Our Letter to MP Kim Rudd re: Proposed Tax Changes
click here for: PDF version of our letter to Kim Rudd
Re: Tax Planning Using Private Corporations
On July 18th the Department of Finance issued the above referenced document as a proposed measure for consultation. I have been in practice working with small owner managed businesses for over 30 years. Small business is the life blood of the Canadian economy. Statistically, small businesses that employ less than 300 people provide more than 50% of the jobs in this country.
I am writing to you specifically as a Liberal MP that has run a small business. You represent a riding that has many small businesses and farms. In fact in Peterborough alone while large businesses like Quaker Oats and others have closed or cut jobs, small businesses have filled in and Peterborough has grown significantly in population and jobs. This is true in so much of Ontario.
I am the Managing Partner of Yale & Partners LLP a Toronto CPA firm that services exclusively owner managed businesses and Non-Profit organizations. I am very familiar with your riding as our firm has clients in the Peterborough riding and we have a long standing relationship with an accounting firm in Peterborough. I can say that before these proposals were published I have never written to the Finance Department or any other government office. However these proposals truly lack planning and consideration.
Bill Morneau is not telling the truth when he says that these proposals will only affect a very few corporations as the proposals currently stand. While I do not have a problem with the Capital Gains Exemption proposals the other proposals have significant deficiencies. They also adversely affect many corporations not just a few.
On the income splitting I would like to go through the same math that the finance department went through in their letter. Employees have health care, severance pay, pensions, and employment insurance. None of those factors have been considered in the evaluation performed by the Finance Department. In the example used by Finance, Jonah and Susan both earn $220,000. Finance documents that Jonah pays dividends to his children. The tax rules on this are very specific: if the money does not stay with the children, then it will be attributed back to Jonah and he will have to pay tax on that amount. The tax savings mentioned by the Finance department total a $35,000 advantage for Jonah. If we compare apples to apples the following additional considerations should be made: the severance that Susan accumulated each year amounts to about $13,000; the health care costs which Jonah must bear will be about $8,000 per year for the family to be equivalent to Susan; and the tax preparation and record-keeping requirements, as well as the quarterly HST filings, will result in average additional administrative costs of $6,000. If we add the employer portion of CPP and a 5% employer contribution to a pension plan for Susan, there is no savings at all for an independent consultant. This applies to doctors and consultants. I can say I have many consultant clients who would give anything to get back to a full time job with benefits.
The passive income considerations are particularly poorly conceived. The truth of the matter is that most small businesses do not earn over $250,000 annually. This proposal wants to tax income left in a corporation at 73% (according to a number of tax professionals) no matter the size of the business, be it a profit of $100,000 or $10,000,000, the penalty tax is the same. There is nothing about fairness in this proposal. This proposal has no consideration of the importance of diversification. Large corporations can diversify to different markets and into different product lines. That is simply not feasible for a company that has 15 employees. Their diversity is in accumulating investments to backstop the business from economic difficulty or sudden calamitous events. In 2008 in Ontario and British Columbia, or 2015 in Alberta, small businesses that diversified made a great decision that saved jobs. Entrepreneurs make smart decisions to diversify when times are good to ensure that they will survive when things go poorly. In both of the examples of 2008 and 2015, small businesses could not count on government or banks to help them in tough times. Small business in bad times need funds to tide them over. They are not like public corporations that get government bailouts. In our Practice alone this saved hundreds of jobs for our entrepreneurial clients in 2009 so that they could be ready to pick up the pieces when the economy recovered. If an entrepreneur ever takes the money out for personal purposes then the taxes paid will be fully integrated as if they were employees. As stated before, investment income within a corporation is taxed at 50%, so this new income will not have a beneficial rate. The ability to accumulate income in a business also aids in the transition of the business. Many small corporations have no ability to be sold given the nature of the business or because the business could just be the entrepreneur. This proposal inhibits the ability of these people to retire and is all about Finance and the Liberal desire to front end collection of taxes with no regard for future consequences.
The capital gains proposals probably affect the most businesses of all of the proposals. In the document the Finance department mentions a very obscure transaction. The proposed fix is going to affect far more than the obscure transaction. This will affect family farms and family businesses. It motivates people to do things that I am sure the finance department has not contemplated. This is because it is far more beneficial for me to sell my business to a third party or foreign buyer than it is to transition the business. The rate comparison is 25% to 45%. I would like to point out that if you have two families where the last surviving parent passes away. One family holds Royal Bank shares with a gain of $500,000. The other family owns an incorporated family business (farm) with a gain of $500,000. The beneficiaries of the family holding the Royal bank shares pays a top tax of $132,500. The beneficiaries of the incorporated family business pay $226,550. There is no doubt that faced with this, every small business owner will sell to a third party to pay the $132,500. If fairness is the objective, I think this math shows that this has not been achieved.
Finally I want to point out that the very rich. People like the Morneau family and the Trudeau family will be unaffected. They have already accumulated funds. These passive holding companies can simply elect to be considered passive and the tax rates will not change. On this issue I want to clear up some comments made by academics. Mr. Michael Wolfson has repeatedly commented on the percentage of wealthy people with holding companies. I can tell you that if you are the CEO of a large public company and you have significant wealth you should have a holding company. This does not avoid tax to Canada it avoids tax to the US. If you have material holdings of US securities and your net worth is over $5 million a Canadian company avoids US estate tax on US owned securities. It does not avoid Canadian tax. Mr. Wolfson apparently is unaware of this situation as he has never acknowledged it. Therefore his presumption that it must be a tax dodge, while correct on US taxes, is incorrect that these companies are avoiding Canadian taxes.
These proposals make Canada a very uncompetitive place for small business. In the UK and the US the regimes are vastly more competitive for small business. So for companies that have mobility, like technology companies, these proposals will hurt Canada’s chances of attracting or keeping companies.
I have also heard from the National Angel Capital Organization. They are also very concerned as these proposals will profoundly affect venture capital funding for start-up businesses. They have surveyed their members and fully 70% of their members said that these proposals will reduce or eliminate their venture capital funding. These are high risk investments where only a few succeed, Canada should not be discouraging them.
I know that it has been said that doctors will not leave. I am not convinced that general practitioners will leave. I already know that specialists and surgeons are considering leaving now. In Peterborough – Northumberland there is already a long and difficult wait for any specialists. This will only get worse if the proposals are passed.
Ms. Rudd, every tax professional and lawyer I know will benefit enormously if these proposals are passed. All of our clients are extremely concerned. I want to let you know that none of these professionals are in favour of these proposals because they are so detrimental to all small businesses. As professionals we will develop ways to minimize the impact but it will be a sad diversion of resources that could have been spent to bolster jobs at these enterprises.
These proposals are anticipated to add about $250 million to the bottom line. That is less than 1% of the tax revenues collected annually by the federal government. For this paltry amount the Honorable Mr. Trudeau and Mr. Morneau are willing to hand the Conservative party an election platform and enrage some of the most beneficial contributors to our society in terms of jobs and in terms of existing revenues.
I hope that you are considerate of all of the implications of these proposals. I think they will be profound and it is important that this government consider all implications before they implement such a profound change in policy.
Gordon Lee, CPA, CA
Yale & Partners LLP