The Liberals are coming to confiscate
As part of its upcoming spring budget, the federal Liberal government intends to table draft legislation to change the taxation of investment income earned by Canadiancontrolled private corporat i ons ( CCPCs). The proposal, first floated last July, is confiscation, pure and simple. The proposal is also bewilderingly complex, and understood by very few. That is no doubt the way the government would like to keep it. But let’s try to make some sense of this.
Assume that Jonah and Andrea are neighbours, and that both pay personal tax at a rate of 50 per cent. Jonah is a salaried employee, and earns $100,000 in 2018. Jonah uses the after- tax amount to acquire $50,000 of mutual funds. After 25 years, Jonah earns $500,000 of investment income — 10 times his initial investment. After paying 50- per- cent tax, Jonah has $250,000 of after-tax investment income to help fund his retirement.
Andrea owns a CCPC — Aco — that carries on business. Aco also earns $100,000 in 2018, but pays corporate tax at a small-business rate of 15 per cent, and has an aftertax amount of $ 85,000. Aco does not require the funds for its business, and uses the cash to acquire the same mutual funds as Jonah.
Aco started with a larger amount than Jonah and, after 25 years, Aco earns $850,000 of investment income, again equal to 10 times its initial investment. Under existing rules, Aco pays corporate tax at a rate of 50 per cent each year as the income is earned. Aco therefore pays total corporate tax of $425,000. Also, under “tax integration,” the combined tax to Aco and Andrea remains at $425,000 in future when Aco pays its after-tax investment income to Andrea as dividends.
The government’s concern is that Jonah only has $250,000 of after-tax income to help fund his retirement, while his neighbour Andrea has $425,000. This is not fair, says the government. So what to do?
Under the government’s proposal, Aco would still pay immediate tax of $ 425,000 as the investment income is earned. However, when Andrea is about to retire and Aco pays dividends to her out of its after-tax investment income, the tax results are very different.
The government’s position is that Aco should only have earned $ 500,000 before tax, the same as Jonah, not $ 850,000. And so the proposal effectively splits Aco’s investment income into two parts — the “legitimate” portion of $ 500,000 and the “tainted” amount of $350,000.
Under the new rules, Aco and Andrea will still pay combined tax of 50 per cent on the $500,000 portion — tax of $250,000. And what of Aco’s additional investment in- come of $350,000? The government will take all of it as tax — every penny. The result is that Aco earns $ 850,000, and Aco and Andrea pay combined tax of $ 600,000 ($ 250,000 plus $ 350,000). Andrea is left with an aftertax amount of $250,000, the same as Jonah.
The mechanics of this confiscation involve changing some arcane tax rules such as refundable taxes and dividend gross- ups and credits. But forget the mechanics. The result is a tax equal to all of a CCPC’s investment income, except for the amount that a salaried employee could have earned.
The reason that Aco can earn more investment income than Jonah are government rules that have been in place since 1973. Under those rules, a CCPC can use low-taxed business or professional income to acquire a larger amount of investments than can a salaried employee. Some argue that this is fair. A small- business owner takes risks that a salaried employee does not. Family assets are often put at risk; there are many business failures; there are no indexed pensions; there are no paid vacations or paid maternity or paternity leaves.
Still, the small- business rate was introduced to assist in the financing and expansion of business activities in Canada — not for passive investments. And so a thoughtful and measured legislative response may well be in order. However, the government’s proposal — with or without a $ 50,000 annual exemption — is neither. It should be abandoned.
Speaking in Davos at the World Economic Forum in January, Prime Minister Justin Trudeau continued his anti-business mantra. He stated that “too many corporations have put the pursuit of profit before the well-being of their workers,” and that “companies avoid taxes and boast record profits with one hand, while slashing benefits with the other.” With both its rhetoric and its legislative initiatives, the government seems intent on driving business investment and jobs out of Canada.
THE RESULT IS A TAX EQUAL TO ALL OF A CCPC’S INVESTMENT INCOME, EXCEPT FOR THE AMOUNT A SALARIED EMPLOYEE COULD HAVE EARNED.