Questions linger over final look of tax reforms

FEDERAL BUDGET Passive income proposal to arrive next week

The government will use next week’s budget to unveil the last major piece of its controversial reforms to how private corporations are taxed, and business groups are anxiously anticipating the details — and hoping their concerns have been listened to.

The announcement caps off the largest fight the Liberal government has faced since the 2015 election, and will show just how far it was willing to bend in response to the widespread outcry that greeted the initial proposals.

The first consultation document, released last July, addressed three ways that private corporations could be used for tax planning purposes: income sprinkling, converting income into capital gains, and passive investment income.

After a massive political firestorm lasted throughout the fall — and escalated to the point where Finance Minister Bill Morneau was under daily attack and his job seemed in danger — the government dropped the capital gains proposals but largely stuck with the income-splitting provisions, which kicked in on Jan. 1, 2018.

To soften the blow, it also announced a phased reduction in the small business tax rate from 10.5 per cent to nine per cent.

It was the passive investment income changes, however, that were always the most complex, the least developed, and involved by far the most amount of money, with billions of dollars in taxes at stake. In October, the government announced a $50,000 threshold that would exempt most private corporations from the new tax, but gave few other details. A government official said the full draft proposal will be released on Feb. 27 with the budget.

A coalition of business groups that formed last fall to fight the tax changes has already asked for the whole package of passive income reforms to be dropped until more study is done. But individually, most lobby groups have been focused on shaping the final details of the proposal.

“There are a lot of unknowns,” said a policy analyst who works for an industry group that has met with Finance Canada officials numerous times, but wasn’t authorized to speak on the record.

“I think we’ve found that (finance officials) have been receptive to some of the concerns, have acknowledged them and looked into them further. But I can’t say what that means for the end result at this point.”

Passive investments are funds kept inside the corporation and invested in areas unrelated to active business operations. Because it’s taxed at the small business rate instead of the personal income tax rate, the initial money available to invest inside a private corporation is much higher than it would be outside.

Morneau has said the government’s goal is to wipe out the income tax difference between investing that money inside or outside a corporation. Small business groups, trade associations and professionals such as lawyers and doctors furiously fought back, arguing the proposed reforms are heavy-handed, confusing and a punishment on entrepreneurs who deserve some reward and protection in a risky business environment.

The government already scaled back the reforms last fall. The $50,000 passive income threshold — which amounts to a five per cent return on $1 million of savings — is meant to exempt all but a tiny number of corporations (the Parliamentary Budget Officer reported that just 2.5 per cent of private corporations were above that threshold in 2014).

Furthermore, existing passive investments would be grandfathered in under the current tax regime.

But questions remain around whether the threshold will be indexed to inflation, whether it will be cumulative (meaning unused spaced in one year can be carried forward), what its implementation date will be, and exactly what kinds of investments would be included under the threshold. Some groups have pushed for the threshold to be raised higher.

In conversations with the National Post ahead of the budget, government officials have said they’ve listened carefully to the concerns around passive investments and hinted that many groups will be pleased with what the final proposal looks like.

Tuesday will reveal if that turns out to be true, or if the small business tax revolt roars back to life.

I THINK WE’VE FOUND THAT (OFFICIALS) HAVE BEEN RECEPTIVE TO SOME OF THE CONCERNS.