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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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A Personal Service Business is a structure where a person sets up their own corporation (“PSBco”) and then provides services to another corporation. If it weren’t for their PSBco they would be considered an employee for tax purposes.  This is a structure that has been specifically targeted by both the Federal and many Provincial Governments to make this arrangement unattractive from a tax perspective.  Unlike most small businesses a PSB is not allowed to get the small business tax rate on the first $500,000 of earnings, and can often end up paying more tax than if they really were an employee.  This ‘carrot and stick’ approach is to encourage the owner of the PSBco to pay all income out as salary as that is the only way to bring the tax payable down.  Note: PSBco’s cannot deduct most business related expenses that any other corporation could – the allowed deductions are really limited to just those items that an employee can deduct on their personal tax returns.  Further, being self employed the now business owner loses things like Employment Insurance coverage, Employment Standards Act protections (i.e. no rights to for Severance or vacation pay) and now will be paying twice the usual amount for CPP and likely will have to pay premiums for WSIB on their earnings.

 

I was reading a recent report from the Canadian Tax Foundation and there was an interesting article written by a tax lawyer named H. Michael Dolson of Felesky Flynn LLP, Edmonton  titled “Stop PSB Proliferation”, Canadian Tax Highlights, vol. 22, no. 9 (Canadian Tax Foundation) (September 2014). Although I enjoyed the entire article there is one paragraph that Mr. Dolson wrote that I found to sum up PSBco’s very well.   “The fact that PSBcos are apparently becoming more common is ultimately a reflection of the power imbalance between workers and employers and the inaccurate information provided to individuals. The payer can circumvent substantially all the hard-won rights and protections for workers created during the 20th century without any corresponding benefits for the workers. Finance’s and Parliament’s approach produces an inequitable and unjust result: it imposes punitive tax consequences on the party that has less bargaining power.

 

What you should know is the government is aware that there are more and more PSBco’s out there and many of them are not paying the correct amount of tax and have become an increasing target for CRA audit, complete with findings of large amounts of tax owing, plus interest and penalties.  According to Statistics Canada, between 2000 and 2008 47.7 percent of companies created had one or less labour unit in their second year of operation – which is one of the ‘red flags’ that the company **may** be a PSBco.

 

If you think your company, or soon to be formed company, may be a PSBco it is important to meet with your tax professional so you can be satisfied that you are paying the correct amount of tax and do not have to fear a CRA audit, and what to do if you are a PSBco.  In many cases being a PSBco can be managed so that it is still financially rewarding for the business owner, but the key is knowing that in advance and then managing your affairs appropriately.  In many other cases it is possible to arrange the relationship between your corporation and its client(s) such that it would most likely not be found to be a PSB.

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