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.

Posted under: Income Tax

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