October 23, 2017
The Honourable Bill Moreau
House of Commons
Ottawa, ON
K1A 0A6
Bill.Morneau@parl.gc.ca
The Right Honourable Justin Trudeau
House of Commons
Ottawa ON
K1A OA6
Dear Sirs:
Re: Proposed Changes to the taxation of Private Corporations
The Department of Finance’s release of the document “Tax Planning for Private Corporation” for consultation and comment in July 2017 has resulted in significant and justified outrage from Canadian professionals and small business owners. I am writing this letter to address your concept of “fairness”, since you have used this term to justify this latest attack on the entrepreneurial middle class. It appears that you have taken a very narrow and misleading position when using the term “fairness” in order to sell your proposed changes to that portion of the general electorate that is not familiar with the economic reality facing small businesses and professionals.
It is not surprising that there are loud objections to the proposed changes, since the whole tone of your messaging has deliberately and profoundly offended the main economic and wealth creators of our economy. Additionally, the slanted and incorrect mathematics of these proposals makes a mockery of “fairness” in the tax system, and appears to be more an attempt to incite class division than the fair review of the tax system promised by this government. We hope that pragmatism and not political dogma will prevail in your government’s review during the consultation process, which itself needs an extended timeframe and significantly more depth to the commentary and analysis. The future success of the Canadian economy depends on your Government and the Department of Finance in particular being pragmatic not dogmatic and open to constructive criticism through public review. As Manitoba Premier Brian Pallister correctly points out:
“I’ll use the phrase poisoned water …. The federal government needs to pull back on its rather misguided proposition that we should have class warfare in our country between small family-run business and everyone else.” – Manitoba Premier Brian Pallister.
As for myself, this is the first time in my over 35 years of public practice and as a staunch advocate and defender of small business that I feel compelled to write an open letter to our Government to protest what can only be described as an attack on entrepreneurs and professionals by your government: particularly by yourself and Mr. Trudeau. My tax team at HS+ Partners, LLP has been studying the impact of these proposals and I must say that, contrary to your political rhetoric, the irony of the proposals is that you are not attacking the wealthiest of Canadians but instead effectively your plan adversely affects the small business owner who earns up to $250,000. Those earning higher incomes have other means of tax management, and thus will pay lower taxes than the middle-class small business owner.
Before addressing the specific proposals, let’s first address the basic reasoning used by your government to implement the proposed changes. The communications from you and your Department focus on “fairness in the tax system”, without defining to whom that “fairness” applies. If it is fair to raise government revenue, then by all means the proposal is “fair”, to the Government. If the measure of fairness is to provide equally effective tax advantages to small business owners, investors in large corporations, and employees, then your proposal is one-sided, and thus “un-fair”. It would seem therefore that your use of the term “fair” is politically engineered for vote buying – effectively concocting a crisis to fight a problem that does not exist. If your Government is really interested in “fairness”, then any new tax proposals affecting small businesses in Canada must be assessed based on all business. legal and tax concerns related to small businesses and their owners – not just the tax raising objectives of Government.
In the interest of “fairness”, private Canadian-owned corporations most definitely pay their fair share of tax and in some cases, like those owning real property; they pay perversely higher than “fair” taxes. It is also important to clearly understand who small business {entrepreneurs and professionals with less than 100 employees) are:
- These are the people that own a small business that, depending on which think tank’s statistic you believe, employ anywhere from 70% to 75% of non-government workers in the economy. These are not the big banks or international corporations. These are mostly family owned businesses and very few are in the top 1% of income earners;
- These people are NOT passive income earners such as non-resident trust-fund owners, politicians with investment assets managed through trustees, or those foreign corporations using Canadian tax law to take advantage of small business legislation;
- These are the people that are required to put up personal guarantees and use their family homes as security to obtain operating lines and equipment loans for their business. Once they put the family home and assets at risk, they correctly view that every family member becomes a stakeholder and principal of that business.
- These are the people that according to Mark Mike’s 2014 Globe and Mail article, 68% of all tax filers had annual incomes of less than $50,000. They earned 32% of all income, and paid 13% of all federal income taxes. Those earning over $100,000 were 8% of filers, earned 33% of income, and paid 52% of taxes. The top one percent – those making over $250,000 – earned 11.3% of all income and paid 21.1% of all taxes.
- These people typically work 80 to 100 hour weeks to start and grow a business. They have their children and spouses contribute as the family livelihood depends on the cost savings realized when family members contribute. They often, especially in the early years, work for little or no pay and vacation and certainly cannot afford those health and dental plans most people take for granted. There are no labour laws to protect them and their families.
- These are the people that hire other people and are always the last ones to take a salary if there is not enough money …….. and, they are personally responsible for any unpaid payroll or payroll taxes. Can a President of a Bank or any large corporation claim the same exposure?
- These are the people that the Canada Revenue Agency requires to be tax collectors for HST. And again, they are personally responsible for any unpaid amounts – even if their customer refused to pay the HST.
- These are the people that are not allowed to collect El if they own even 1% of a company but are forced to pay the El premium if they own anything up to 30% of the company. How fair is this?
- In the case of professionals, doctors, lawyers, dentists, accountants etc., they went into debt to obtain higher education as an investment in their future only to be villainized by our government. They work long hours, often in stressful deadline based existences.
- These are the people that typically do not have pension plans that government and big business and employees enjoy and take for granted. Their pension plan is whatever they can save, the value of the business, and more often than not, their homes. The current tax rules for Small business corporations allows for a modicum of ability to save for the future effectively. Changing the rules will seriously erode the ability to save for retirement or manage assets within a business. Is this what you deem fair as compared to employees and what they have?
- These are the people that do not have legal rights to severance pay. If a business fails, they have nothing to fall back on and likely still personally owes for unpaid payroll, payroll taxes and HST after being financially wiped out.
- These are the people where labour laws offer little or no protection from unscrupulous employee do not conduct nor do the civil laws make it as easy as it is for employees to find rectification. In fact, Labor laws are more skewed towards the employee and offer employers even more liability.
The bottom line is that, in spite of all the above, these are the people that create the majority of Canada’s wealth and employment opportunities while they subject their families to the burden of a financial “sword of Damocles”. They are the Golden Goose of our economy; the visionaries and risk takers; the drivers of ideas and action. Can employees say the same? Of course not, yet our government choses to sell these proposals on the basis of obtaining fairness between small business owners and employees from purely a tax perspective. Fairness must be gauged in totality by viewing all the relevant elements that impact each sector of our society: civil and labour laws, financial realities and finally tax. You cannot look solely through the tax lens without considering all elements and then conclude unfairness.
A fellow CPA, Gordon Lee, wrote an outstanding letter that also addressed these issues. In his letter he writes:
One fallacy is the comparison of a small business owner to that of an employee to document
unfairness. 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 dividends amounts 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. 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.
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. 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.” Frankly, most small business owners, professionals and tax experts who clearly understand the genuine challenges and reality of small business are profoundly offended by the very comparison and assertion of unfairness between them and their employees. The fundamental tone of your proposals is justifiably seen as punitive towards the entrepreneur and those who take significant risk in starting a business. Our tax system was designed to not only collect tax revenues for our society’s needs but to also motivate and encourage or discourage desired economic activity. It is designed to ensure that all Canadians pay their fair share of taxes. You have taken an ideological position that “loop holes exist” where these “loopholes” were seen by both previous Liberal and Conservative governments as fair and strategically motivating tax legislation. Messer’s Trudeau and Morneau; either you are governing by pure unmitigated dogma rather than pragmatism, or you are painfully naive as to how the world works. Neither answer is good. Now let’s look at a couple of the proposals:
Income sprinkling
The Government acknowledges that existing rules are already in place to address the reasonableness of salaries in private corporations. Income reasonableness has already been tested by CRA for over 30 years. As for children, once a child becomes an income earning adult, sprinkling makes very little sense and is not a problem. Why then, has this become an issue if not for political motivations?
The proposed initiatives indicate your Government’s intention to expand the tax base and specifically target the capital gains exemption on the sale of small business – particularly in context to those situations where the family business has adult family shareholders that may no longer be contributing to the business. This is an attack on retirement planning for families that own business.
The Government cannot ignore the fact that the collective effort and contribution of a family unit to a family business is the reality of many private corporations, and that their exposure to economic liability due to personal guarantees of the parents and the family home used as collateral for business purpose affect all family members, and therefore makes them all stakeholders/shareholders in the truest sense possible. For true fairness, and to eliminate the need for income sprinkling, your government should finally accept the often recommended policy to tax families together as units. You must recognize that families make financial decisions together and are jointly exposed to the business risks. Based on that irrefutable reality, one must fairly conclude that if they are exposed to those risks, they deserve the desired rewards and that together they should be the taxed as a family and not as individuals. The current round of tax reform proposals miss this opportunity, one which would eliminate the needs of “reasonableness tests” on family labour and capital contributions and “income sprinkling” concerns.
Holding passive businesses in private corporations
The government’s position is that saving money within a corporation is bad and an unfair way for small business owners to reduce taxes. The reality is that most small businesses have annual net incomes of less than $200,000. If a company feels the need to save money for future investment or to offset harder times, then it now faces our government’s new proposal to tax these savings at 73% (according to the number crunching of a number of tax Professionals}. How is this fair and reasonable? How does this address the need for a small business to manage diversification and managing risk? As Gordon Lee further wrote:
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. They must 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 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 with no regard for future consequences.
Your Government is apparently concerned that when passive investments are retained in a corporation, and earning income, there is avoidance on the tax that would be due upon distribution to shareholders. Our tax system is based on an integrated model between a corporation and a shareholder. When money is ultimately paid out to the shareholder it will be taxed at the highest combined rate for the amount in question. So, it has never been an issue of “reducing or avoiding taxes” it is only an issue as to when those taxes are paid. Small business can delay paying that additional “second tier” of personal tax by not taking the money out until they need to. The rules allow them to save within the corporations for the business purposes discussed above. Again, this was a tax policy to help small business deal with the risks and challenges of running a business. It is painfully evident that banks are not strong supporters of small business, so they must prepare for the need of future investment themselves, as tax efficiently as possible.
One should also consider which investments are deemed as passive vs active. The Government appears to want to second guess the intent of holding any investment in a corporation, which could include short to medium term portfolio of investments held pending considerations of expansion, or further evaluation of capital investment and real estate.
With Real estate in particular, it is nice to hear that you both want fairness in the tax system. If that is true, then let’s discuss Real Estate investment holdings. Profits from owning a rental property within a corporation (with less the 6 employees} is considered “passive” income for tax purposes and is taxed at 49% as compared to a normal small business that pays tax at 16%. I have yet to meet a small landlord that feels that being a landlord is a passive activity equal to giving your investment advisor money and seeing them once a year. This is an active form of business that should be taxed as such ……….. if you truly believed in fairness. Yet I digress …… I appreciate that the term “fairness” is a particularly malleable and useful term your government can chose to define differently for different people to suit your own political purposes.
Your Government’s proposals intend to attack the “wealthy” however the facts suggest 1% of the top income earners in Canada already contribute about 22% of all income taxes to federal and provincial governments. The top 10% contributes 55% of all income tax and the bottom 50% of earners pay just 4% of all income tax collected by federal and provincial governments. So how is this unfair to the majority of Canadians?
University of Ottawa researcher Michael Wolfson’s co-authored reports on the small business corporation and its use by high income Canadians appear to have spearheaded the Governments foray into tax reform, however these studies appear to view taxation in isolation, without considering the multiplier effects of Private Corporation spending and competitiveness of the private corporation on the world stage. I have an honest question regarding Mr. Wolfson: Has he ever had to run a business and deal with the risks vs. rewards that would give him a real understanding of small business and thus the credibility to advise anyone on it?
Without doubt, any revised tax reform which addresses the taxation of “passive investment income” will create more challenges for business owners, since the Canada Revenue Agency will shift focus of its corporate tax audits towards, for example, the real estate industry and the characteristics of active verses passive income. In addition, the concept of reinvested capital is not black and white, as a reinvestment takes time to consider risks, the conditions of the economy, and business negotiation as examples. It is therefore not fair to subject passive investments in a corporation to more stringent taxation.
The issue of the proposed tax reform is an issue of Government priority. Your Government must realign its priorities to focus on larger gaps of accountability as in the problem of the underground economy. Your government should be working with Business owners to help expand our economy. They are the “low hanging fruit” towards greater economic prosperity. This must be understood.
I recommend a review of Newtonian Physics where Newton’s Third Law should be clearly heeded: For every action there is an equal and opposite reaction. There will be consequences arising from your attack on the middle class, professionals and small business. To name but a few:
- I am already aware of numerous business peers choosing to now expand in the US instead of Canada. The US admires the entrepreneur, where local municipal governments have more power to negotiate and thus attract Canadian business to locate there. Why would you further exasperate this problem by creating adversarial relationships with small business?
Do you not understand that the new economy, made up of service and tech, is highly mobile and will go where they will benefit the most? Canada’s population is roughly equivalent to the state of California. The US market is far larger, far more inviting and far more respectful to entrepreneurs and professionals. Why would you propose changes that will make the US even more inviting? Taxpayers are motivated to find ways to reduce taxes – especially when they believe those taxes are unfair. Some provinces already have top marginal tax rates of more than 50 percent. Small business owners will never accept that any government is entitled to more than half of the profits and rewards resulting from their hard work and additional risk to expand their businesses.
The US admires the entrepreneur, where local municipal governments have more power to negotiate and thus attract Canadian business to locate there. Why would you further exasperate this problem by creating adversarial relationships with small business?
Do you not understand that the new economy, made up of service and tech, is highly mobile and will go where they will benefit the most? Canada’s population is roughly equivalent to the state of California. The US market is far larger, far more inviting and far more respectful to entrepreneurs and professionals. Why would you propose changes that will make the US even more inviting? Taxpayers are motivated to find ways to reduce taxes – especially when they believe those taxes are unfair. Some provinces already have top marginal tax rates of more than 50 percent. Small business owners will never accept that any government is entitled to more than half of the profits and rewards resulting from their hard work and additional risk to expand their businesses.
The existing tax system and the small business deduction to Canadian controlled private corporations was intended to incentivize reinvestment and entrepreneurial growth. The spirit of the new proposals thwarts this fundamental concept. Your government must always consider what is best for the economy and who drives economic success. You need clarify the strategic need and then find the effective tactical solution. It appears you used this methodology in your “Green” and “gender equality” policies but not with your economic policies and the use of the tax act therein. You need to rethink your narrow definition of fairness as the one you currently hold will have many unintended consequences not the least of which shows your governments cavalier and dishonest declaration of attempting to find fairness in the systems for political gain. If you really want fair and raise revenues, then it is time to take a hard look at government employees and their ridiculously inflated compensation models and job security over the their private sector equivalents of working class Canadians. I, as most Canadians workers and entrepreneurs know you will find far more revenues with that foray then what you’re currently attempting. If you are seeking class warfare then that is an excellent place to start.
Yours Truly,
HS & Partners LLP
Chartered Professional Accountants
Louis J. Sapi CPA-CA, MBA
Entrepreneur and concerned Taxpayer
Zd
cc The Honourable Andrew Scheer
Andrew.scheer@parl.gc.ca
