While Finance Minister Bill Morneau, in his recent federal
budget, did not propose an increase in either personal or corporate
tax rates, and while the feared increase in the portion of a
capital gain that is taxed (capital gains inclusion rate) did not
come to pass, there were some troubling signs for owners of private
businesses and investment companies.
One is actually a proposed change to the income tax rules; the
second is an announcement of a review of a number of common
Under the guise of "closing loopholes and addressing tax
planning," the Budget documents state that "the
Government will identify and close tax loopholes and tax planning
schemes that disproportionately favour the wealthy - including tax
planning strategies that involve private corporations".
As is often the case, what is originally described as an
incentive when introduced into tax legislation is later labelled,
when it is politically expedient to do so, as a loophole that
disproportionately favours the wealthy. In this context, one
can imagine an all-out attack on the use of private companies.
The measure that is proposed in the Budget targets the
small business deduction, which is the ability of
Canadian-controlled private corporations to earn up to $500,000 per
year of active business income at lower tax rates.
Tax planners have spent considerable time developing ways for
family groups to access more than one small business deduction by
ensuring that two or more corporations are not
"associated" for the purposes of the Income Tax
Act. One such method is to require that a person who controls
one corporation does not have "factual control" (as
opposed to legal control) of a second corporation.
A recent Federal Court of Appeal decision restricted this
factual control test to one where the person had a legally
enforceable right to effect a change of the Board of Directors of
the corporation. Revenue Canada clearly did not like this decision,
as it drew a clear line for planners as to what would or would not
constitute factual control.
Hence, the Budget resolution proposes that the Income Tax
Act be amended to clarify that the test for factual control
not be limited in the manner outlined in this Court decision and
that other factors may be taken into consideration.
Thus, Revenue Canada takes us back to a murky test which leaves
planners unsure as to where CRA may or may not choose to
The Budget also proposes a review of tax planning using private
corporations. Again, in the Budget documents, the Government cites
the use of tax planning strategies using private corporations which
can result in high-income individuals gaining unfair tax
advantages. Specifically, the Government mentions three common
Using private corporations to
sprinkle income among family members who are in lower personal tax
Holding a passive investment
portfolio inside a private corporation which may be financially
advantageous for owners of private corporations compared to other
investors due primarily to the fact that income, once taxed at a
lower rate, can be accumulated in private corporations before being
paid out as dividends to the shareholders; and
Converting a private
corporation's regular income into a capital gains, presumably
through selling the shares of the corporation rather than
distributing its income.
The common sin in all these strategies is the intent to arrange
one's affairs so that income is taxed at anything other than
the highest possible marginal rate. The Budget states that the
Government intends to release a paper in the coming months setting
out the nature of these issues in more detail and proposed policy
So, again, the news the Government wants you to hear is that
personal tax rates are not going up - they are already as high as
53.5% in Ontario.
What is also apparent is that there is a very clear intention to
raise revenues by once again "taxing the rich".
The question is, will the incremental revenue the government
raises be anywhere near the political benefit it hopes to
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