The federal government’s proposed changes to the tax treatment of passive investments in a private corporation will not achieve its goal of promoting tax fairness, suggests a report published Thursday from the C.D. Howe Institute, entitled Off Target: Assessing the Fairness of Ottawa’s Proposed Tax Reforms for “Passive” Investments in CCPCs.
The proposals, outlined in the government’s consultation paper on the taxation of private corporations, “risk delivering a blow to the retirement planning of many small-business owners,” says the report’s author, Alexandre Laurin, director of research at the C.D. Howe Institute in Toronto. That unfavourable impact would be in addition to the potential negative consequences of the proposed changes to entrepreneurship in the small-business sector overall.
One of the possible tax changes proposed in the consultation paper would involve ending the passive investment income tax refundability for Canadian-Controlled Private Corporations (CCPCs). That would mean taxes paid on investment income in a CCPC would no longer be tracked and refunded upon dividend payments. Private corporations would be taxed on their passive investment income on the same basis as if they were individual investors in fully taxable accounts.
“There would be diminished incentives to defer business consumption, and less income and business saving available for spending on capital equipment,” Laurin says. There would also be greater incentive for immediate personal consumption of business income generated, rather than retaining income in the CCPC for retirement savings.
Tax simulations show that the current system is not inequitable when benchmarked against the tax treatment afforded to personal retirement savings, the report argues. It concludes that income in a private corporation taxed at the general corporate rate and reinvested passively in the corporation enjoys no significant tax advantages over other saving options; and business owners earning income taxed at the small-business tax rate and saving it in the corporation for future personal consumption enjoy a tax treatment “pretty much on par” with other ssaving through an RRSP or a TFSA.
“Considering that additional administration, accounting, and tax compliance costs need to be incurred in corporate accounts, one could reasonably conclude that passively reinvested small-business earnings receive a tax treatment similar to that of RRSP/TFSAs,” the report says.
The report argues that the playing field for tax-assisted saving opportunities is unequal in other ways, citing the relative advantage that defined benefit pension plan participants, particularly those in the public sector, have over other Canadians, who cannot achieve similar outcomes as do DB plan participants via RRSPs under current rules.
If the government proceeds with changes it has proposed, it should allow business owners to have access to tax-assisted retirement saving opportunities comparable to those public sector workers enjoy, the report says.
One possible reform would involve establishing a lifetime accumulation limit of personal tax-assisted savings to replace the current system of annual limits, the report suggests. A lifetime limit would ease the transition to the proposed regime, and provide contribution flexibility and room to all Canadians, including small-business owners.
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