Alternative Solutions - an Open Letter to Justin and Bill

Tax Changes – An Alternative Open (and Opinionated) Letter to the Government of Canada

By Cory G. Litzenberger, CPA, CMA, CFP, C.Mgr – President & Founder of CGL Strategic Business & Tax Advisors

Greetings Justin and Bill.

Can we be real for a second?

Skip the rhetoric, the partisan sound-bites, the flawed economist spreadsheets showing only one tax bracket, and let’s cut to the chase.

There are much simpler ways to change the tax system and have the same effect for both revenue generation and targeting “loopholes” - whatever that means. Following tax laws as they are written is not a loophole, but I digress.

Even if you truly believe the commentary put out that there is abuse by small business owners and the wealthy, let’s take a different look at how we can achieve similar results that are not only “fair” (to use your words) from a tax revenue standpoint, but also much easier to implement from a “red tape” standpoint.

First, my proposals should be used to replace the proposed rules from July 18, 2017, as well as some of the tax changes regarding specified partnership income and specified business income in 2016. 

I know you might have those things framed as the first budget, but the reality is they are impossible to comply with and really need to go. Don't worry... I have a solution.

Obviously, as a tax nerd, I’m all for low taxes, but if you are going to make changes, can you at least make simpler ones to follow, comply with, and enforce?

Many of colleagues, clients, friends, family, even strangers may want to slap me for my recommendations, but this is how I see you could simplify the Income Tax Act immensely and have a similar tax revenue impact.

Proposal #1 – Increase the Capital Gains Inclusion Rate to 75% from 50%.

The main driving factor behind many aggressive tax planning arrangements is trying to convert dividends into capital gains. This has gotten bigger because of the increased rates you passed on incomes over $200k. Dividend rates are much higher than capital gains rates and so many plans are done to reduce the tax bill.

Rather than having a bunch of complex legislation trying to catch these types of plans, why not just change the tax rate on capital gains? 

We had a 75% inclusion in the 1990s, and tax professionals all expected to see this increase in the last budget, and it didn’t happen.

Most people with RRSPs, TFSAs, or pensions won’t be affected because those assets are tax-deferred vehicles that don’t pay any taxes on the investments inside them, so who cares.

Those with left over money that can invest in capital gain investments usually have more wealth to do so with, and the small business and qualified farm property capital gains deductions would still provide relief to the smaller operations.

Financial institutions are not affected because it is taxed to them as income anyways so they will still be filling your government war chest.

Proposal #2 – Reduce the Small Business Limit down to $250,000 from $500,000

Another area of aggressive planning is the multiplication of the small business deduction. In 2016, the government brought in rules that are impossible to comply with. If you own a $5 co-op membership just so you can get a small discount on your groceries or fuel (something us prairie-folk are familiar with) you might be connected to another business and may have to share the small business deduction. 

It is quite far reaching and cumbersome. It is impossible to comply with and enforce. I can’t imagine how anyone at the CRA is going to enforce such a rule.

Worse, is that these new rules target small rural businesses because many in the community are related through marriage to the others. Yes, I am originally from Saskatchewan, and we’re all cousins.

Instead of introducing anti-multiplication rules on the small business deduction, why not reduce the amount available to multiply? 

We already know that 80% of small business corporations make less than $250,000 in profit, so why not reduce the limit as such.

This would reduce the incentive to try and multiply the deduction because the administrative costs of such a multiplication would eliminate much of the potential savings, and would also simplify the Income Tax Act immensely.

Proposal #3 – Professional Corporations Must have 3 Full-Time Staff for Small Business Deduction

Dare I say Quebec got this right? (Please don’t lynch me Alberta)

Effective January 1, 2017, if you are a Professional Corporation in Quebec and want the small business deduction on your provincial taxes, you need to have at least three full-time staff members. This greatly reduces the high-income professionals that are keeping cash inside their Professional Corporations after paying low-rate corporate tax. They would now pay the high-rate corporate tax instead. 

(Full Disclosure: I run as a Professional Corporation and have 4 full-time staff (not counting myself or any related party) and so I would still be entitled to the small business deduction on currently up to my proposed limit of $250,000 of profit (if I ever get to that level).)

We all know that the government is trying to target professionals over the last two budget cycles. Many of the rules were targeting professional partnerships (even in the explanatory notes) and now they are targeting Professional Corporations in general so why not define the eligibility for the small business deduction for Professional Corporations?

PS: Bill, just to clarify the reason Professional Corporations have tripled since 2000 (your recent Globe and Mail column) is because they weren't even allowed in places like Ontario until 2001... but I'm sure you just forgot to include that fact.

Proposal #4 – Remove Subjective Terms like “Reasonable” and Tax on Split Income and Replace it with Something More Concrete (Dollar or Percentage Thresholds Perhaps?)

Simple laws are easier to follow and comply with than areas of uncertainty. If you want to target dividends paid to 18 to 24-year-old related persons, then say it. The issue with things like the Tax on Split Income proposals is that you are creating punitive uncertainty on what is split income because “reasonable” is a subjective term.

If instead of a punitive provision, why not just expand on already existing attribution rules? Or maybe have a requirement that they are receiving a wage before they can receive a dividend. Something… anything… that is more concrete than the term “reasonable”.

As a result, your intention of targeting the individual taxpayer that “should” report the income is achieved as it would be attributed back to them at whatever tax bracket they happen to be in. They would be paying their “fair share” (to steal a phrase from you) of tax, rather than making the lower income bracket individuals pay tax at the highest tax rate which punishes them much worse than a high-income earner.

Proposal #5 – Tax the Household Unit Like the Carter Commission Recommended in 1966

Many tax plans involve splitting income with spouses, or as you call it, “sprinkling” - although that's what my son does when he forgets to lift the toilet seat... so I'm not sure that's the right word. 

Anyways, instead of trying to combat it, why not embrace it and figure out what rate to charge? We already look at household income for the Child Benefit, the GST credit, and many other social programs. Why not look at it for income tax? 

I’m not saying you would just have to take the existing brackets and double it for couple-households but the Income Tax Act could be simplified if you just looked at taxing the household units. 

How many spousal attribution rules could be eliminated? 

How many aggressive and complex tax plans could be eliminated? 

The cost of compliance by taxpayers and the cost of enforcement to the CRA would be drastically reduced under this type of simplification.

Families, middle-class incomes, seniors, business owners, new residents (where only one has a work visa and the other cannot work in Canada for example) would all benefit from this. I knew you’d like that last one Justin.

Proposal #6 – Create a Cap on Passive Investments in Private Corporations

We already have a cap that says if you have more than $10 million in taxable capital, you start losing the small business deduction and it is completely gone at $15 million.  If you think the wealthy are abusing corporations with passive assets, why not place a cap on it before the tax rate goes up?… or they lose the small business deduction?… or some other definitive situation? This makes much more sense rather than these complex changes targeting the small business trying to save for a permanent building location for operations.  

(Full disclosure: this is my personal situation, I need 25% as a down payment for a commercial property for the business and don’t have the cash yet, so I’m trying to save up inside the business for the purchase of a permanent location so we can stop renting.)

Maybe passive assets get capped at $2 Million… or maybe 50% of total asset value (or a combination thereof) or some sort of definitive number that we can work with. 

If they go over the number or the percentage, they pay more in tax on investment income. Simple.

I think many taxpayers including my clients would be comfortable with the reasoning for the cap, plan for it by taking additional money out of the corporation (which is what you want anyway), and it would not penalize the small businesses trying to grow.

Proposal #7 – Remove the Carbon Tax Proposal and Increase GST back to 7%

This one will make me need a bullet proof vest - or possibly a relocation to Texas with all the doctors that will be leaving next year if the current proposals are passed. 

The truth is the carbon tax, levy, fee, whatever you want to call it is an inflationary consumption based tax. It will increase the cost of living for most Canadians because businesses will pass on the extra cost in the form of higher costs for goods and services.

Whereas the GST is a flow through and does not cause inflation on its own. It is still a consumption based tax which means the more you consume, the more you pay – taxing the wealthier consumer like a carbon tax. But the system is already in place for compliance, enforcement, and will not cause hyperinflation like hidden excises tax like the carbon tax.

Proposal #8 – Listen to Us

Tax professionals are chiming in not because we like to hear ourselves talk (although in my case, maybe that’s one of the reasons). But many of us in the tax community see that there is a problem in the complexity of existing and proposed changes and it should be simplified. 

We aren’t trying to increase our fees to our clients for compliance, but that is what is happening. 

While many families and clients (even myself as a taxpayer) liked the Children’s Fitness Credit it really was kind of a pain during tax time to get all those receipts together for a handful of dollars.

Why not simplify it for everyone?

Right now you have hundreds of thousands of dollars in billable time being spent by tax professionals trying to communicate with you about these issues for free! 

If that isn’t cost-effective research for the government, I don’t know what is.

Conclusion

This isn’t a letter of rhetoric (mostly). These are alternative solutions.

Personally, I liked the way things were in 2014. But if you are going to make changes, can we at least be smart about it?

Thanks for reading – I’m still voting Conservative in 2019 because I really do like Andrew – but maybe if you listen to the tax professionals today you might still have a job (or a business that will hire you) after the next election.

Yours very truly,

Cory G. Litzenberger, CPA, CMA, CFP, C.Mgr

President & Founder of CGL Strategic Business & Tax Advisors

PS: to those reading it that disagree with me - that's fine - I disagree with me too... but I'm trying to find a solution that is simpler than the gong show of tax changes from 2016 and 2017 that achieves similar results.

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