Letter to the Federal Government regarding the Proposed Tax Changes
The following letter was sent by Howard Sone, CPA, CA to the federal government in connection to the proposed federal tax changes announced July 18, 2017 impacting private businesses and owners:
September 26, 2017
The Honourable Peter Kent
7378 Yonge Street Suite 41B
Thornhill, ON L4J 8J1
Dear Mr. Kent,
Re: Tax Changes for Private Business
I am a Chartered Professional Accountant (CPA), and Chartered Accountant (CA), practicing in Ontario, and I live in your riding. I’m writing concerning the July 18, 2017 tax proposals for private business and business owners. While I recognize that your political party, the Conservatives are not the governing party, I am hoping you can provide a strong and effective opposition to the tax proposals.
I have now had the opportunity to study the proposals in detail, and to attend a seminar which illustrated the implications of the proposals.
I am very concerned that these proposals are wrong conceptually in many aspects, and will bring harm to the Canadian economy. These proposals need to be reconsidered. A meaningful process of consultation needs to begin.
More specifically, I have the following concerns about the proposals and the way the government has conducted itself surrounding them:
Prime Minister Trudeau has said that these proposals represent a “small tweak” to our tax system for private business. This is misleading. These proposals carry with them major changes. If the government’s stated objective is to make a small tweak to the tax system, then these proposals obviously do not achieve that goal.
Finance Minister Morneau has stated that nobody will be affected who makes under $73,000. Examples I have seen do not show this. It was explained to me that a dividend received by an individual who fails the “reasonableness test” will be taxed at the top tax rate, regardless of that person’s income or the family’s income. Accordingly, it seems obvious to me that the proposals apply, regardless of a family’s level of income. So, the $73,000 threshold seems to be without justification. I am also concerned that this will affect many of my clients, some in a drastic way, increasing their tax liability very significantly and very disproportionately to the rest of the population.
It has been demonstrated to me that these rules create double taxation. The same amount or the same value is taxed twice. I am satisfied that the examples I have seen are a correct and are an appropriate characterization of how the rules might apply to a wide range of business owners. Under the proposals, a total tax of 72% can occur when the value in a corporation is passed down to the heirs and the amount is withdrawn. Other examples show that the tax rate could reach as high as 90%. I believe that double taxation is wrong, and that the top personal tax rate is already very high. There is no reason why a person should have to pay a rate of tax of more than the top personal tax rate, whether it is directly or indirectly, and regardless of the circumstances.
One of the most troubling aspects of the proposals is that they create a significant bias in favour of selling a business to an outside party rather than passing the business on to family members. I have seen an example where the tax on selling the business to family members is 45%, whereas if sold to an unrelated person, the tax would instead be around 27%. In addition, because the capital gains exemption can be claimed in the latter case, this creates an even bigger bias. In fact, due to the capital gains exemption, the tax could in fact be close to 0% on a sale to an unrelated person.
I am concerned about the complexity of these proposals which seems unwarranted especially when targeted at small business. The rules for private business and business owners are already unduly complicated, and I know this because I deal with these matters on a daily basis.
I am concerned about the uncertainty which will result from applying a “reasonableness test” to the taxation of dividends received by private business owners. This will require me to exercise judgement as to reasonableness of overall compensation for large numbers of my clients. This will involve great difficulty, a large amount of time and effort and hence a commensurate cost. There will be considerable uncertainty. It can be anticipated that the Canada Revenue Agency (CRA), charged with administering these proposals, will struggle with the same difficulties. The cost of compliance will be significant, for taxpayers, professional advisors, and CRA alike. It is foreseeable that there will be large areas of disagreement, and this may result in unprecedented litigation, on top of a tax system which is already severely backlogged at the appeals level. Taxpayers have a right to a level of certainty in their tax affairs, particularly when making a bona fide attempt to comply with all relevant tax rules.
I am concerned about the underlying philosophy of comparing a business owner to an employee, on the basis that the tax treatment should be roughly the same. This seems to be fundamental to the proposals, in that both groups should be treated equally. However, their circumstances are not the same, and there are numerous economic and tax benefits which an employee can obtain which a business owner does not. The tax treatment of stock options is one example of very different tax treatment. Unemployment insurance, the rights to severance and putting one’s personal assets at risk are examples of fiscal inequality. Instead, I believe that the tax system should treat taxpayers appropriate to their circumstances, in a way which is fair and balanced. It is clear to me that this does not necessarily mean that all taxpayers should be treated equally.
I am concerned that the government is promoting these proposals as furthering “fairness” to the so-called middle class, which is a term which that has never been defined. If it were defined, it would be clear that these proposals will affect large numbers of the so-called middle class, and not just the very wealthiest of Canadian taxpayers. More fundamentally, I believe that the government should appropriately represent the legitimate interests of all Canadians, regardless of the level of income or wealth. These proposals unfairly target a specific segment of Canadians.
I am concerned that the proposals have been portrayed as being necessary to close so-called loopholes. I take offence to the suggestion that large numbers of private business owners are exploiting loopholes. Whatever advantages private business owners derive from the current rules of the Canadian tax system are a result of deliberate government policies and policy choices which have evolved over decades. It has been said that tax incentives are there to be used, provided their use complies with the requirements of the tax system. If tax changes are needed, so be it. However, to portray these as loopholes, when they are legal, and created by government policy in the first place, is wrong and insulting.
I am concerned that if tax changes of this magnitude, which are hardly “small tweaks”, are to be introduced, they should be introduced gradually and only after they have been fully studied. The 75 day consultation period, which began in the heart of the summer, is completely inadequate for changes of this magnitude. Many of the proposals contain an effective date of July 18, 2017, the date that the proposals were announced. Many have retroactive effect going back as far as 1985. There is very little in the way of transitional rules to eliminate retroactive application. Even more importantly, like all responsible Canadian families, business owners plan their financial expenditures and financial arrangements over many years. I understand from various studies that taxation is the largest expenditure of Canadian families already. To dramatically increase this level of taxation with, in some cases, retroactive effect, and in other aspects from 2018 onwards, is irresponsible.
I am also concerned that the rules inappropriately target certain businesses more severely in terms of how the reasonableness test is applied. For example, businesses which primarily earn rental income from real property or royalty income, do not allow any account to be taken for the labour and effort of the business owners. This is unfair, and violates the proposition behind the rules that taxpayers should be treated equally.
Singling out for harsher treatment persons under the age of 24 is discriminatory, in my view, without just cause.
I am also concerned that taxpayers which are unrelated who collectively own a business are treated differently to family members in equal circumstances. Indeed, a person who invests in a private corporation through a private equity fund would seem to gain an advantage over a family member in equivalent circumstances, and this difference is not adequately answered by applying a reasonableness test. In addition the rules apply to persons who are related but live in different households. For example, they apply to two brothers who own a corporation together, even though they do not split their income. This does not seem fair to me.
- Business families have only a limited capacity to pay income tax, particularly in the case of smaller private businesses. The resources of these families are not unlimited. If these families have to pay significantly more in income tax, as would be the case under the proposals, this will not come without other economic effects, whether it be a downsizing of the business, lower disposable income to spend, or a delay in plans to expand the business including deferring of investment or hiring decisions.
For the reasons given above, it is my view that these proposals need to be rethought in many aspects. The consultation period should be extended, and any new rules should be implemented gradually with the appropriate grandfathering of these new rules.