With the submission deadline for the Canadian-controlled private corporations tax proposals now behind us, the government is poring through more than 21,000 submissions. Even if a full-time staffer at the federal Department of Finance of Canada spent a mere 10 minutes reviewing each submission — and many of them are 50 pages or more — it would take more than 465 work days to read them all. Still, some, if not many, of the submissions bring up significant concerns that the government needs to consider thoughtfully.
Of the three areas the government has targeted — namely income sprinkling among family members (including the multiplication of the lifetime capital gains exemption); converting dividends into capital gains; and passive investment income earned within corporations — it’s the last one that has caused the most concern among advisors. That’s because this proposal could result in corporately earned passive investment income taxed at a combined effective tax rate, of, say, 73% in Ontario and even higher in other provinces.
Although no formal effective date or definitive approach for the taxation of passive investment income has been announced, the government has said that it “will be designing new rules over the coming months to tax corporate passive income in a way that’s more fair for Canadians.” The government invited Canadians to “share views on any aspect of these new rules that you feel are important to bring to the government’s attention.”
The Canadian Bar Association and Chartered Professional Accountants of Canada’s Joint Committee on Taxation, which brings together members of Canada’s legal and tax communities periodically to evaluate and offer the federal government input on tax laws, provided a detailed submission in three parts.
The Joint Committee on Taxation’s submission on the proposed passive investment income proposal points out that there are important reasons, non-tax related, for carrying on business activities through a corporation; namely, the corporate form limits the business owner’s liability, thereby encouraging risk-taking and facilitates the raising of capital. In fact, longstanding tax policy in Canada has been to reinforce the incentive to conduct business activities through corporations by having a substantially lower corporate tax than the top personal tax rate. Many other jurisdictions have low corporate tax rates relative to the top marginal personal tax rates and nonetheless don’t appear to tax passive income at high rates, as Canada does or, generally, have legislation that penalizes leaving funds in a corporation for investment.
The Joint Committee on Taxation’s submission points out that Canada’s tax system is actually currently “under-integrated,” meaning that there is no meaningful tax advantage to earning business income through a corporation if that income is taxed at the general corporate tax rate. In fact, in nine of 10 provinces, both corporate income subject to the general corporate tax rate and investment income earned by a private corporation are subject to higher tax rates than would otherwise apply to such income were it earned by an individual.
Although the Joint Committee on Taxation concedes in its submission that the investment of income eligible for the small business rate is, in some — but not all — provinces taxed at a lower rate, thereby providing an advantage, “that advantage is not significant, and the entire system should not be upended merely to address potential anomalies that arise when corporate income is taxed at the small business rate.”
It will be interesting to see how the government responds to all these submissions in the days and weeks ahead.