is President of Knowledge Bureau, Canada’s leading educator in the tax and financial services, and author of 52 books on family tax preparation and planning.


New Canadian Tax Reforms Fail to Address Modern Challenges

Just how much is too much tax? For whom? In case you missed it, Canada is in the midst of a contentious tax reform that increasingly advocates the defeated reforms of yester-year. It seems governments think a “buck is a buck” for tax purposes again. But taxpayers who find themselves under siege — investors in small business in particular — say, it just isn’t so. Here’s why.

Back in 1962, Prime Minister John Diefenbaker initiated the Royal Commission on Taxation, headed by Kenneth Carter. A related White Paper was released five years later, in 1969. Whether your earnings were from salary, wages, a gain on your investment or real estate, the thesis advanced was this: the same tax should be levied on your increase in economic power regardless of how you earned it. The goal was to remove the distinction between property gains and income gains and abolish all those tax privileges of the wealthy by introducing the full taxation of capital gains, including estate gains.

Boris I. Bittker of Yale Law School did an impressive review of the Carter Commission reforms back in the day, asking several important questions:  how important is income source, when measuring discretionary income? Should a tax on labor — the salary paid to employees — be at the same level as a tax on invested capital, dividends paid to shareholders, inheritors of a trust fund or the net profit taken home by small business owners? Is “discretionary income” (what’s left after a reasonable standard of living is considered) the right measure of tax? How much tax should be charged on discretionary income?

Progressivity (the more you make, the more you pay) looks quite different when comparing discretionary income and total income (income before unique deductions and credits), and that comparison is crucial to avoid a regressive rate of tax on one group of taxpayers over another.  He concluded, that taxing increases in discretionary income does not harmonize well with the concept of a “buck is a buck”.

The measurement of income source and its timing must be taken into account in setting rate structure, together with the unique consequences that require exemptions for catastrophes (medical and disability credits for households, for example, or business-loss carry-forwards for businesses), in order for a tax regime to be accurate and fair to all stakeholders in the economy.

This is precisely the issue behind the increasingly loud and outraged voices of Canada’s millions of small business owners, who have read today’s proposed reforms to private business taxation. When some taxpayers — in this case, business owners who invest both human and financial capital — could be left with less than 30 cents on the dollar for their efforts, the incentive to work harder and invest more is lost.

Dan Kelly, president of the 109,000-member Canadian Federation of Independent Businesses (CFIB) nailed it with his blog in HuffPost last week, citing 10 reasons why individual and business income differ for tax purposes to arrive at discretionary income. He correctly points out that far from being tax cheats, small businesses have been using legitimate tax provisions put into effect by former Liberal and Conservative governments who have tried to grow the economy through small business support.

The unfortunate dialogue that accompanies the government’s mid-summer proposals, adds insult to injury.  The small business community takes on exorbitant risk, by investing their own precious time and money, paying every stakeholder in the business first, hiring and training people who pay taxes, and voluntarily collecting a variety of taxes on behalf of various government levels – all without paying themselves first.  They are not the enemy.

The exceedingly complex and prohibitively expensive family income splitting proposals, as well as the capital gains exemption need to be taken off the table.  They are too complicated for fairness to result in the transition of family business enterprises. Further, the taxing of the family unit, rather than the individual, needs to be reconsidered.

When it comes to family income splitting, the proposals also ignore the fact that times have changed.  Families increasing making financial decisions as a household.   In 1976, women earned 8.5 per cent of taxable income; men earned 91.5 per cent. Today the split is closer to 30/70 per cent. Family income impacts non-refundable and refundable tax credits, like the Canada Child Benefits, which are income tested based on family income. Private pension income withdrawals are today subject to income splitting; so is the CPP. Income pools saved within the family business should have the same privilege.

Perhaps of most concern is the proposed taxation of passive investments income generated by retained earnings within the small private business. The proposals attempt to apply marginal tax rates of more than 70 per cent to some income sources, after flow-through to the individual family. This will discourage and cripple private investment in future risk management, as every business needs to be prepared for potential catastrophes by investing their retained earnings.

Back in his day, Bittker concluded, “The Carter Commission’s Report is an outstanding intellectual achievement, but it is an installment in a debate over tax policy, not a final solution.” Now, 55 years later, a new instalment of tax reform goes back to old ideas, but with a twist:  it treats the taxation of a “buck” differently, depending on whether you are incorporated or not, thereby compromising ideals of fairness and equity.

In their current form, these new proposals could indeed drive many businesses and professionals out of the country or underground.  And that would be a pity, as today, more than 90 per cent of Canadians pay their high taxes on time, mostly because they agree with its ideals of fairness and equity, and are willing to comply through self-assessment, despite the level of complexity at the moment.

These tax reforms should, therefore, be of concern to anyone who cares about patronizing their local business establishments or working in them.  They offer little new to address modern challenges: a variety of family structures, changes resulting from a global economy and new political and technological risks.

Worse, they attempt to create a common enemy – small private enterprises – and shame them into paying more than their fair share; all the while extending a woefully inadequate consultation period to consider such massive change.

This is regrettable and ultimately unfair. When overtaxed segments of the population base move to jurisdictions that treat them more fairly, it always falls to the middle to pay more.

Additional Educational Resource: November CE Summits will discuss the proposed changes to private corporations’ tax obligations and year-end planning with individuals and corporate owner-managers.

Evelyn Jacks is President of Knowledge Bureau, Canada’s leading educator in the tax and financial services, and author of 52 books on family tax preparation and planning.


Do Passive Investments in a CCPC Still Make Sense?

The federal government is on the hunt for new tax revenue from Canada’s small businesses, mainly because of an erosion of the personal tax base and a significant shift of taxable income to the corporate tax base instead. Specifically, the amount of taxable passive investment income earned by private corporations has increased from $8.6 Billion in 2002 to $26.8 Billion in 2015. And the government wants a bigger piece of that pie.

The view is that because small business tax rates are low, any returns made on passive investments from that capital provide an unfair advantage to the small business investor. “Preferred tax rates for corporations were never intended to facilitate passive wealth accumulations, such as through passive investments,” the Department of Finance says in recent proposals to make sweeping changes to tax planning within private corporations.

In fact, the private corporation does now pay additional taxes on passive investment income at a rate that equates to the top tax bracket paid by individuals. These pre-paid taxes are then refundable when dividends are paid out to the individual shareholder, who again pays taxes on those dividends on the personal tax return. The integration of the two tax systems is almost perfect when a dividend gross-up and dividend tax credit are combined to reconcile the amounts on the personal return to avoid double taxation. How perfect that integration is depends on where you live in Canada.

Passive investments held by small business owners within the corporation as part of their retained earnings are often parked there in readiness for new opportunities or as a hedge against other risks. Pre-funding operating lines, and guaranteeing them personally, are often a pre-requisite for borrowing, which must be secured by other assets. Investment income earned also offsets the costs of expensive financing and interest. Yet, the government compares an investor who is an employee – who bears none of those risks – with a successful entrepreneur in making a new case for new taxation.

The assumption is that the business owner would prefer to retain business income, for passive investment purposes, within the corporation, to reap tax benefits. However, since the 33% top marginal tax rate was introduced in 2016, the advantages of earning dividends within a small business corporation have already been curtailed, when combined personal/corporate tax rates are considered.

In its proposals, the government presents the case that capital taxed at low corporate rates within small business corporations and then invested there, will compound and grow faster, when compared to the investments made by an individual employee, where tax is lopped off the top, leaving fewer after-tax dollars for investment purposes. Now proposed is that the “source” of the earnings used to fund passive investments will be tracked in the future. Top marginal tax rates will be applied to earnings if the investment was made with low-taxed corporate dollars.

The proposals are mostly silent on the fact that the individual taxpayer benefits from the progressive personal tax system – a basic personal amount and a variety of tax brackets. However, deep in the fine print there is an acknowledgment that the corporate investor who pays personal tax at a rate below the top marginal rate, would in the future be incentivized to draw money out of the business to invest in a personal savings account of some kind.

For owners of Canadian Controlled Private Corporations (CCPCs) who want to invest retained earnings to prepare for the next business opportunity, the news is not good under these proposals, especially if the investment of choice is publicly-traded securities.

The current system of taxation on portfolio dividends – prepayment of tax at top tax rates with a refundable tax when passive income is distributed to shareholders – would be replaced. Instead, all income generated would be taxed inside the corporation at an amount equivalent to the top personal tax rates; then once again as “non-eligible dividends” once the money flows through to the individual. This would apply to both capital gains (the non-taxable portion of the capital gain would no longer be eligible for tax-free distribution to shareholders) and dividend income from publicly-traded securities.

Corporations that only earn income taxed at the general rate could elect to pay additional non-refundable taxes in return for “eligible” dividend tax treatment, for which investors receive a higher dividend tax credit personally.

For corporations focused on passive investments – that is, not set up to earn active income – not much would change under the proposals, as the earnings are already taxed at the highest rates inside the corporation.

All of the proposals under discussion would necessitate complex and expensive annual recordkeeping and reporting, as business owners sort the capital available for investment purposes into categories of income taxed at low and high rates before making an investment. Sorting is required again before distribution to the individual taxpayer, this time through the pools of eligible dividends, non-eligible dividends and tax-free dividends.

If the changes do take effect as described, they will significantly raise taxes on new passive income investing activities within the corporation, making that option prohibitively expensive.

Here’s an example of how $1,000 passive income earned in a CCCP would be taxed when flowed through to the shareholders (assuming they pay at the highest rate in Manitoba – 45% on non-eligible dividends):

Income: $1,000

New tax (50.4% in Manitoba) ($504)

Dividend to shareholder $496

Personal tax @45% on dividend ($223)

After-tax income to shareholder $273

Total taxes ($504 + $223) $727

Effective rate of tax $727/$1000 = 72.7%

With the current tax system, the tax rate would be 50.4% (assuming perfect integration). This is obviously a huge tax increase.

Alternatively, the personal tax system offers progressive tax rates, 50% capital gains treatment, and the opportunity to have dividends from publicly-traded securities taxed as “eligible” rather than “ineligible.” Small business owners will no longer be incentivized to park retained earnings within the corporation if their income falls below top personal tax brackets in the future. In that case, distributing corporate earnings as salary or dividends in order to make passive investments personally will make more sense. In the process, complex and expensive tax preparation costs within the corporation will also be avoided.

What will happen to the large existing pools of passive investments within private corporations if the changes as proposed should come to pass? Business owners with retained earnings subject to low corporate rates may wish to make passive investments inside the corporation now to avoid the punitive new rules after the proposals take effect. After public consultations end on October 2, 2017, there is a promise in the proposals that “time will be provided before any such proposal becomes effective.” However, there is no guarantee on the effective date of change.

Whether this leaves the business itself at a disadvantage remains to be seen. Planning is required to determine “what if” scenarios now. In addition, tax and financial advisors will want to work together with business owners to understand the effect of the proposed changes on family compensation planning, business succession planning and debt and cash flow management.

Evelyn Jacks is a bestselling tax and financial author and President of Knowledge Bureau, a national educational institute for continuing professional development of financial advisors