Addressing Unfair Tax Changes, Morneau Makes a Second Attempt at Tax Reform

The Finance Department backtracked on a few of their controversial tax reforms for private corporations this week, adding a tax cut of $2.9 Billion over the next five years to douse the flames of discontent. However, family businesses will continue to face tax risk and uncertainty due to a “reasonableness” test – albeit a simplified one – that will limit income sprinkling to contributors of labor, risk or capital in the business.

Acknowledging the fact that the Canadian economy is growing faster than it has for a decade, with over 400,000 jobs created in the last two years, the government continues with the narrative that the benefits of that economic growth have not been evenly shared.  (One could perhaps counter that neither have the risks).

It again points out the real issue that started this initiative: should significant growth in private corporations continue, the personal tax base will weaken, and that will have the effect of increasing taxes for unincorporated taxpayers. It points out that 80% of passive investment income is earned by private corporation shareholders who make more than $250,000, perhaps providing a clue to some upper income taxation measures to come.

The government also stands firm in its commitment to limit income splitting to family members who are not active in the family business and to tax dividends received by non-active family members to high marginal tax rates, based on a reasonableness test that requires a demonstration by adult family members of their contribution to the business based on any combination of the following:

1. Labor
2. Capital or equity
3. Financial risk – such as co-signing a loan and/or
4. Past contributions of labor, capital or risk

The burden of proof will rest with the family based on a “reasonable” contribution to the business. This reads much the same as the mind-numbing detail in the original proposals, although simplification of that burden is promised.

On the good news side, the government will not move forward with proposed changes to the Lifetime Capital Gains Exemption. That should ease concerns about intergenerational transfers.

And then there is the sweetener: a reduction in the Small Business Tax Rate. This will bring the average federal-provincial-territorial rate down to 12.9% on the first $500,000 of active business income earned by small business corporations.  The rate was supposed to be reduced to 9% from 11% in 2015; part of an election promise not to undo the former government’s intent. However, the rate was frozen at 10.5%  effective January 1, 2016, when this government came to office. Now, effective January 1, 2018, the rate will go down to 10% for 12 months; and then to the 9% rate on January 1, 2019.

Draft legislation is expected in the next several weeks, with implementation dates of January 1, 2018.  Knowledge Bureau and its expert instructors will discuss these changes at the CE Summits in a four city teaching tour starting November 21 in Winnipeg, November 22 in Calgary, November 23 in Vancouver and November 28 in Toronto.  To register call 1-866-953-4769 or go to workshops at www.knowledgebureau.com.

Evelyn Jacks is Founder and President of Knowledge Bureau and author of 52 books on personal tax preparation, planning and family wealth management.

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