Opinion David J. Rotfleisch Taxation

Morneau tax amendments an assault on entrepreneurs

Canadian Accountant columnist David J. Rotfleisch says Bill Morneau's tax proposals hurts small business owners

Author: David J. Rotfleisch

Be careful what you wish for. How many times have you said “I wish my elected politicians would follow through on their campaign promises?” 

Well, Justin Trudeau promised to increase taxes on the rich members of society, and Prime Minister Trudeau has lived up to his campaign promise.

But I say that the proposed changes to the taxation of entrepreneurs and professionals is misguided and seriously misunderstands (possibly from a deliberate policy point of view) some fundamental concepts. So, the proposed changes to the Income Tax Act announced and defended by the Minister of Finance, the Honourable Bill Morneau, amount to an assault on the engine that creates jobs and stimulates the economy — small business owners.

As a reminder, about 10 per cent of Canadians work for organizations with more than 500 employees and 20 per cent of Canadians work for organizations with between 100 and 500 employees. That leaves the vast majority who work for companies with between 1 to 100 employees. That’s 70 per cent of Canadians who are the economic engine of this country, according to statistics collected by the Government of Canada.

The announced policy reason for the changes is to “level the playing field” and the example given in the summary overview is an individual living in Ontario and earning salary of $220,000, versus his neighbour, who earns the same amount through a private corporation and is able to reduce taxes through “income sprinkling. “

No mention is made of a couple earning $110,000 each who pay less in taxes than their neighbouring couple where one spouse earns $220,000 and the other spouse has no income. This is a result of progressive tax rates and lack of a U.S.-style joint tax return for couples.

Finance Minister Morneau recently said in a newspaper Op-ed that: “An incorporated professional earning $300,000 with a spouse and two adult children can save about $48,000 in taxes by using just one of these loopholes. What that means is an incorporated professional could be taxed at a lower rate than a salaried nurse practitioner or police officer making much less a year.” 

As accountants, we know that this is political rhetoric and plain wrong. While the professional corporation may be paying tax at a lower rate, when the income is taken out by the professional it is taxed at high progressive marginal tax rates. 

Morneau said further: “For passive investment income to provide an advantage over and above what is available to every Canadian through RRSPs and TFSAs, a business owner needs to earn more than $150,000. That is because the more you earn, the more you stand to benefit from these tax-planning strategies. No wonder some estimate that two thirds of the wealthiest 0.01 per cent own a CCPC.” 

Of course this is true, but why? Progressive tax rates. As accountants, you know that the more a taxpayer earns, the more he or she benefits from tax-saving strategies simply because the more you earn the higher your rate of taxation.

The Society of Tax and Estate Practioners (STEP) released a discussion paper with five cogent examples of adverse and patently unfair tax results in each of those situations. I don’t propose to discuss or even comment on each example. I recommend that you review each of the situations for yourself to see the manifest unfairness in those commonplace scenarios. However, some things need to be said.

Example 1 addresses much maligned medical professionals who, presumably, should be content with saving lives and not be so mercenary as to focus on after tax income. Medicine is becoming dominated by women as they outnumber men in medical schools and Example 1 is a very realistic scenario. It makes financial sense for a lower income husband to be the primary caregiver for the kids while his wife earns higher income as a doctor.

I understand anecdotally that many medical families with the mother who is the doctor have undertaken family financial planning with this income splitting front and centre and are rightly incensed by these proposals. The STEP example is a perfect and simple analysis of the unfairness of this proposal.

Several other of the examples show inappropriate results on a sale of shares where one would think the capital gains exemption should be available but might not. However, this brings me back to my opening statement, that the proposals manifest a significant misunderstanding of some small business concepts. 

A small business is a family business. The whole family is involved, even if only one spouse actually works in it (although often many family members pitch in). The family home is often mortgaged to finance the business. The spouse or in-laws or parents often lend money. The entrepreneur works long hours and sometimes takes out little if any income.

So, why should the family not benefit if the business is eventually successful? Why is income splitting and multiplying the capital gains exemption inappropriate? It is recognition of family unit risk by providing family unit reward. And again, let us be cognizant of marginal tax rates and lack of joint returns in Canada.

So I ask again, what is the problem with income splitting in these scenarios?

And my answer is it’s a political wrong, not an economic one.

And a final thought. We have all had clients come in and ask about the mechanics of moving offshore. The more high-tech the industry, the easier it is to leave. As Canada’s tech hubs grow in size and economic importance, tax changes that alienate the very people who are driving the economy forward are generally a bad idea.

David J Rotfleisch, CPA, JD, is the founding tax lawyer of Rotfleisch & Samulovitch P.C., a Toronto-based boutique tax law firm. With over 30 years of experience as both a lawyer and chartered professional accountant, he has helped start-up businesses, resident and non-resident business owners and corporations with their tax planning, with will and estate planning, voluntary disclosures and tax dispute resolution including tax litigation. Visit www.Taxpage.com or email david@taxpage.com

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