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 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.