The federal government recently released Tax Planning Using Corporations, a paper that proposes changes to the taxing of private corporations.
The laws that govern our tax system are convoluted. The Income War Tax Act was a 10-page document in 1917; it’s now a bloated 3,000 pages. Governments amend, repeal, and introduce new provisions to support their agendas and budgets, influencing the behaviour of people and businesses. Want people to ride the bus more? Here’s a tax credit (that was repealed). Want to attract businesses to Canada? Slash the corporate tax rate (it is the second lowest of the G7 countries).
These new proposals will be much more contentious. The paper highlights three strategies that could get the axe: income sprinkling through dividends, corporate passive investment portfolios, and the converting of dividends into capital gains.
Of arguably the most impact, and least complexity, is the income-sprinkling issue.
For example, say an incorporated business owner made a $220,000 profit in the year. They paid $100,000 as salary to the owner, and the remainder as dividends to their spouse and adult children. Since dividends are treated differently from employment income, the tax paid would get a $35,000 haircut.
Opponents of the current system argue that this is unfair, and it’s not a hard argument to make. Those numbers show a person paying less tax simply because they operate under a corporation.
Proponents of the status quo have a more nuanced view. That side may argue that business owners assume a lot of risk: losing their capital, not having access to pension programs, and potentially facing lawsuits (a possibility for oft-incorporated professionals who are held to standards by their governing bodies). For assuming this risk, and creating jobs along the way, they are rewarded with a break on taxes.
I will leave the fairness argument to those more qualified, but one big problem will be the retirement planning of corporate business owners.
We tend to think of corporations as big and evil, but they include small-business owners at the community level who employ locals and who have legally taken advantage of this system for decades.
These owners have probably paid themselves and their spouses (who maybe eschewed a career in favour of being a stay-at-home parent because it made sense from a tax perspective) a lot of tax-efficient dividends. And, instead of an RRSP, they would hold investments inside their corporation to benefit from lower tax when sold to fund their retirement.
Their accountants told them to do it. But, in the process, their RRSP planning is pooched (dividends don’t count as contribution room), their investment accounts may soon be penalized with heavy taxes, and their families are left in a bind if they planned to only have one income earner.
Fair or not, I can say that these sweeping changes could disrupt the lives of many entrepreneurs who played by the rules, and they may leave others wondering if starting a business is worth the risk.