Tax policy-makers in Canada are set for a busy 2018. The most pressing issue will be to determine the way the federal government will proceed with its proposed changes to the taxation of private corporations – changes the Liberals first introduced last summer and have amended heavily since.
“[The Liberals] have moved off the mark by a huge amount from where they were,” says Rick Robertson, associate professor with the Ivey School of Business at the University of Western Ontario in London, Ont., of the Liberals’ proposed changes. “And I don’t think they’re done making adjustments yet.”
The government also faces the challenge of responding to the significant tax reform legislation passed in the U.S. late last year, which lowers tax rates for both corporate and individual taxpayers.
“The movement of capital is so easy these days,” says Dave Walsh, partner and tax service line leader with accounting firm BDO Canada LLP in Ottawa. “You have to be careful to remain competitive with the U.S.”
Tax experts such as Lana Paton, managing partner, tax, with PricewaterhouseCoopers LLP, suggest the government will favour a slow and steady approach to tax policy in the 2018 federal budget, avoiding any new big reforms in favour of modest measures. “I suspect this budget will be more [about] clarification,” she says, “calming some of the noise that was created by the introduction of the private-company tax changes.”
Walsh agrees: “I honestly believe the first two [Liberal budgets] were ‘bad news’ budgets. So, I think [the 2018] one will have to be neutral. [The government] will save up any goodies for 2019 and try to use that one as a so-called ‘election’ budget.”
Last July, the Department of Finance Canada delivered what the small-business sector largely regarded as bad news when the feds released proposed changes to the taxation of private corporations. The government, arguing that the existing rules gave an unfair advantage to wealthy Canadians, targeted three types of tax planning involving private corporations: “income sprinkling” of dividend income; the retention of passive investment income; and the conversion of dividend income into capital gains.
Facing intense criticism, the government backtracked on many significant parts of the proposed legislation over the next few months, including ditching the proposal against the conversion of income into capital gains. The feds also announced that they would be lowering the small-business tax rate in 2018 and 2019. In December, the government announced revised rules against income sprinkling, which came into effect on Jan. 1, but also narrowed the scope of the previous proposed rules.
The government also announced that the 2018 federal budget will have further details regarding the tax treatment of passive investment income from a private corporation. The government already has signalled that it will allow a $50,000 annual exemption on passive investment income earned in a private corporation before any new taxes apply, as well as full grandfathering of investments already held in a business.
Still, uncertainty exists regarding how the grandfathering rules will work.
“Business owners will be looking for clarity on how the government will go forward on passive investment income,” says Jamie Golombek, managing director of tax and estate planning with the financial planning and advice group at Canadian Imperial Bank of Commerce. He believes the government may revisit the proposed rules against the conversion of dividend income into capital gains. “I think that will come back in some form or another, either in the 2018 budget or later, when the government has had a chance to be precise in drafting the rules so that they don’t catch the intergenerational transfer of businesses.”
The government appears likely to continue to look for ways to pursue its major tax policy theme of helping the middle class, although there will be little room to hike tax rates further, particularly in light of U.S. tax changes. One possibility is to increase the capital gains inclusion rate – a move that has been rumoured before each of the previous two Liberal budgets. That development would present its own risks for the government, Golombek says.
“We know that most capital gains are earned by the wealthiest, because most Canadians don’t have a lot of non-registered money,” he says. “But capital gains also affect small-business owners. If you increase the inclusion rate, you also increase the tax rate on the sale of small businesses. I’m not sure that this would fly politically.”
The fact that U.S. corporate tax rates now will be lower than rates in Canada also will hang over the heads of Canadian policy-makers, Robertson says. The possibility that the North American Free Trade Agreement could be ripped up by the U.S. government only clouds the picture further.
“If I were a business trying to make a decision on where to expand, I’m not convinced Canada would be high on the list,” he says. “I’d consider the U.S., because the rates are better and I can deal with the uncertainty of trade.”
Another trend we’re likely to see this year is a move against offshore tax evasion and aggressive tax avoidance. Late last year, the government announced a less forgiving voluntary disclosure program for taxpayers who have been intentionally non-compliant – a move Robertson calls a “political winner.”