Flying blind on tax ‘tweaks’

This certainly did not go as planned. In July, the federal government issued a package of taxreform proposals, ostensibly to close “loopholes” being used by the wealthy to gain unfair tax advantages. By the end of the abbreviated 75-day consultation period, the government had received more than 21,000 submissions. Many will likely gather dust and never be read. But the message from the business community had already been heard, and it was loud, angry and clear.

In what must have felt like death by endless cuts, the finance minister made a series of announcements in mid-October to try and control the damage. The federal small-business rate would be reduced to nine per cent because — the government now says — that’s what the consultations were all about. Some of the original proposals were simply abandoned. Others were “tweaked,” including the proposal for passive investments held by Canadian-controlled private corporations (CCPCs).

Under the current system, a CCPC pays immediate tax of 50 per cent on any income it makes from investments in its portfolio. As a result of our system’s “tax integration” principle, there is little further net personal-corporate tax added when that CCPC then pays dividends to an owner in the top personal tax bracket. However, under the proposal, a CCPC would still pay 50 per cent immediate tax, but the corporate tax would now be non-refundable, and individuals at the top rate would pay a combined personal-corporate tax rate of about 73 per cent on a CCPC’s investment income. No wonder people were angry.

The recent “tweak” now states that existing rules will continue to apply to annual passive income of up to $50,000 — equivalent to a return of five per cent on $1 million of savings. Income from existing savings would be grandfathered under the old rules. As a result, immediate tax of 50 per cent provide an owner with an annual annuity of between $34,000 and $54,000. That’s hardly the territory of the one-percent club. And what about the largest and most profitable CCPCs — the ones that punch well above their weight in terms of job creation and economic growth? Doesn’t matter. It’s a hard $50,000 cap for everyone — not a percentage of assets or revenue or earnings. And so a CCPC with annual revenue of $100 million that accumulates $10 million for future business expansion and acquisitions will face a professional corporations? Other factors? If the Department of Finance knows, it is not saying. What we do know is that the stock market more than doubled from 2002 to 2015 in both Canada and the United States, a fact that could account for much of the increase.

Second, how significant is the amount of passive income? One economist says that passive income was about 16 per cent of total private-corporation income in 2015, versus 10 per cent for all Canadian firms in that year — hardly a remarkable difference.

Third, is the fact that CCPCs have significant amounts of passive investments objectionable as a matter of tax policy, or is it a blessing? Economists have mixed views. Tax expert Jack Mintz has noted that these investments play a positive role: they provide a business with the opportunity for additional investment, and enable efficient firms to separate themselves from those that are less efficient.

Professor Michael Wolfson of the University of Ottawa has been vilified by the business sector for supporting — and perhaps inspiring — many of the government’s original proposals. But in recent testimony before the finance committees of both the House of Commons and the Senate, Wolfson bemoaned the erosion of analytic capacity within the government, an erosion that may have started under the former Conservative government when reasoned economic analyses did not support its own legislative agenda.

This proposal is the result of flawed reasoning and inadequate analysis. For the sake of the Canadian economy, it should be abandoned.