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The following is a newsletter posting that was originally prepared by one of my tax research firms, written by Cameron Mancell of Wolters-Kluwer:

“Jay Goodis, CEO and co-founder of Tax Templates Inc., has published an analysis of the numbers and rhetoric behind these proposals. The publication also includes a large (and growing) list of publications that discuss the implications of the proposed changes. His other publications relating to these changes include: How Not to Reform Taxation and See Beyond the 1%.

Moreover, a petition to extend the consultation period has been launched and has received 2,000 signatures so far.

CPA Canada is offering a free 60 minute webinar on these proposals on September 12, 2017.

On July 18, 2017, the Department of Finance released its long-awaited consultation paper on tax planning using private corporations. We took the time to compartmentalize and assess the draft legislation, and in brief, the following changes have been proposed:

  • The tax on split income will be extended to include adult individuals where the amount received is unreasonable (a test based on the extent of the individual’s capital and labour contributions). The types of income subject to the tax will also be extended to include income from debt, gains from the disposition of property from which the income is split income, and second-generation income on amounts that were previously subject to split income tax.
  • New rules will crack down on strategies that multiply access to the lifetime capital gains exemption (“LCGE”). Minors will no longer be able to claim the LCGE. Gains that are subject to the extended split income tax are also ineligible for the LCGE, so an individual’s eligibility for the LCGE is based upon the labour and capital contribution tests mentioned above. Last, gains accrued while the property was held by a trust are no longer eligible for the LCGE, with some minor exceptions. Regardless of whether the trust flows out the capital gains, or rolls out the property to the beneficiaries who then dispose of it, using a family trust to own a business will disqualify access to the LCGE—this will no doubt disrupt many plans and structures currently in place, including “garden-variety” estate freezes.
  • Although no specific amendments have been proposed, the government plans on eliminating a perceived tax deferral advantage from holding passive investments within a private corporation. The government is asking for input from the tax community on how best achieve this. The white paper provided by Finance suggests making changes to the current system, or replacing it with a new system. Potential replacement systems are also discussed in the white paper.
  • Section 84.1 will be amended, and a new section of the Act will be introduced to prevent certain strategies that allow a corporation to convert its regular income into capital gains. If implemented, it appears that these changes will put an end to the so-called “pipeline” arrangements that are currently used to avoid the double-taxation that otherwise can arise during the administration of an estate of a small business owner.

Only after everyone has taken the time to meticulously analyze these proposals will we have a complete understanding of all the implications of the changes. After all, members of the tax community have been presented with what are likely the biggest changes to small and medium business tax planning to happen in recent years. But, firms are already sharing their first-impressions with their clients and the community.

Michael Atlas, whose practice focuses on international taxation, concludes that the changes will further disincentive current and prospective businesses from operating in Canada:

“[W]ith proposals like those, which will substantially remove the ability of high-income Canadians to soften the tax rates they pay, many such taxpayers will head for the nearest exit and do whatever they can to become non-residents. Remember, unlike the situations with our brethren to the South, Canadian citizens can completely say ‘bye bye’ to Canadian taxes by becoming non-residents. Remember the line in the 1976 film Network, ‘I am mad as hell and I can’t take it anymore!’ I also submit that, with the world of the internet and the ‘cloud’, it is easier and more feasible for Canadians to follow that path, even if they maintain business interests in Canada.”

Partners at Moodys Gartner Tax Law echo Michael’s sentiment with respect to a flight of business-owners, and also stress that these proposals will result in a significantly higher compliance burden for small businesses:

“These changes have the potential to add another layer of complexity to an already mind numbingly complex area. There is a need to remember that these are tax rules for small businesses, most of whom don’t engage in complex tax planning, don’t have dedicated tax people on staff, and do not have the resources to comply with overly complex tax laws. These rules risk increasing compliance costs, and distracting from the core businesses carried on.”

“Our firm has seen an uptick in Canadian business owners leaving Canada, and also changing their plans so that the growth of their business will occur outside of Canada rather than within it. We are concerned that these and other measures announced by the government will have exactly the opposite effect from that intended and effectively shrink the Canadian tax base rather than broaden it.”

If the foreseen consequences of these amendments come true, it appears that they would be at odds with the overall purpose to which the proposals intend to serve:

“These tax advantages are in place to help Canadian businesses reinvest and grow, find new customers, buy new equipment and hire more people. Businesses big and small are the lifeblood of our economy. Our tax system is designed to help them thrive…”

Those are the words of the Minister of Finance who also highlighted Canada’s “highly competitive business environment” while discussing the merits of the proposals. To be clear, there are good intentions behind these proposals. However, it remains to be seen whether these proposals will have the desired effect. There are already rules in place to deal with many of the perceived abuses noted and the vast majority of jobs in Canada have been created by small and medium sized firms which are now facing increased complexity and compliance.

It’s important to note that the period for providing input to Finance is relatively short given the scope of the proposals – 75 days – and the fact that this time period runs over the summer when many people are on holiday.”

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If after reading this you wish to lend your voice to the growing chorus against these proposals, then you will find a sample e-mail at the bottom of the first article referenced from Mr. Jay Goodis (it is the first Appendix of his article) to send to your MP.

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These articles (and many others) raise valid concerns from experts and those affected:

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2015_February_Business_Matters_Newsletter

In this issue you will find articles on:

  • Income Tax Fraud
  • USB Thumb Drive Technology
  • Preparing for an Orderly Exit
  • Moving Inventory

Click on the above link above to access the newsletter.

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Small Business Deduction – not everyone qualifies

The CRA has yet again won a court case where two corporate taxpayers were claiming the small business deduction only to have it denied as each company was found to be ‘personal service business’ (see 1165632 Ontario Limited, 2014 DTC 1184).  This is important because the combined corporate tax rate in Ontario at the time of this writing is 26.5% unless the company qualifies for the small business deduction, then it drops to 15.5% – that is an 11% lower tax bill.  A personal service business does not qualify for the small business deduction.  Further, the expenses a personal service business are allowed to deduct are very restricted, generally limited to only those items that an employee could deduct (i.e. home office, use of auto, …).  Lastly, a company that does not qualify for the small business deduction also does not qualify for the lifetime capital gains exemption on qualifying small business shares, currently $800,000.

Subsection 125(7) of the Income Tax Act defines a “personal services business” to be a business of providing services being carried on by a corporate taxpayer through an employee who could be reasonably regarded as an officer or employee of the person or partnership for whom the services are being provided, but for the existence of the corporate taxpayer.

The issue, therefore, is whether a person would have been an employee of the  client company (“ClientCo”) if that persons company (“ConsultCo”) did not have any agreement or management contracts with ClientCo. Determining the existence of an employer-employee relationship requires an analysis of certain factors associated with that relationship (i.e., control, tools, opportunity for profit, and risk of loss; see Wiebe Door Services Ltd. v. MNR, 87 DTC 5025 (FCA)). Applying these factors to the person’s relationship with ClientCo, if the conclusion is that the person would have been an employee of ClientCo if Clientco’s business management contracts had not been with the ConsultCo but with the person directly then ConsultCo is a “personal service business”.

 It is always a good idea to sit down with your tax professional, such as Numbers Plus Professional Corporation, to have a detailed discussion of your plans and consideration to issues such as this need to be taken into account.

 

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