Feds launch consultation on tax proposals

Tax experts disagree over whether professionals, such as doctors and accountants, and small business owners who are considering incorporating their businesses should hold off from doing so as the federal government reviews the practice of tax planning using private corporations, which it announced in the 2017 federal budget.

“I wouldn’t bother spending the money on legal and accounting fees right now to set up a structure that might be useless in a few months’ time,” says Jamie Golombek, managing director of tax and estate planning in Toronto-based Canadian Imperial Bank of Commerce’s wealth strategies group.

However, other tax practitioners argue that if the potential tax savings from incorporation exceeds the cost of setting up the corporation, professionals and small business owners would be risking little by going ahead — even in light of the federal government’s current review.

“If the tax savings and/or deferral benefit from this year alone is enough to more than cover the cost, I would proceed without hesitation,” says Jason Pereira, a partner and senior financial consultant with Woodgate Financial Inc., which offers investment services through IPC Securities Corp.

Adds Michelle Connolly, vice president of tax, retirement, and estate planning with CI Investments Inc. in Toronto: “If you’re dealing with a business owner who is very fortunate, and is making money hand over fist, and isn’t spending it [and therefore can retain it in the corporation], does it make sense to incorporate? I say yes.”

However, tax experts appear to be in agreement that small business owners and professionals who’ve already incorporated are better off not making any tax-planning changes in anticipation of the government review.

“Once we see what the government is actually thinking about, then we’ll be able to plan around it,” Pereira says. “Any kind of action now is ridiculously premature.”

Adds Connolly: “In terms of planning, I’d agree, don’t do anything rash.”

The federal government indicated in the budget released last month that it was concerned with three particular tax-planning strategies involving the use of private corporations:

> “Income sprinkling,” or reducing overall income taxes by causing income that would otherwise be taxed at the individual’s top tax rate to be realized by an eligible family member who might be in a lower tax bracket, or who may not be taxable at all.

> Holding a passive investment portfolio in a private corporation, which provides the advantage of tax deferral.

> The conversion of a private corporation’s regular income into capital gains, which is taxed at a lower rate.

Read: Professionals will no longer be able to use billed-based accounting

Read: Budget proposes clarification of “factual control”

Watch: Changes to tax structures on private corporations

The government said that it was currently reviewing these strategies, as it was concerned that they “inappropriately reduce the personal taxes of high-income earners.” The government intends to release a paper “in the coming months” providing more details about its specific concerns, as well as proposed policy responses.

“My guess is that they’ll do this over the summer, ask for comments [from interested parties], and ultimately introduce legislation in the fall or in the next budget,” Golombek suggests.

Based solely on the information provided in the budget documents, it’s difficult to speculate on what steps the government might take or, indeed, what exactly troubles the government about these particular tax strategies, these experts say.

However, Connolly suggests the government is likely generally concerned about incorporated professionals accessing the lower tax rate associated with the first $500,000 of active business income available through the small business deduction (SBD) and using it to reduce taxes and accumulate wealth in a way that the government considers to be inconsistent with overall tax policy.

“[The government] wants to ensure that business owners or incorporated professionals are genuinely putting back into the economy, that they are creating jobs, that the corporation is an active business in a way that aligns to the true intent of why the government is providing the SBD [in the first place],” she says.

There are many steps the government could take to address the issue, experts say, including providing for only one lifetime capital gains exemption amount per family or re-introducing a capital tax on investment income held in a corporation.

However, the likeliest solution, at this point, may be for the federal government to copy a recent Quebec tax change that limits access to the SBD only to those small businesses, outside of manufacturing and other key industries, whose employees worked a minimum of 5,500 hours in total in a taxation year (the rough equivalent to employing three full-time workers). That law goes into effect this year.

“I think they’re going to follow Quebec’s lead,” Connolly suggests. “Essentially, the federal government is going to make it more difficult to qualify and use the SBD.”

Says Jack Courtney, vice president of private client planning at Investors Group Inc. in Winnipeg: “[The Quebec approach] is an option for the federal government.”

There may be a lot of pushback from a variety of groups, including professional associations, to the government’s review, Pereira suggests.

“The problem here is that a lot of professionals rely on incorporation for tax planning, and a lot of politically sensitive [groups], such as doctors, are going to be massively up in arms over this,” he says.

Some groups will argue that increasing the tax burden on incorporated professionals and small businesses will stymie economic growth and innovation, which the government says it’s trying to encourage. It may also lead to a “brain drain” of talent away from Canada to the U.S. or other lower-tax jurisdictions.

“There are a lot of people who will be interested in these [possible] changes, and will be making comments and representations,” Courtney says. “It’s tough to gauge now how fast this will move, and whether any of these things, in the end, will gain traction.”

Photo copyright: rabbit75123/123RF