Latest version of small-business tax proposal 'confiscatory'

A tax expert says that the proposal to tax Canadian-controlled private corporations must be abandoned

Latest version of small-business tax proposal 'confiscatory'
After its initial proposals on small-business taxation were met with criticism from advocates and pundits, the federal government made some revisions and introduced policy sweeteners to stem the tide of criticism. But that doesn’t mean the revised policies have been perfected — far from it, according to one expert.

“The proposal, first floated last July, is confiscation, pure and simple,” said Allan Lanthier, former chair of the Canadian Tax Foundation and retired partner of Ernst & Young, in a think piece for the Financial Post. “The proposal is also bewilderingly complex, and understood by very few. That is no doubt the way the government would like to keep it.”

Celebrating our industry successes in the wealth management industry

Lanthier focused on the portions of the proposal concerned with taxation on investment income earned by Canadian-controlled private corporations (CCPCs). He used the example of two neighbours, Jonah and Andrea, who both pay a personal tax rate of 50%.

Jonah, a salaried employee, earns $100,000 in 2018 and, after taxes, buys $50,000 of mutual funds, which allows him to earn $500,000 of investment income in 25 years; after taxes, that’s $250,000 in retirement income.

Meanwhile, Andrea carries on business through a CCPC called Aco. Aco also earns $100,000 in 2018, but is taxed at a small-business rate of 15%; the $85,000 isn’t needed by Aco, so it uses the cash to buy the same mutual funds as Jonah. After 25 years, Aco is earning $850,000 in investment income, which is taxed at a 50% corporate rate. The total tax paid by Aco — which, under tax integration, is the same as the combined tax charged to Aco and Andrea —is $425,000.  

“The government’s concern is that Jonah only has $250,000 of after-tax income to help fund his retirement, while his neighbour Andrea has $425,000,” Lanthier said. The government’s proposed solution, he explained, is to introduce alternative tax treatment when Andrea is about to retire and getting dividends out of Aco’s after-tax investment income.

Under the new proposal, Aco’s after-tax investment income would be split into two parts: $500,000 that would effectively be taxed the same amount as the $500,000 Jonah would be getting as investment income in retirement; and $350,000, which the government would take away completely. In that way, the government would ensure Andrea and Jonah earn the same after-tax income of $250,000.

Lanthier noted that the question of CCPC taxation is a delicate issue. On the one hand, small-business owners assume risks than salaried employees do not, which is why long-standing rules allow lower tax rates for CCPCs. “Still, the small-business rate was introduced to assist in the financing and expansion of business activities in Canada — not for passive investments,” he said. “And so a thoughtful and measured legislative response may well be in order.

“However, the government’s proposal — with or without a $50,000 annual exemption — is neither. It should be abandoned.”

Related stories:
Add chief justices to chorus of tax-change critics
Ottawa's tax proposals not fair for businesses: study