In June 2016, Regina–Lewvan MP asked the House of Commons finance committee to study the use of private corporations by high-income Canadians to avoid personal tax. In July 2017, the federal government began consultations on proposed solutions.
The top personal tax rate for individuals making more than $200,000 per year is 48% (33% federal tax and 15% Saskatchewan tax). But the corporate tax rate for “small business” profits up to $500,000 per year is just 12.5% (10.5% federal and 2% provincial), only about half the lowest personal tax rate.
By setting up a private corporation, some people in the top income bracket can cut their tax rate by three-quarters from 48% to 12.5%. In theory, they pay back the difference when they take money out of their corporation.
But the theory breaks down if the corporation transfers money to a family member in a lower tax bracket. Furthermore, shares in the corporation are eligible for the Lifetime Capital Gains Exemption of $800,000 per family member. Only half of capital gains exceeding that amount are subject to tax.
The government’s proposals focus on closing these loopholes by preventing private corporations from “sprinkling” income to family members not involved in the business and from converting the income into capital gains. The basic principle is that people with the same income should ultimately pay the same amount of tax, whether or not they incorporate.
Of course, this issue is complex and the government needs to get the details right. In Saskatchewan, it is particularly important to ensure that these tax reforms do not inadvertently hurt family farms. You can participate in the consultations by e-mailing firstname.lastname@example.org
The following commentary appeared in The Financial Post (page FP9) on July 28, 2017:
“Small Business” Tax Loophole a Test for NDP Leadership
Last week, federal finance minister Bill Morneau announced consultations on the use of private corporations in “tax planning” by wealthy professionals. These consultations provide an opportunity to close a significant tax loophole and present a key test for NDP leadership candidates.
The ostensible purpose of a corporation is to raise capital for a business from investors while limiting their personal liability. It is not immediately obvious why a professional engaged in self-employment, rather than such entrepreneurial activity, would need to structure their practice as a corporation. Indeed, provincial governments have generally allowed regulated professionals to incorporate only since the year 2000.
By doing so, doctors, lawyers and others can take advantage of low corporate tax rates for “small business” instead of paying regular personal income tax rates on self-employment income. They can then transfer money from their private corporations to themselves, or to family members in lower tax brackets, as dividends that receive tax credits or as capital gains that are partially exempt from tax.
Such tax avoidance is a large and growing problem. Over the past 15 years, the amount of income reported through Canadian-controlled private corporations has doubled as a share of the overall economy, while income reported from self-employment has declined.
Finance Canada estimates that the preferential tax rate for “small business” reduces federal corporate tax revenues by $4 billion annually. It reduces provincial corporate tax revenues by billions more. The loss of personal tax revenue is harder to calculate, but Finance Canada estimates that its proposal to stop professional corporations from “sprinkling” income to family members in lower tax brackets would recoup at least $250 million annually.
While specific proposals to address the most egregious “tax planning” techniques are welcome, a broader question is why incorporated professionals have access to the “small business” rate. The federal government cannot stop professionals from incorporating in provincial jurisdiction, but it does not need to give them the small business deduction. Simply applying the general corporate tax rate to professional corporations would help to level the playing field and greatly reduce tax avoidance.
The most common argument for low small business taxes is to create jobs. The Quebec government, which administers its own income tax, announced last year that only Canadian-controlled private corporations that provide at least 5,500 hours of employment will be eligible for the provincial small business deduction. The federal government could emulate this policy for the rest of Canada or prevent corporations from claiming the deduction in excess of the dollar amount paid to employees.
Morneau’s announcement highlights these important issues just as the federal NDP leadership race is heating up. All contenders want to close tax loopholes for the wealthy, but have presented few specific examples beyond the preferential treatment of stock options. They should commit to concrete measures to end the abuse of private corporations by high-income professionals.
The NDP has advocated further reducing the small business tax rate. Doing so without an appropriate definition of “small business” would widen tax loopholes related to private corporations.
During the last federal election campaign, Charlie Angus – now a candidate for NDP leader – demanded that Liberal leader Justin Trudeau apologize for noting that “a large percentage of small businesses are actually just ways for wealthier Canadians to save on their taxes.” Angus engaged in semantics about what constitutes a “large percentage” to downplay the substantial problem of tax avoidance through private corporations.
As a matter of policy, New Democrats are deeply committed to a progressive tax system to reduce inequality and fund important public services. As a matter of politics, we cannot allow the Liberals to outflank us on the issue of tax fairness.
New Democrats need to know that our next leader not only opposes tax shelters for the wealthy in the abstract, but will push for concrete solutions to specific tax shelters like private corporations for wealthy professionals.
- Erin Weir, the NDP MP for Regina–Lewvan, had asked the House of Commons finance committee last year to study the use of private corporations by high-income professionals to avoid personal tax.