Everyone should play by the same tax rules

In 1966 the Royal Commission on Taxation issued its report recommending a fundamental change in the philosophy and structure of the federal tax system. At the heart was the idea that “a buck is a buck,” which meant that any dollar of income, no matter how earned, has the same utility as any other.

In essence that meant, among other things, that capital gains should be taxed at the same rate as regular income. It also recommended that corporate income be attributed directly to shareholders and taxed as part of their regular income.

The reaction from the business community, especially oil, gas and mining, and several provincial government was ferocious.

The Trudeau government in 1972 introduced changes to the tax system that bore little resemblance to the recommendation of the Carter Commission.

The lessons to be learned from this little bit of history are: First, the tax system is far from fair. While the income tax is progressive, capital gains are taxed at a favourable rate and most such gains are earned by people in the higher income tax brackets.

Second, making changes in the system that will bring about a greater degree of equity can be expected to evoke strenuous objections from the beneficiaries of inequities in the system.

Third, it takes a resolute government to withstand the lobbying efforts of those whose special treatment is under attack.

All of which brings us to the Minister of Finance’s present proposed changes in the taxation of some earnings of small business. Those changes, all aimed at proving the equity in tax measures, are:

1. The elimination of income “sprinkling” whereby a small business owner could “sprinkle” profits over relatives who had little or no income (for example children under the age of 18) and thereby reduce total taxes paid by the family.

Family members who receive dividends from the firm will need to be able to demonstrate such dividends are proportional to their contribution to the business.

2. There is also a proposal that will impact the taxation of income earned on passive investment accounts held within a corporation. These profits are currently taxed at a lower rate than regular income with the goal of allowing small businesses to build up capital that can be used to grow the business. It appears, however, that in many cases, particularly with physicians, these investments are being used primarily to save for retirement. Such an option is not available to salaried Canadians.

3. Finally, there is a proposal to constrain the ability of small business owners to convert income into capital gains. Since capital gains are taxed at a lower rate this is an attractive feature of the current regime.

Minister Bill Morneau’s proposals have generated a torrent of opposition by those facing the potential loss of favourable tax treatment.

Some objections raised are frivolous; for example, the argument that 75 days to consult is too short a time.

Others try to discredit the changes’ authors rather than attacking the substance, arguing the proposals were drawn up by bureaucrats with no knowledge of business.

Still others contend that the adverse impact on physicians, who will no longer be able to collect retirement savings in their corporations, will move to the United States, rather than use tax-efficient vehicles such as RRSPs, TFSAs and RESPs available to ordinary Canadian wage-earners.

In essence they argue that physicians deserve special tax treatment.

Many small business owners contend that current tax policy has been in place for more than four decades and therefore should not change. Their accountants should have explained that tax policy can change at any time and that taking financial decisions based only on tax treatment is risky.

Morneau should hold the line and not give in to special interests who believe they deserve special treatment.

All income, regardless of how earned and by whom, should be taxed equally. That is simply fair.

David Bond is an author and retired bank economist. Email: curmudgeon@harumpf.com.