Small businesses wary of new income-splitting rules in 2017 federal budget

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The Trudeau government says in its 2017 budget that it plans to tighten tax rules that allow Canadians to share income with their spouse and adult children, a measure the small-business sector warns could hurt tens of thousands of family-based enterprises.

The Liberals are withholding precise details of this tax clawback until later this year but say it is necessary in the name of building a more "fair and efficient tax system for Canadians." The government will release a paper – expected before the fall of 2017 – that will elaborate on this and other measures designed to eliminate tax breaks that benefit only privileged Canadians.

This forewarning of a crackdown on tax-reduction practices was part of a slew of measures Finance Minister Bill Morneau unveiled Wednesday that he said are aimed at improving the efficiency of Canada's tax system and reducing tax benefits that "unfairly help the wealthiest" in this country.

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"Let me be clear: All Canadians must pay their fair share of taxes," Mr. Morneau said in a prepared speech to the House of Commons.

He also announced Ottawa would collect about $1.4-billion more in taxes annually through new measures that scrap tax loopholes, further crack down on tax evasion and eliminate tax breaks that the Liberals consider "ineffective and inefficient."

Items on the cutting block include a tax credit Canadians could claim for using public transit, a measure introduced by the former Harper government that cost Ottawa $200-million in forgone revenue annually. The Liberals said in the budget that this break was "ineffective in encouraging the use of public transit and reducing greenhouse gas emissions." Mr. Morneau said the government would prefer to funnel this money into transit infrastructure projects.

All told, the specific tax clawbacks unveiled Wednesday reap relatively tiny gains for the federal coffers. In the 2017-18 fiscal year, individual Canadians will pay an estimated $152-billion in personal taxes to Ottawa and collecting an extra $1.4-billion from some Canadians and corporations does not spread the load around significantly more.

Dan Kelly, president of the Canadian Federation of Independent Business, said he's worried about the Trudeau government's intention to limit how Canadians can distribute income among family members because this is a common strategy used by family-based businesses.

"This is a pretty significant threat to a lot of independent business owners across this country," Mr. Kelly said.

Prime Minister Justin Trudeau has expressed skepticism publicly about the tax-planning practices of small businesses in Canada. In 2015, before the Liberals won the federal election, he told CBC TV that he believes "a large percentage of small businesses are actually just ways for wealthier Canadians to save on their taxes."

The Finance Department is targeting Canadians who, faced with a high personal income tax rate, have a private corporation where their spouse and, or, adult children are shareholders and are subject to a lower tax rate.

To avoid all the income being taxed at this high rate, the individual distributes income as dividends to the spouse or adult children shareholders. The department considers this a form of income splitting for tax purposes.

It remains to be seen at what level of income Ottawa might bring in limitations on distributing earnings among family members. One official, speaking on background because he was not authorized to speak publicly, suggested it could be as high as $300,000 to $400,000.

Kim Moody, an accountant with Moodys Gartner, said entrepreneurs in Canada risk their capital when running small- or medium-sized businesses and there should be an incentive for people who take this gamble. He said he would be concerned if Ottawa reduced the advantage conferred upon such businesspeople.

The government said it's also looking at cracking down on two other types of practices designed to reduce taxes, including situations where owners of private corporations hold a passive investment portfolio inside the corporation and benefit from a lower tax rate. Ottawa is also targeting behaviour where a private corporation's regular income is converted into capital gains to take advantage of the lower tax rate paid on capital gains.

Closed loopholes

The tax loopholes or tax breaks the Liberal budget closed on Wednesday include:

• A tax exemption for allowances granted to members of provincial legislative assemblies and certain municipal officers that cost Ottawa $30-million in forgone annual revenue.
• A change in how development expenses by small oil-and-gas companies are treated that will recoup approximately $50-million a year in future years.
• A measure that would prevent investors from deferring income tax through sophisticated derivative investments known as “straddle transactions,” a change expected to yield $60-million annually in additional tax revenue.
• Hikes in tobacco excise duty rates and a new tax on cigarette inventories to bring in an additional $40-million a year.
• Raising alcohol excise duty rates and tying future duties rates to increases in inflation, to recoup an additional $60-million in 2017-18 with revenue projected to rise over time.
• Expanding the definition of a taxi business to capture ride-sharing service providers that might not already be subject to sales taxes, to bring in an additional $4-million per year.