Beware of closing so-called tax ‘loopholes’

Liberal plan to clamp down on small business corporations has potential to backfire, Bernard Shinder cautions.

The minister of finance recently announced proposed revisions to Canadian taxes affecting small business corporations and their shareholders. Current tax planning for almost all small business corporations would allow the net, after-tax income of the corporation to be distributed to shareholders as dividends.

Because we give recipients of the dividend a “dividend tax credit,” it is possible to distribute over $30,000 to low-tax recipients free of tax.

Also, should a corporation be sold, the small business capital gains credit could be multiplied by the number of shareholders. Finance Minister Bill Morneau now plans to clamp down.

But this tax planning is widespread and affects considerably more taxpayers than Morneau has estimated. One tax adviser described the planned changes as being fundamentally negative to tax planning as we know it.

Screwing down the tax laws so that abuses are eliminated is on the continuing agenda of the Department of Finance.

But describing current policy as loopholes is a totally political description of the provisions.

A loophole is an unintended result of a tax provision. These provisions, however, were part of an intentional policy of how small business corporations were to be taxed. The provisions were part of the discussions between doctors and the province of Ontario when calculating the after-tax take-home pay of the doctors, for instance. Taxpayers relied on these provisions in planning their income or their estates.

We all engage in some form of tax planning. RRSP contributions are tax expenditures. Every deduction that is allowed is a tax expenditure. If the government wants to change these, it can do so.

But to do so is a fundamental change to the after-tax income of the taxpayer — that is, the money that is left to pay rent and buy groceries.

The political assumption in Morneau’s latest announced changes is that the general population will not feel sorry for lawyers, doctors or accountants who are said to “abuse” the tax system. However, if the tax system for small business is fundamentally changed, someone will pay. And the government may not like how that payment plays out in the economy.

For instance, some capital and much income will be driven offshore, where the Canadian government will lose revenue.

Some taxpayers will physically move to jurisdictions where the tax rates are lower (or are projected to be lower) than they are in Canada.

Mickey Cohen, a former deputy minister of finance, had a rule: “Don’t make the tax system so tight that we can’t see the players playing. When things get bad enough, we’ll screw down the system.”

Each tax system has some “loopholes” that everyone knows are there. They get built into the system. The current system provides for many benefits to well-planning taxpayers.

For example, it is wholly legal to “freeze” one’s estate so that future growth accrues to children and grandchildren. All at a cost to taxpayers at large.

Is this the next “loophole” to be fixed?

After feedback, the minister has previously backed away from changes to small business taxation. I hope that will happen again.