Litigation, Taxation law

Tax Planning Using Private Corporations - Part 2

Nov 8th, 2017

By David H. Sohmer

  1. The Prime Minister and the Finance Minister have “referred to the fact that the top two percent of private corporations hold 80 percent of the passive investment assets”.
  2. Michael Wolfson, et al state as follows in “Piercing the Veil: Private Corporations and Income of the Affluent”: (2016 Canadian Tax Journal).
  3. “It is notable that CCCP income is essentially zero in the middle 80 percent…..In the very top income groups, CCPC income is highly skewed. For the top 1 percent, taking into account of CCPC income adds over $100,000. CCPC income adds more than $600,000 for the top 0.1 percent , and between $2.7 and $3.5 million to measured annual income for the top 0.01 percent.”
  4. The implication is that the passive income proposals will not affect those who are not in the very top income group. All CCPCs which have earned passive income in a taxation year will have to determine whether the proposed legislation applies to them. There are 189,000 CPAs in Canada the vast majority of whom will not understand the Annex to the consultation paper titled “Making corporate tax on passive investment income non–refundable: A conceptual explanation” (pages 61-63). The complexity of the proposals will compel many who are not in the top 1 percent to engage tax specialists to determine tax liability even when there has been no tax planning.
  5. At the September 25, 2017 policy conference on tax planning using private corporations, Miodrag Jovanovic, of the Department of Finance, suggested that grandfathering passive income earned from existing retained earnings may require isolating the earnings by transferring assets to a new corporation. This will add annual legal and accounting costs (estimated at $3,000 per year), as well as cost to the government in processing and auditing new company tax returns.
  6. Jovanovic also implied that where passive investments are funded by income taxed at the general rate the benefit “could be quite significant” only in the case of capital gains (a benefit of 0.8% where the capital gain is 4%). The benefit derived by the top 0.1% and 0.01% from investing income taxed at the general rate is microscopic compared to the benefit they derive from the deferral of capital gains tax until realization and from the partial inclusion of capital gains. The implementation of the proposals will be a minor irritant to the top 0.1% and 0.01% and will not do anything to grow or build a strong middle class.
  7. Jovanovic stated that “the government made it clear that it wants to address tax planning strategies”. The context implies that the Department of Finance is not overly concerned about passive investments by CCPCs where the investments are funded by income taxed at the general rate.
  8. The vast majority of the top 1 percent are professionals. If the Quebec approach is adopted most will not be entitled to claim the small business deduction. (If income sprinkling is blocked most professional corporations will cease to carry on a profession whether or not the small business deduction continues to be available). Most of the CCPCs falling into Wolfson’s top 0.1% and 0.01% are not entitled to claim the small business deduction because of the amount of taxable capital employed in Canada.
  9. Conclusion:  If income sprinkling is blocked and a Quebec approach is adopted to limit access to the small business deduction, the benefit of making passive investments funded by active business income will be minimal, and will be   insignificant in the near term because of grandfathering. The complex legislation required to implement the proposals are not warranted and the indications are that the Department of Finance is of the same opinion.
  10. Note: Mr. Ernewein of the Department of Finance stated that  the cost of allowing intergenerational transfers of family businesses to benefit from pipeline planning was  “hundreds of millions.. up to 1 billion”. The consultation paper states: “The fiscal impacts of the proposed measure to prevent surplus income of a private corporation from being converted to lower-taxed capital gain cannot be determined based on currently available information”. This is the best evidence supporting the position that implementation of the proposed  measures is premature.