DAVID WILKENFELD, CPA, CA, canadian tax CONSULTANT

Posts Tagged ‘Professionals’

Response to Tax Proposals – Part 2

In Canadian Income Tax on September 14, 2017 at 9:00 am

Yesterday, I published Part 1 of my letter to Bill Morneau, addressing the general tone of the presentation of the federal government’s July 18 proposals to reform the taxation of private corporations. In today’s Tax Issue, Part 2 of my submission, dealing with the specific proposals themselves, and offering some suggestions for improvement, and in some cases, abandonment.

Part 2 – The Proposals – Suggestions for Improvement

Having aired my general concerns with the sweeping nature and tone of the Proposals, my experience as a tax professional leads me to acknowledge that there are, within the Proposals, certain areas that should, in all fairness be addressed. In this section I will review the four areas covered by the Proposals and offer my suggestions for improvement where warranted.

Income Sprinkling

The sprinkling of dividends among family members and other shareholders is a legal right sanctioned by the Supreme Court of Canada in the decision of McLurg v. Canada. Since that time, incorporated business owners have often structured their affairs to multiply low marginal income tax rates by issuing shares to family members, often minor children, even new born babies. The ability to use minor children in this manner was eliminated in 2000 with the introduction of the tax on split income (“TOSI”).

The Proposals now seek to extend these TOSI rules even further, to spouses and adult children. They have introduced legislation that will create an inordinate amount of complexity and uncertainty into the system.

First of all, the sprinkling of income with a spouse should not be disallowed. Often, a business is a family endeavour and a spouse offers support in many ways. Further, there are many instances, such as pension income splitting, where the distribution of family income among spouses is specifically allowed. I would recommend that the proposals with regard to spouses be abandoned.

Secondly, the sprinkling of dividend income to adult children is beneficial generally only to the extent that the child is not otherwise employed. In other words, the real benefit accrues during the time the child is still in school and not earning a salary. If it offensive to sprinkle income with adult children, then I would suggest that the TOSI simply be extended to an age where the most benefit is being attained, i.e., to age 25. After that, the benefits are virtually non-existent, unless the child is, in fact, involved in the business full time.

On the other hand, if the government is intent on introducing another reasonableness test with respect to dividend income paid to children, then they should amend the TOSI rules for minor children as well, since even a 15-year-old child, for example, can work in the business in the summertime and after school.

The proposals with regard to Capital Contributions should be abandoned. The fact is anyone who starts a small business through incorporation will normally capitalize the company with a nominal amount of share capital. No dividend paid on a common share of a small business corporation would meet the proposed reasonableness test in this regard, and it simply introduces more complexity into the law.

Lifetime Capital Gains Exemption

I have been involved in the structuring of many corporations where minor children are issued shares for the purposes of multiplying the capital gains exemption. My feeling is that the parent is using for his or her own purpose, without consent, a benefit that belongs to the child that he or she may wish to access in the future. I therefore agree that the participation of minor children in the ownership of a small business corporation for the purpose of multiplying the capital gains exemption should be curtailed.

With respect to family members over the age of 18, my feeling is that if they are legally allowed to contract, they should be allowed to own shares of a corporation, and as such, make their own decisions as to whether or not to claim the capital gains exemption on the sale of their shares. For spouses and children over the age of 18, therefore, I disagree with any restrictions on the use of the capital gains exemption on qualifying shares. These proposals should be abandoned.

Holding Passive Investments

The deferral of income within the corporate structure has been a staple of small business since the 1930’s. It is correctly considered to be the “nest egg” that a business owner can rely upon for retirement. If we add up the pros and cons of small business owners vs. Rich CEO’s as I did earlier, this item is perhaps the biggest reward that a small business owner can look forward to at the end of his or her career. While the Rich CEO can enjoy a large severance package and a generous pension upon retirement, the small business owner can rely on the accumulated investments in a holding company. The income from these investments is taxed at the highest marginal rate, so there is currently no income tax advantage to earning investment income through a holding company.

The idea that the government would attack accumulated wealth within a small business corporation and undermine a lifetime of labour by its owner seems excessive and cruel.

In my view, these proposals should be abandoned.

Converting Income into Capital Gains

Currently, the rules in section 84.1 address the issue of surplus stripping. Furthermore, the avoidance transaction that the Proposals are trying to address in this area has essentially been settled in cases such as Macdonald v. Canada. The CRA has successfully applied the General Anti-Avoidance Rule to curtail abusive transactions in this regard. Due to the CRA’s success in the courts in attacking these transactions, I would not recommend them to any of my clients. I therefore see no need to introduce legislation that would not only target abusive transactions, but would also deny capital gains treatment in cases where bona fide share sales were made. The Proposals make no allowances for the possible transfer of a business from a parent to a child or a sale between siblings. In fact, the Quebec government has recently gone in the reverse direction, introducing legislation that facilitates business transfers to the next generation.

Furthermore, these proposals will subject estates to double and in some cases triple taxation. Upon the death of an individual, there is a deemed disposition of shares at fair market value. The estate pays capital gains tax. When the company then liquidates its assets for distribution, there is a second tax that must be paid on the accrued increase in the value of investments within the company. Finally, upon distribution of the corporate assets to the heirs, a third dividend tax is levied. This is clearly unfair.

There is only one mechanism currently in place within the law that directly relieves this burden. Subsection 164(6) allows for an election to be made to offset the capital gains tax on death, but only where the company is dissolved within one year from the date of death. The administration of an estate can run much longer than one year. The government has acknowledged this with its newest laws regarding Graduated Rate Estates (“GRE”), which have a life of 36 months.

The Proposals will eliminate the ability of estates to implement what is commonly referred to as the “Pipeline” plan, which involves capitalising the cost base of shares that were taxed on death. In my opinion, the Pipeline is not an unfair advantage. The capital gain triggered on the death of an individual is clearly not a voluntary tax outcome. It is an automatic tax triggered by virtue of the law. The government seems not to be satisfied with this tax, and by denying the ability to plan to limit their taxes to this involuntary event, wishes to force a second and more onerous tax on the estate. Again this seems cruel and unfair.

My recommendation is that the anti-avoidance provision contained in the Proposals be abandoned and that the “Pipeline” transaction be expressly sanctioned by the CRA.

Failing this, at the very least, the election under subsection 164(6) should be made available to an estate for as long as it remains a GRE. Further, the designation currently allowed in certain circumstances under paragraph 88(1)(d) should be extended to corporations that have been liquidated in favour of a GRE. This would limit the tax burden on an estate to one incidence of tax, albeit the result of a forced transaction yielding a higher tax burden.

Yes, It Is Safe To Incorporate!

In Canadian Income Tax on August 8, 2010 at 2:22 pm

Is it safe? Maybe Sir Lawrence Olivier’s demented sadist was simply a frustrated Quebec dentist, driven crazy over the years by government restrictions preventing him from incorporating his practice. OK, maybe not, but he could have been :-).

Are you also a member of one of Quebec’s 45 professional orders? Did you know that you can finally start thinking about running your business through a corporation? It’s been a couple of years now, but Quebec has joined the rest of Canada and now allows professionals such as pharmacists, lawyers and dentists to incorporate their practices.

I’m A Dermatologist. Surely I Can’t Incorporate, Can I?

Yes you can. Any business can incorporate as long as there are no legal restrictions to doing so. A member of a profession governed by the professional code of Quebec has, until recently been restricted legally from incorporating due to concerns for the protection of the public. But that has all changed now and the tax benefits of incorporation are now available to all professionals, including physicians.

Tax Benefits? What Tax Benefits?

There are essentially 3 main tax advantages to incorporating your practice. Let’s discuss them in order of importance.

Tax Deferral: If you are a high income earner in Quebec, your top personal tax rate is 48.22%. Corporate tax rates for small business income are 19%. So, if you make enough money to save in your corporation, you will defer close to 30% in taxes. This leaves that much more money in your hands to invest until you need the funds personally.

Income Splitting: Generally, anyone can own shares in a corporation. If you have family members with low income, you could pay out those low-taxed dollars from your corporation to them as dividends. This strategy turns a deferral into a permanent tax savings!

Capital Gains Exemption: If you run your business through a corporation and then sell your practice, the capital gain on the sale might wind up being tax-free. Every individual in Canada is allowed an exemption for up to $750,000 in capital gains on certain shares of small companies. What’s more, those family members of yours each have the same access to the exemption, so this amount could be multiplied with the proper planning.

What about the Public? Don’t we care about them anymore?

Sure we do. The main reason why professionals were restricted from incorporating in the past was that we didn’t want them hiding behind the “corporate veil” in terms of their professional liability. Under the new regulations, any professional who incorporates must still acquire professional liability insurance within their corporation. There are also restrictions on who can run the company and who can hold voting shares. Any professional thinking about incorporating must carefully examine the regulations governing the incorporation of their practice to ensure they comply with all the restrictions.

OK, I’m ready. What Now?

My best advice is – don’t try this at home! I strongly suggest that you consult your tax advisor, but the basic steps are as follows:

  • First, check with your professional order to ensure that they have adopted the necessary regulations to allow their members to practice through a corporation. While the province has opened the door to all professions some have been slow to step across the threshold.
  • Set up a new company: You can create a company under the Canada Business Corporations Act or under the laws of the province in which you practice.
  • Inform your professional order: Again, check the regulations – your professional order will likely require a signed declaration and a fee before they will approve your change in status.
  • Transfer your business assets: An established professional practice will have to be transferred, or sold from you personally to your corporation. This will normally require transfer documentation and special tax election forms for the CRA and Revenue Quebec to ensure that you don’t inadvertently trigger any tax on the transfer of the practice.

Thanks. But I’m Still Confused. Where can I get more information?

Your professional order should have a website with a special section on incorporating your practice. Check it out or give them a call. They will likely have someone on staff in charge of incorporating your practice.