Trudeau’s passive aggression
Both Prime Minister Justin Trudeau and Finance Minister Bill Morneau have stated that the government’s private-corporation tax proposals will not affect businesses earning less than $ 150,000 a year. But one of the coalitions opposing the changes says that two- thirds of Canadian small businesses earn less than $73,000 a year, and that the proposals will hurt the majority of these middleclass business owners. How to make sense of these different analyses?
The government’s package has three parts, one of which — and the most contentious — involves passive investments, such as mutual funds, held by Canadian-controlled private corporations (CCPCs). At present, a CCPC pays immediate tax of 50 per cent on its investment income. Under “tax integration,” a large portion of this tax is refunded when the CCPC pays dividends to its owner. As a result, there is generally no further net personal- corporate tax when dividends are paid.
Under the proposal, a CCPC would still pay 50 per cent. However, the concept of integration would be repealed, and the corporate tax would be non-refundable. For individuals at the highest personal tax rate, this would mean a combined personal- corporate tax rate of close to 73 per cent on investment income earned by a CCPC. However, the proposal not only impacts high-rate individuals: It also hammers CCPC owners with much lower earnings.
Assume that a CCPC earns business income of $70,000. At a tax rate of 15 per cent, it is left with $59,500. Assume further that the business has reached a stage where it no longer requires funds for expansion, and the owner needs to start saving for retirement. The CCPC therefore acquires investments. The owner is in a middle-income tax bracket, and resides in the province of Quebec. Her combined personal- corporate tax rate on investment income under current law is about 40 per cent once the CCPC pays dividends. Under the proposal, this cost increases to 60 per cent. The proposal certainly affects this small business owner. So where does the government’s number of $150,000 come from?
In 2017, an individual can base his or her RRSP contri- bution on earnings of up to $ 144,500, and can also contribute $ 5,500 to a TFSA. These are the maximum amounts on which tax-assisted savings for individuals are based. The total of these two amounts is $150,000.
Under the proposal, it is assumed that a CCPC that has business i ncome of $150,000, and does not need the funds for business expansion, would pay a salary of $ 150,000 to its owner. The owner will have an after- tax amount of $75,000 for investment. The individual would then contribute $26,000 to an RRSP ($ 144,500 multiplied by the prescribed limitation of 18 per cent) and $5,500 to a TFSA, the same amounts that a salaried employee earning $150,000 can contribute.
But there is a problem. The 18-per-cent limitation for RRSP contributions is based on analyses that show that this percentage should provide a retirement annuity of two per cent a year. This may be fine for an individual with 30 years of employment, who can accumulate a retirement annuity equal to 60 per cent of annual earnings. However, many small business owners must invest in a business for many years, and are only able to contribute to RRSPs in later years. These owners will never be able to accumulate a reasonable amount of retirement savings using only RRSPs and TFSAs.
I am not aware of a single country with rules that are even remotely similar to the passive investment proposal. In the United Kingdom for example, a private corporation is taxed at the general U. K. corporate tax rate of 19 per cent, on both business and investment income. And in Canada, corporations that are not CCPCs will continue to be taxed at a rate of about 26 per cent — again on all sources of income.
The government has a legitimate concern regarding the substantial amounts of passive investments now held by CCPCs. However, this proposal is not the best way to address the problem. Canada needs a comprehensive review and reform of the taxation of private corporations and their owners. In the interim, the proposal should be put on hold. Instead, a special refundable tax of 25 to 30 per cent should be introduced for professional income earned by CCPCs. This eliminates the initial deferral, which is after all the major source of the problem.
I AM NOT AWARE OF A SINGLE COUNTRY WITH PASSIVE INVESTMENT RULES EVEN REMOTELY SIMILAR.