Sweeping U.S. personal and corporate tax reform. An overtaxed one per cent. Small business owners still seething over last summer’s controversial private corporation tax proposals. It’s truly anyone’s guess how the Liberals might (or might not) address these major tax policy issues in its third federal budget, set to be delivered on Tuesday.
To prepare you for the big day, here are a few issues on the table.
Corporate tax reform
On Jan. 1, 2018, U.S. President Donald Trump’s sweeping tax reform package took effect, dramatically changing the corporate tax environment. The U.S. nearly halved its federal corporate tax rate to 21 per cent from 35 per cent, allowed for the full expensing of investments in machinery and equipment, and introduced international tax rules that bring in a substantially more competitive business environment.
The Business Council of Canada, a non-profit group comprised of 150 Canadian chief executives and headed by former finance minister John Manley, called on Canada to “move quickly to shore up its business tax competitiveness” in a recent letter to Finance Minister Bill Morneau.
The council points out that Canada’s average combined federal/provincial corporate tax rate of 26.7 per cent now sits almost three percentage points above the average of the world’s advanced economies and, therefore, urges the government to announce “an immediate cut to the corporate tax rate coupled with a commitment to ensuring that Canada’s average combined statutory rate falls below the OECD average over the medium term.”
It also recommended that Budget 2018 contain a temporary tax measure allowing companies to immediately deduct the full amount of capital expenditures, rather than amortizing such expenses over several years.
Personal tax rates
The government in 2016 cut the tax rate on the middle-income bracket to 20.5 per cent from 22 per cent (for 2018 income between $46,605 to $93,208) and introduced a 33 per cent high-income bracket (for income above $205,842). Adding in provincial/territorial taxes and surtaxes puts the statutory tax rate between about 20 per cent and somewhere north of 50 per cent, depending on your income and province of residence.
But contrast our top 2018 tax rates with the new U.S. rates introduced by Trump as part of his tax reform package. The new U.S. federal top rate for 2018 is 37 per cent and is reached only when income tops US$500,000 (about $630,000 in Canadian dollars).
Some states, such as Florida, impose no personal income tax, meaning that the top rate for a radiologist in Miami is a mere 36 per cent — and only on her income above $630,000. Compare that to a Halifax dentist who pays 54 per cent on income of more than $206,000 and you have an 18 per cent tax rate differential between the two countries.
If Canadian governments fail to address this massive gap, we risk losing some highly paid, highly skilled and mobile workers to our southern neighbour.
Boutique tax credits
Anyone who’s tried to complete their own tax return knows that the tax system is so complex that it’s nearly impenetrable. The Fraser Institute points out that when the (temporary!) Income Tax Act was introduced in 1917, it contained a mere 3,999 words on six pages. By 2016, it had ballooned to 1,029,042 words and now takes up some 1,412 pages.
The institute believes “a key source of complexity in the tax system is the long list of tax credits, deductions and other special preferences.” From 1996 to 2014, the federal government added 27 personal tax expenditures for a total of 128. There are “boutique” tax credits for volunteer firefighters, first-time home buyers and, more recently, teachers’ school supplies.
The 2016 federal budget announced the elimination of the children’s fitness and arts credits as well as the education and textbook credits for students. A year ago, Morneau announced a review of the “tax expenditures in the code … (to make) sure they are all consistent with our approach to tax fairness.”
We’ll see if this year’s budget further eliminates some of these administratively burdensome and costly credits in an attempt to simplify our tax code and reduce the compliance burden.
Small business taxes
Of most concern to small business owners, including incorporated professionals, who operate their businesses through a Canadian-controlled private corporation (CCPC) is how the government plans to deal with passive investment income earned and retained inside a CCPC.
CCPCs are able to claim the small business deduction on the first $500,000 of active business income, thereby paying an extremely low tax rate when the income is initially earned. This results in a significant tax deferral advantage (up to 40 per cent depending on the province) when leaving the after-tax corporate income inside the corporation as opposed to paying it out immediately.
Last week, the Coalition for Small Business Tax Fairness, a collection of 75 organizations representing hundreds of thousands of business owners, wrote to Morneau urging him to abandon the proposed rules that could tax passive investment income (above the previously announced $50,000 annual threshold) in CCPCs at total effective rates as high as 73 per cent.
In an accompanying press release, the coalition announced it “is deeply concerned that changes to tax rules for passive investments may severely limit small businesses’ ability to save for large investments, creating a significant barrier to innovation and growth.”
Capital gains inclusion rates
Under current rules, capital gains are taxed at a 50 per cent inclusion rate. Each year prior to the budget, there is widespread speculation as to whether the government will increase the inclusion rate to 66.67 per cent, which we had in 1988, or to 75 per cent, which lasted for a decade from 1990 to 2000.
An increase in the inclusion rate would increase the taxes on the sale of stocks, bonds and mutual funds, as well as increase the tax bill when a small business owner sells the business.
Given the widespread, ongoing negative criticism Morneau continues to face over the small business tax reform proposals, it seems unlikely the government would further risk irking the small business community.
Jamie Golombek, CPA, CA, CFP, CLU, TEP is the managing director, Tax & Estate Planning with CIBC Financial Planning & Advice.