Business Law, Litigation, Succession, Taxation law

Comments on the Consultation Paper on Tax Planning Using Private Corporations.

Jul 26th, 2017

By David H. Sohmer

Dr. Chris Boyce is one of the co-authors of a study titled “Money and Happiness: Rank of Income, Not Income, Affects Life Satisfaction”. The study’s conclusion is consistent with what is widely accepted by behavioral economists, namely, “Making everybody in society richer will not necessarily increase overall happiness because it is only having a higher income than other people that matters.”

The Department of Finance recently issued a consultation paper titled “Tax Planning Using Private Corporations”. It proposes certain measures which it contends will “help business grow, create jobs and support their communities” while at the same time making the middle class happier by “taking steps to address tax planning strategies and close loopholes that are only available to some - often the very wealthy or the highest earners-at the expense of others.”

The principal tax planning strategy addressed by the Consultation Paper is holding a passive investment portfolio inside a private corporation. Doing so “may be financially advantageous for owners of private corporations compared to other investors. This is mainly due to the fact that corporate income tax rates, which are generally much lower than personal rates, facilitate the accumulation of earnings that can be invested in a passive portfolio”. The Government proposes to apply an additional non-refundable tax on passive income funded using income taxed at the general rate. Capital gains would continue to be eligible for the 50% inclusion rate but the non-taxable portion would no longer be credited to the capital dividend account where the source capital of the investment is income taxed at corporate income tax rates.

Were these proposals intended to both make society richer by promoting growth and job creation and make the middle class happier by making the very wealthy less wealthy or were they primarily intended to make the middle class happy so as to garner votes? The fact that the Government did not propose to increase the capital gains tax or reduce the benefits of the deduction for stock options, the lifetime capital gains exemption or the principal residence exemption, may provide the answer. A few observations should be noted first:

1)    The Consultation Paper does not estimate the cost of the tax expenditure related to the proposals.

2)    The Consultation Paper does not consider other implications of its proposals. For example, physicians may demand that provincial health authorities compensate them for any decrease in tax benefits by increasing scheduled fees. Dentists and other health professionals not covered by medicare may increase their fees.

3)    The Consultation Paper does not discuss the impact on growth and job creation of its proposals.

Rumours were widespread that the March, 2017 budget would increase the inclusion rate for capital gains to 75%. It is likely that these rumours were attributable to deliberate leaks by the Government to test the waters. Focus groups and polling would have indicated that the proposal did not make the middle class happy. The reason may have been that the middle class also own stocks, so increasing the inclusion rate would have gored their ox as well. The challenge for the Government was to target tax benefits which appear to advantage only the wealthy. If this is in fact what occurred, the proposals are primarily politically motivated and have little to do with making society richer by promoting economic growth and job creation. The objective is to poach more middle class voters from the NDP than the number of professionals who may defect to the Conservatives.

The lesson for those who oppose the proposals is that arguing that they unfairly target taxpayers who are in the top 10% but not in the top 1% will not be effective. To be effective, the arguments must demonstrate to the middle class that the proposals may threaten their jobs, may cut take-home pay and may make health care less accessible and more expensive.