Business Law, Litigation, Taxation law

Making Canada Fair Again: Politics and the Consultation Paper on Tax Planning Using Private Corporations.

Sep 27th, 2017

By David H. Sohmer

In a recent special CNN report, Fareed Zakaria stated that “The Trump vote is in large part an act of class rebellion, a working class revolt against know-it-all elites who run the country. “ In the September 10 , 2015 issue of McLeans.Ca, Kevin Milligan, an outside economic advisor to Liberal Leader Justin Trudeau, stated that “……the deft policy action required here is to try to accommodate the needs of corner- shop small businesses without helping multi-millionaires further reduce their taxes…. The parliament we elect in October will have to grapple with these issues and find a balance between helping small business without further advantaging the tax-planning top earners”.

On February 23, 2017, the Department of Finance released the 2017 Report on Federal Tax Expenditures-Concepts, Estimates and Evaluations (the “Tax Expenditure Report”).  The media release accompanying the report states that “the Government of Canada’s commitment to fairness to the middle class includes ensuring a modern and efficient tax system that is simple and properly targeted”   In keeping with this commitment,  On July 18, 2017, the Department of Finance issued a Consultation Paper titled “Tax Planning Using Private Corporations” (the “Consultation Paper”). It proposes certain measures which it contends will “help business grow, create jobs and support their communities” 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 stated objectives of growing the economy and achieving fairness for the middle class and the measures proposed to achieve these objectives raise several related issues. Is attacking the wealthy primarily a measure intended to secure a middle class voting base or is it primarily an economic measure intended to grow the economy and create jobs? Is there evidence that the proposed steps will grow the economy and create jobs? To what extent will the proposed steps actually achieve fairness for the middle class?

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. The other tax planning strategies addressed are the sprinkling of income using private corporations and the conversion of a private corporation’s regular income into lower-taxed capital gains.

The avowed purpose of the proposals is not to raise the revenues required by the Government to finance spending but to achieve social and economic policy objectives. The amount of revenue raised in achieving such policy objectives as well as what the Government intends to do with such revenue should be major factors in determining whether implementing each measure is warranted. (footnote 1)   Openness and transparency would dictate that at the very least the Government should provide an estimate of the amount by which a particular tax planning strategy benefits the wealthy at the expense of others before implementing a remedial measure. While the Consultation Paper estimates the additional revenue from preventing income splitting to be $250 million per year, it does not provide estimates of the additional revenues resulting from the measure neutralizing the benefits from holding passive investments inside a private corporation- the additional revenues   will only be provided once the Government has made a decision on the final design of the new tax rules. No estimates are provided with respect to the proposed measure to prevent surplus income from being converted into capital gains because information is not currently available.

Openness and transparency would also dictate that evidence be provided that the measures will help the economy grow and create jobs. The Consultation Paper contains platitudes but no evidence.

In a letter included in the Consultation Paper, the Finance Minister states that “ (W)hen it comes to paying taxes…there is a sense that some may be getting a better deal than others” The Tax Expenditure Report indicates that the measures in the Consultation Paper are intended to address the middle class’s perceptions rather than the facts. The third largest tax expenditure by value in 2015 was the partial inclusion of capital gains ($11.6 billion). The fourth largest was the non-taxation of capital gains on principal residences ($6.2 billion).   Warren Buffet noted that he pays a lower share of his income to the government than his secretary because of the low rate on capital gains and because capital gains are only taxed on realization. Furthermore, most members of the middle class hold mutual funds and stocks in RPPs, RRSPs and TFSAs, and so do not benefit from the partial inclusion of capital gains. It is self-evident that the wealthy can afford more expensive housing and so disproportionately benefit from the non-taxation of capital gains on principal residences.(footnote 2) The employee stock option deduction ($.685 million) and the lifetime capital gains exemption ($1,4 billion) are other examples of tax expenditures which benefit the wealthy disproportionately. The $250 million in additional revenue from preventing income splitting is insignificant compared to the value of these tax expenditures. While the Consultation Paper does not provide estimates of the additional revenue   from the measures neutralizing the benefits from holding passive investments inside a private corporation and preventing surplus from being converted into capital gains, it is reasonable to assume that the amount will not be significant in comparison to these tax expenditures either.

The foregoing indicates that the objectives of the proposals are primarily political: to preserve the Liberal middle class base and to add to it by poaching  more middle class voters from the NDP than the number of professionals who may defect to the Conservatives. Whether openness and transparency are more important to the Canadian middle class than to its   American counterpart remains to be seen.


Published in The Canadian Taxpayer, September 8, 2017 - Vol.xxxlx No.17


footnote 1: An example of why decisions should be informed is the case of doctors. They receive both fees and tax benefits from the state. If their tax benefits are reduced then they will attempt to compensate for the reduction by negotiating higher fees.

footnote 2: The non-taxation of imputed rent from owner-occupied property also benefits the wealthy disproportionately. Imputed rent is how much it would cost to rent out an owner- occupied property : the more expensive the property the higher the imputed rent. $1 million invested at 3% will provide the investor with $30k of taxable interest – the same amount invested in an owner-occupied property will produce $30k of non-taxable rental value. Imputed rent contributed $4 billion to Canadian GDP in 2015 ( per Professor Trevor Tombe in Huffington Post -3/02/2016)- this does not include owner-occupied property situated outside Canada such as seasonal residences in Florida, most of which are owned by the wealthy.