DAVID WILKENFELD, CPA, CA, canadian tax CONSULTANT

Archive for September 13th, 2017|Daily archive page

Response to Tax Proposals – Part 1

In Budgets, Canadian Income Tax on September 13, 2017 at 9:00 am

As predicted, the Minister of Finance, Bill Morneau started a firestorm in July with his proposals to reform the small business corporations tax system. I have added my voice to the concerns of my colleagues and clients in a letter to the minister. Due its length, I will reproduce it here in two parts. Part 1, deals with the general tone and sweeping nature of the proposals. In Part 2, to be published tomorrow, I address the specific proposals themselves, offering suggestions for improvement.

Part 1 – Overall Tone and Targeting of Incorporated Small Businesses

I am troubled, as are many of my clients and colleagues, by the language used in the Minister’s letter introducing the proposals. He states that the government is taking steps to “close loopholes that are only available to some – often the very wealthy or the highest income earners – at the expense of others.” He goes on to state that “There is evidence that some may be using corporate structures to avoid paying their fair share, rather than to invest in their business and maintain their competitive advantage.”

This language is disturbing. The Income Tax Act sitting on my desk at this moment weighs in at 2484 pages of charging provisions, income inclusions, allowable deductions, tax rates, formulas, incentives, penalties and anti-avoidance rules. The rules used by everyday small business owners in carrying on their day-to-day businesses, which you have characterized as “loopholes” have been entrenched in the law since its inception. They were addressed in the Carter Commission report in 1966. They have been sanctioned and approved in numerous decisions of the Supreme Court of Canada. For you to suggest that incorporated small business owners are using “loopholes” to “avoid paying their fair share” “at the expense of others” seems unfair. With respect, it appears that you are using this kind of inflammatory language to bolster your popularity among what you perceive as your political base of support, at the expense of hard working and honest tax-paying Canadian small business owners.

Furthermore, for you to suggest that small business owners should be using their accumulated earnings to “invest in their business and maintain their competitive advantage” is presumptive and unwarranted. The business decisions made by owners of small enterprises are not the concern of the government. While the tax system currently does provide incentives for certain types of investment behaviour, the suggestion that a business owner who chooses to invest his hard-earned money for his retirement rather than risk it in further business investment is going beyond your purview. Indeed, even the Supreme Court of Canada, in the Case of Stewart v. Canada refused to allow the government to interfere with a taxpayer’s business decisions, regardless of whether they generated profits or losses.

While it may be true that there are certain ways in which taxpayers who conduct their businesses through corporations have the potential to enjoy certain advantages from a tax point of view, there are many factors and moving parts in making the decision to incorporate. Furthermore, there are many extraneous factors that affect incorporated businesses which should be taken into account when comparing the tax status of an incorporated business with that of an employed individual. It appears that these factors have been totally ignored by your government, which is why the only conclusion that many taxpayers, myself included can reach, is that that these proposals are a clear attack on a specific segment of the taxpaying public, designed to increase the government’s political capital with so-called “average Canadians”.

Here are some of the factors that I refer to:

A taxpayer who makes the decision to go into business takes risks with their lives that cannot be measured in dollars and cents. They often leave the security of a job for an uncertain future. If the rewards of success are diminished, as they surely would be under the Proposals, the incentive to leave a job and risk starting a business endeavour is reduced.

The Proposals are a clear attack on small business owners. While it is true that the tax benefits of incorporation don’t really kick in unless the business earns, as a general rule of thumb, more than $150,000 of profit, the Proposals are singling out business owners as being so-called “wealthy Canadians”. Firstly, the use of the buzzword “wealthy” was clearly intentional and has its obvious negative connotations in a political context. Secondly, small business owners are not the only taxpayers who earn higher than average incomes. The government does not address the advantages enjoyed by salaried individuals. And let’s not compare small business owners earning over $150,000 with the average salaried employee who makes $50,000. Let’s compare them with employed individuals who make over $150,000 per year. Let’s call them “Rich CEO’s”, for lack of a less inflammatory term. Rich CEO’s, in general are able to enjoy the following benefits:

  1. No risk to personal capital
  2. Stock option benefits
  3. Company-funded private registered pension plan
  4. Paid vacation time
  5. Paid maternity/paternity leave
  6. Employment insurance
  7. Severance package upon termination
  8. Low-interest housing loans
  9. Health insurance benefits
  10. Life insurance benefits
  11. Automobile benefits
  12. Entertainment expense accounts
  13. Reimbursements for travel expenses
  14. Reimbursement of relocation expenses
  15. Golf club membership
  16. Prizes and corporate scholarships
  17. Christmas bonuses
  18. Performance bonuses

None of the above seems to have been affected by the Proposals.

On the other hand, a small business owner enjoys none of the above Rich CEO perks. On the contrary, he or she makes the following sacrifices when becoming involved in a business endeavour:

  1. Risk of capital – often life’s savings
  2. Risk of start-up losses
  3. Risk of business failure
  4. Risk of personal bankruptcy
  5. Risk of legal attack from clients and suppliers
  6. Risk of audit by CRA and/or Revenu Quebec
  7. Incurring personal debt, often mortgaging their homes
  8. Entering into lease obligations
  9. Requirement to keep bookkeeping records and file corporate returns
  10. Payroll obligations
  11. GST/HST/QST obligations
  12. Employer portion of CPP/EI/Health care
  13. Personal liability for deductions at source
  14. Personal liability for GST/HST/QST payments
  15. Unstructured and unlimited working hours
  16. Need for family involvement

None of the above risks are taken by Rich CEO’s and again, none of these factors is mentioned in the Poposals.

I personally offer my services to both incorporated business owners and Rich CEO’s. I would like to offer an example of a comparison of the annual accounting and legal fees involved in incorporating and maintaining a small business with those incurred by a Rich CEO.

Incorporated Business                                                          Rich CEO

 

Initial Incorporation fees                         $     2,500
Annual bookkeeping fees                               10,000
Annual legal fees                                                2,000
Annual external accounting fees                   15,000
Annual registration fees                                        107
Annual personal tax preparation                     1,500                         1,500

Total fees                                                      $    31,100                        $1,500

As you can see, the increased costs faced by a business owner simply to comply with existing tax laws and legal obligations makes the Proposals that much more difficult to digest.

In conclusion, the Proposals seem to me to be a clear attack on a large sector of the population that the average middle class Canadian – your constituency, would not have a problem hurting, especially given that you have characterized them as wealthy Canadians taking advantage of tax loopholes. This is clearly not the case, and the Proposals in general are prejudicial and unfair.