The new tax law proposals have been generating a lot of press.  The government is spinning misinformation, and nobody is quite sure what the fuss is all about.  So we decided to have our tax consultant, Mark Lencucha, FCPA, FCA, TEP, FEA, draft a number of articles that will hopefully explain these proposals with a more relaxed style.  Some are quick. Some are tough sledding, but we hope you enjoy them and share them with your friends!

If you pay dividends, or wish to protect your capital gain exemption in particular, we recommend a sit down sooner than later.  We hope these rules are either dropped, seriously modified, or repealed when a new government takes charge.  For now, we must treat them very seriously indeed.

Pivotal LLP
Chartered Professional Accountants

**The views, thoughts and opinions expressed in this article belong solely to the author and not necessarily to the Partners or staff of Pivotal LLP

 

 

Abusing Low Tax Rates?

Building Up Investments With Cheap After-Tax Dollars Pensions, Public Companies and you.

Ethical tax for owners

Next in our little educational seminar about “ethical tax”, is visiting the land of abusing your tax benefits and not doing what you’re told. This discussion is going to be a little longer.

The Government has decided to give us all a little reminder of our ethical duty as small corporations.  Let their own words speak. Let their own words condemn. Let their own words come back to bite them in the…Sorry, got carried away there!

Abusing our generous benefit for your own selfish purposes!

Here is how they state the abuse:

“There is evidence that some may be using corporate structures to avoid paying their fair share, rather than to invest in their business and maintain their competitive advantage.”

“Holding a passive investment portfolio inside a private corporation, which may be financially advantageous for owners of private corporations compared to other investors. This is mainly due to the fact that corporate income tax rates, which are generally much lower than personal rates, facilitate the accumulation of earnings that can be invested in a passive portfolio.”

“Preferential tax rates for corporations were never intended to facilitate passive wealth accumulation, such as through passive investments.”

We must read between the lines here. It is not too hard to do. I think what they’re trying to say is that “if we give you a tax break by lower corporate taxes, you should “use” them in a certain way”. A “use” test. Dug up from some old comments. New to me…New to us all, since the tax code clearly identifies a regime of extremely high private corporation tax on investment income.

Nevertheless, the lecture from the pulpit seems to be this:

  • We give you (private) corporations really nice tax rates,
  • You’re supposed to enjoy these so you can grow your little business into a big business some day,
  • You stopped doing that,
  • You started using these generous rates to start saving for yourself – you Scrooge!
  • You were supposed to keep growing your business, and creating jobs!
  • We must do something about this.
  • Myopia – “…a lack of foresight or discernment; a narrow view of something…”

    Now that we have some hypothetical principles firmly established, let’s consider how a new pair of spectacles may help Finance see more clearly.

    1. Public Companies

    The proposals create punishing new tax law, aimed at private companies only, to address the inequity of using cheap tax money to grow passive investments. We will particularly note one of them – a non-refundable 50% tax on investment income, followed by a penalty tax on dividend distributions (since 50% is otherwise the maximum tax rate in Canada, anything more is punishment, giving you a spanking).

    Public companies are however given a Pass! A get out of jail free card!  Finance condemns investment accumulation by private companies but ignores the same actions when undertaken by public companies. The best means to illustrate this is to simply repeat their concern on page 32 about private corporations but change “private” to “public” and see where it all goes!

    “Corporate income is taxed at lower rates than personal income, giving businesses more money to invest in order to grow their business, find more customers and hire more people.  But there are times when PUBLIC corporations earn income beyond what is needed to re-invest and grow the business. In these cases, those who own and control a PUBLIC corporation have the opportunity to hold passive investments inside the corporation. The Government is of the view that fairness and neutrality require that PUBLIC corporations not be used as a personal savings vehicle for the purpose of gaining a tax advantage. Passive investments held within PUBLICLY controlled corporations should be taxed at an equivalent rate to those held outside such corporations.”

    By this simple word substitution, and the unassailable logic of Finance, we find ourselves compelled to agree that public companies should face a non-refundable 50% tax on investment income. Yet somehow the provisions were omitted from the draft legislation! 

    Aren’t you glad we caught their little oversight? They will be so pleased at our diligence! But wait! It wasn’t an oversight at all!  They plan to put in laws to make sure you don’t go public just to avoid the tax. They knew there was an inequity all the time. So much for “requiring” companies not to build up investments, they really meant only private companies, only the little guys. 

    I guess they learned, just like you and I, not to kick sand in the big kids face!

     

    1. Pension Funds

    We will come back to the real world of tax sheltered investment in a later article!  Suffice, for now, to know that Pensions and RRSPs not only obtain fully tax-deductible contributions but completely tax-free growth. Presumably “they” get pensions and “we” get RRSPs and “we” should only use RRSPs as our tax-sheltered vehicle. We will later explore how these vehicles are effectively only used by the wealthy, mostly the top 10% or so of income earners, and how “we” give “them” more tax preference than the Federal Government spends on health care transfers, or taking care of the elderly, and how “they” ignore the above “use” test.

    Finance will reply that Pensions and RRSPs are different, they can skip the use test and enjoy low (is 0 low?) tax rates to provide retirement income to the Few, but you should not do the same to provide retirement income to the You. Only You, and not the Few, have obligation to grow jobs for your low rates. 

    A last bit of Nonsense

    My favorite quote of the day however is this one:

    “There are no restrictions on the type of assets that can be held in a corporation, while some exist for tax-assisted savings vehicles (e.g., real estate). The rules pertaining to prohibited investments for registered accounts generally aim to prevent self-dealing arrangements and tax-planning opportunities.”  

    Let’s zone in (or out) on real estate. It sounds like they don’t like real estate in a company since registered vehicles are somehow limited. Well, RRSPs cannot invest in real estate directly. You can’t buy a rental property, or part of a little strip mall you like down the street. You might do so indirectly by going to the stock market, if that is your cup of tea. Now they have decided that your company apparently should not invest in real estate.  So who’s left to buy real estate? Especially those big office towers on Bay Street? 

    Why, it’s the government pension plans! Take a read from the CPP website discussion of the Top 10 pensions in Canada;

    “The Funds are among the top infrastructure and real estate investors globally. They comprise four of the top 20 global real estate investors. They also comprise six of the top 20 global investors in infrastructure assets.”

    Last Thoughts

    The new rules are meant to punish those using low corporate tax rates to buy investments. They’re very onerous. They do not apply to public companies doing precisely the same. Let me ask you why not.

    They do not apply to pensions who are like not so little tax havens right here in Canada, and who therefore have a massive advantage in competing for those same investments. Let’s save that best discussion till last.

  • Mark Lencucha
  •  

     

     

    The new tax law proposals have been generating a lot of press.  The government is spinning misinformation, and nobody is quite sure what the fuss is all about.  So we decided to have our tax consultant, Mark Lencucha, FCPA, FCA, TEP, FEA, draft a number of articles that will hopefully explain these proposals with a more relaxed style.  Some are quick. Some are tough sledding, but we hope you enjoy them and share them with your friends!

    If you pay dividends, or wish to protect your capital gain exemption in particular, we recommend a sit down sooner than later.  We hope these rules are either dropped, seriously modified, or repealed when a new government takes charge.  For now, we must treat them very seriously indeed.

    Pivotal LLP Chartered Professional Accountants

    **The views, thoughts and opinions expressed in this article belong solely to the author and not necessarily to the Partners or staff of Pivotal LLP**

     

    Income Splitting: A Fireside Chat With Your Tax Auditor!

    By way of background, in this world there are several types of income splitting:

  • Dividends paid until now to family shareholders under the traditional law (fully legal, Supreme Court approved, not a loophole);
  • Dividends paid to family under the new law after 2017 (now nasty, not nice, painted as a loophole, and will often be attacked);
  • Pensions received by, among others, your retired auditor and split at their discretion with their spouse (the “oh so proper” way to split income, and fully legal! Under law created by the same people who say your income splitting is abusive!).
  • As you can see, it depends who you are; whether you are friend or foe. The pensioned class are encouraged to income split by favorable law, you are pilloried in public.

    Rather than go through a bunch of technical stuff (TOSI, specified individuals, connected persons, split income....blah blah blah) we thought we could fast forward to listen in on a audit…coming to a theatre very near to you…soon!  Let’s call the tax auditor “A” and you “You”…

    A:  I notice that both of you received dividends last year from your company. This has raised a red flag with us, and I’m here just to make sure there are no abuses occurring.

    You:   OK

    A:  Are you among the top 1% of income earners?

    You:    Wow! I don’t know, let me check the list…Bill Gates, Mark Zuckerberg…Trudeau, Morneau!  Whew! I’m not on the list. No wonder it’s called a “Sunshine” list…look at all those wealthy people.

    A:  Well then you should be just fine. We’re really only after those dastardly 1%-ers, but we have procedures to carry out first. A few questions. Nothing threatening.

    A:  You seem like nice people, but unfortunately my job is to believe the worst of you. To ensure I remain independent and show no favoritism. So let’s start there…I think your dividends are totally unreasonable and we must apply the full extent of the law.

    You:    LOL…NOT!  What’s going to happen to me?

    A:  Well, it works like this. We pretend each of you are earning more than $300,000 and then earned the dividend on top of that. You pay the tax rate normally reserved only for the rich and famous!  Aren’t you thrilled that you too can be rich and famous?

    You:    Well…But…I guess it would be nice…

     A:  It’s OK, we might still get you out of this…You have defences, three only, we designed the game like baseball. I will pitch you three questions. If you strike out, I have no choice but to do what must be done.

    You:    Only three questions? Only three ways to defend myself?  Who set those questions?

    A:  We did!  You must prove to me that your dividends are “reasonable” based upon three defences… your effort, your capital contributed or risk. Neither I, nor the Courts can listen to anything else, no matter how sympathetic we may be, or eloquent you may be. 

    A:  First.  I notice you each take a small salary. Do you pay yourself a reasonable salary, too little, or too much (editor’s note – “too much” is a trick question leading to a terrible place). 

    You:    We pay ourselves fairly. We have a great management team now so we just provide a little oversight.  We thought a modest salary was fair.

    A:  Good! A reasonable salary has been paid, properly compensating your efforts, so we cannot accept anything beyond that as reasonable.  STRIKE 1!!

    A:  Second.  I notice you are owed a $100,000 shareholder loan and have $100 invested in shares.  I’m going to give you a break here. I will concede that it is reasonable that you should have taken a 5% interest and dividend but did not.  I’m happy to announce that $5,005 of your dividend is home safe!  But you took so much more! STRIKE 2!

    You:    Not even a base hit??

    A:  Third.  How much did you risk? I see a$100,000 loan and $100 of share capital.  Anything else?

    You:    We risked everything to guarantee the bank, we had to borrow another $100,000.

    A:  OK.  I’ll give you another 2% for guarantee fees so another $2,000.

    A:  There!  $7,005 is safe. Regrettably the rest of your dividends are utterly unreasonable, and the law is the law. The assessment will be in the mail. You are free to object and complain through formal channels including Appeals (A heaven on earth where weary auditors go when promoted) and Court (entry fee $50,000 or so).  Have a nice day!

    A:  (quietly to self) - “What a great day, what an amazing Tax Auditor I am.  Nailed my TEBA! (Editor’s note - TEBA is “Tax Earned by Auditor”, a statistic kept by the government, no doubt to keep their auditors under the gun and motivated. I hope those Auditors report those tax earnings when they file their tax returns!).

    This little exercise is not the end of it.  These same tests can eliminate your capital gain exemption.  CRA is always assumed correct. Reasonable salary? We can look at comparable jobs. Reasonable expenses? We can look for what others do.

    But a “reasonable dividend”?  In my humble view, all dividends are reasonable…your efforts, capital and risks originated the business, which eventually produced real extra income available for you to distribute by dividend. Facts, not some nebulous nonsensical rules and the argument department of the CRA!

    Ingenuity. Ideas. Risk. Debt. Luck. Perception. Hard work. All of these can contribute to a successful business, and many businesses fail, leaving those families poorer for their risk taking.

    What is then a reasonable reward? I would say it is whatever the company has earned, does not require, and can afford to distribute. Even under their tests!  But I doubt it will be so simple.

    More fun coming up!  Look for our next article! - Mark Lencucha

     

     

    Caution to Reader:  I like tax auditors when we get to meet and spar over the law! Good people. Tough job. This is parody only!  These articles are statements of opinion! Sadly, I’m not an academic or researcher, it’s just me. Blame my friend Mr. Google if there are any factual errors, or omissions.  Blame me if there are misunderstandings!   - Mark Lencucha

     

     

     

    The new tax law proposals have been generating a lot of press.  The government is spinning misinformation, and nobody is quite sure what the fuss is all about.  So we decided to have our tax consultant, Mark Lencucha, FCPA, FCA, TEP, FEA, draft a number of articles that will hopefully explain these proposals with a more relaxed style.  Some are quick. Some are tough sledding, but we hope you enjoy them and share them with your friends!

    If you pay dividends, or wish to protect your capital gain exemption in particular, we recommend a sit down sooner than later.  We hope these rules are either dropped, seriously modified, or repealed when a new government takes charge.  For now, we must treat them very seriously indeed.

    Pivotal LLP Chartered Professional Accountants

    **The views, thoughts and opinions expressed in this article belong solely to the author and not necessarily to the Partners or staff of Pivotal LLP.**

     

     

    Finance Decides To Play Favorites, And You Aren’t It!

    On July18, 2017 the government decided to declare war on small business. They have learned from the guerilla wars of the past and decided on the “Stealthy” approach…under the radar. 

    Although they talk about “Fairness” and “the 1%”, they should really be honest about what they are really doing.  These are the headlines the Government should have put out:

  • “Small business owners should be punished with 70% tax on their income.”
  • “Sell your small business to strangers, it’s too expensive to sell to family now.”
  • “Don’t die with shares of your small business, we can take 82%. Better to sellout before you die and pay only 25%.”
  • “Building up investments from favorable tax rates is a terrible loophole. That’s why we are closing it…but not for public companies, and not for pension funds. Just for you!”
  • “Splitting income is very odious and onerous, so we must tax your dividends as if you were one of the top 1%. Except for our defined benefit, gold plated, limited edition pensions…for some reason, it’s just fine to income split those.”
  • “We know your small businesses are inefficient and uncompetitive and cannot last. That is why we must help the Darwinian selection along…” [1]
  • We will explore several of these tax and fairness issues in detail in subsequent articles. We will focus on a few comparisons where they get a pass and we get a bullet. Where they say “fair” and we say “foul”.  We will go light on the technical and heavy on the ethics of their proposals.

    I look forward to our discussions! - Mark Lencucha

     

    [1] The author of our misfortunes seems to be a Mr. Wolfson whose research prompted these new rules. One tax firm (Moodys Gartner) in their article “Liberals want to wipe out the family farm”, has noted that in a CBC interview Mr. Wolfson indicated that family farms are likely inefficient and obsolete. The sentiment about greater efficiencies can lead one to surmise that bigger business is better. The Family Enterprise Exchange may disagree. Their assessment is that family business is more efficient, returns greater relative profit, and even many of our public companies still thrive due to the benefit of significant “family” ownership and that there is a “family-ness” advantage that can’t be reproduced.

     

    Caution to Reader:  I need to take a class in obfuscation, disinformation and weaving straw dogs. These articles are statements of opinion! Sadly, I’m not an academic or researcher, it’s just me. Blame my friend Mr. Google if there are any factual errors, or omissions.  Blame me if there are misunderstandings! - Mark Lencucha

     

     

    Holding a passive investment portfolio inside a private corporation

    The current system allows for a tax deferral of the individual tax payable if the shareholder leaves funds in the corporation for passive investment purposes instead of being distributed to the shareholders, through taxable dividends or salary, for the shareholders to invest personally.

    As corporate tax rates on active income are lower than the marginal personal tax rate, when surplus funds are left in a private corporation, the tax that would have been payable upon distribution of the surplus to the shareholders can be deferred, resulting in the corporation having more capital to invest.

    No specific measures are proposed and the government seeking consultation on an appropriate means of eliminating the tax-deferral advantage.  Implementation of a suggested system could be made in two general ways:

  • Apportionment method – this would involve tracking income used to acquire the passive investments, as well as the income that the investment generates. The source of the funds would determine the rate of tax to be applied on the investment income earned by such funds.
  • Elective method – would subject a private corporations to a default tax treatment, unless an election is made. There would be no tracking of income as under to apportionment method.
    1. Default method – subject the passive income to non-refundable taxes and when dividends are paid the dividends would be taxed as non-eligible dividends.
    2. Elective method – for corporations subject to the general tax rate on all or most of their income, an election could be made to have the additional non-refundable taxes apply to the passive income and treat the dividends as eligible dividends which have a higher dividend tax credit to the shareholder. The election however would remove a corporation’s access to the small business rate.

    For capital gains the 50% inclusion rate will continue to apply and will continue to be subject to the passive investment income taxes.  However, it is contemplated that the suggested new system would eliminate the non-taxable portion of the capital gains being added to the capital dividend account where the source of capital of the investments was income taxed at lower corporate tax rates.  The ability to distribute tax-free dividends to shareholders would be reduced.