Finance Minister Bill Morneau wants to close loopholes that allow highly paid professionals to reduce their taxes by incorporating and then using various small business tax breaks to shelter their income. These loopholes are legal but unfair. They amount to potentially more than $1 billion annually in lost revenues to the government. That money could be used toward pharmacare, affordable housing or building green infrastructure. Morneau argues that he wants to create an improved tax system but some of the reaction has been hysterical.
The National Post newspaper described it as a “class war.” In The Globe and Mail, an economist for a money management firm wrote that the planned changes could create a recession. Predictably, the Canadian Federation of Independent Business (CFIB) described it as an unfair attack on small business. The Canadian Medical Association (CMA) threatened that many of its incorporated members might move to the U.S. As parliament began to sit again earlier in September, an airplane hired by the Canadian Taxpayers Federation (CTF) circled in the skies above Parliament Hill pulling a banner that read “No Small Biz Tax Hike.”
The rush by affluent individuals to incorporate has its roots in the Harper government’s dramatic reductions in the small business tax rate, from 19 per cent to 10.5 per cent in 2015. It’s too sweet a deal to pass up. If they are incorporated, high income professionals pay perhaps 12 or 13 per cent in small business taxes once both federal and provincial jurisdictions are taken into account. The same individuals would likely pay taxes of close to 50 per cent on salaried income.
In addition, some people have found other ways to avoid paying taxes. One such method is called “sprinkling” and it involves having incorporated individuals pay salaries to children and spouses who are in a lower tax bracket. In many cases they actually do no work in return for this compensation. The government proposes having businesses prove that the family members are legitimately earning that income. The CFIB opposes that, saying it “could add more red tape to business operations.”
The business lobby has been aggressive regarding the tax reforms but it does not have the field to itself. A group of doctors has come forward to say that they favour the reforms and are “fed up” by the actions being taken by the medical associations. The Canadian Nurses Association also supports the proposals, and a more broadly based campaign has been created by unions, Oxfam and other civil society organizations. In another action, an open letter to Minister Morneau drafted by the organization Lead Now in favour of the reforms has attracted over 14,000 signatures.
Flawed tax system
The broader question here, which appears to be of no interest to the business lobby, is how a flawed tax system promotes inequality in Canadian society. One example is the off shore tax havens being used by wealthy Canadians to hide money and avoid paying tax. One estimate puts the figure of forgone tax revenues at $6 billion and the Canada Revenue Agency appears unable or unwilling to confront this evasion. If the CMA, the CFIB or the CTF have ever made any statements decrying off-shore tax havens, I must have missed them.
What’s more, the business lobby routinely fights any proposals to raise the minimum wage, as it is now doing in Ontario. The CFIB also opposed measures to improve the modest benefits available to workers under the Canada Pension Plan, which is funded by contributions from both workers and their employers.
It’s interesting that for some people closing tax loopholes is considered class war, but hiding billions in off-shore tax havens or opposing minimum wage hikes merits no such description.
I hope you are sending this to Morneau and to the Conservatives and NDP. With thanks, Jake.
As has so often been the case, those who are at the top of the inequality ladder will fight tooth and nail to stay there or build rungs on the top of that ladder to take themselves higher, HIGHER, AND EVER MORE HIGHER. It matters not how unstable that economic ladder can become or how its crash can cause damage to so many. As an example, some of the ones who caused the economic crash of 2008 demanded millions in bonuses
You make a good point in the lack of taxation for those with offshore accounts…then why is Trudope and Moron not chasing the bigger fish who have these accounts ? That would be tax fairness imho.
My second comment goes to the lack of spending control these politicians have. If they showed some restraint in spending, it would go a long way to having confidence that our hard earned tax dollars were being used efficiently. At this point in time, I know of no single person who would commend the present governement for their thrifty budgets.
As an incorporated small business person I can attest to the indefensibly favourable treatment I receive because of the incorporation provisions. However, it is important to describe accurately where the benefits lie. It is true that the corporation pays, depending on the province, from 15% to 20% on net income which is not distributed to employees or shareholders. If you keep the money in the corporation as retained earnings, that’s it. But to get the money in your hands, you have to either pay yourself a salary, which becomes taxable income to you as an individual, or as a dividend, which also gets favourable tax treatment as part of your personal income, but which is not a further tax deduction or expense to the company. So the final tax percentage is the sum of the, say, 17% the corporation has already paid, and the additional amount you will pay on the income/dividends received from that corporation. The basic principle is that it’s all supposed to work out in the end: by the time the corporate income is taxed and then the personal income is taxed, the total tax is supposed to be about the same as it would have been had all of the income been earned by a non-incorporated person.
But for those who don’t have to take pretty much all of the corporate net earnings as income, or who can take take sabbaticals which they can self-fund from the retained earnings by distributing dividends and/or a salary at levels that don’t trigger the higher marginal tax rates, it’s quite possible to keep the eventual tax bill lower than would have been paid by a salaried person in perpetuity.
It is true that we have to fund our own retirements either by keeping retained earnings in the corporation and/or building our own RRSPs. If we want to contribute to RRSPs we have to take the corporate profits as personal income (not dividends).
But this is not the worst of it: the “income sprinkling” is a flat-out gift for which there is no defense. No one who is not a genuine partner in the business, an independent (i.e., non-family) shareholder, or a family member who does real work to get the income should be able to get a slice of the pie in order to make the principal income look smaller and pay tax at a much lower rate.
Bottom line: the system is designed to do what it does, which is to give incorporated small business owners and their bastard cousins, professional corporations, favourable tax treatment. I am actually a small business person: I have multiple clients, I don’t know where my work will come from next year, and there is real uncertainty. This is hardly the case for a physician, who has one customer – the state – and zero uncertainty.
However, if we’re going to open up Pandora’s box, we should deal with everything that flies out. Maybe a billion dollars is on the table here. Both levels of government have foregone ten to twenty times that annually since the late 1990s in the form of tax reductions. So if governments have a revenue problem to address the problems of failing infrastructure and other perceived needs, revisit both corporate and individual tax rates and progressivity rather than focusing exclusively on one sector. If the government doesn’t want me to pile up money as retained earnings in my company, make it less attractive for me to leave the money in there.
I think those who call for a new Royal Commission on taxation, a la Carter in the 1960s, are basically correct. I suspect a fair-minded examination would come to the same conclusion as Carter: make the tax code simple, tax a buck as a buck as a buck, and make sure that nominal tax rates and actual tax rates are the same. We end up with tax codes thousands of pages long for a reason: the more complex, the easier it is to conceal various interest group accommodations. Note that many countries have very high VATs (value added or sales taxes), on the order of 18% to 20%, precisely to make taxation simple. A very high consumption tax is of course regressive, but there are ways to compensate for it via year-end tax adjustments and exemptions.
Do I believe the Liberals have thought all of this through and really want a genuinely fairer and more transparent tax system? Hell no. I don’t actually think they know what they’re doing. It’s hypocritical and self-serving for people like me to grandstand about the dire consequences of ending our special treatment. But it’s worse than hypocritical for government to demonize beneficiaries of these advantages as if we were cheaters. We play the game as it was created. Shame on governments for setting up the game that way, and shame on those who claim the game is necessary to encourage risk, spur creativity, and save Canada from a massive talent exodus.
Thanks Steven for a knowledgeable insider’s treatment of this tax controversy.