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The coalition sent a letter to Finance Minister Bill Morneau asking him to completely withdraw the proposals and start a new consultation from scratch.CHRIS WATTIE/Reuters

Some children and business partners of recently deceased business owners are suddenly in legal limbo owing to proposed federal tax changes that could have dramatic and expensive tax consequences for estate planning.

Federal officials insist proposed tax changes – including draft legislation and a consultation paper – are merely drafts that have been released for public consultation and discussion.

But lawyers and accountants say they have a professional duty to treat draft legislation as if the measures are currently the law of the land. Some of the proposed measures are retroactive to July 18.

"Tax professionals have always proceeded under the assumption that draft legislation will be passed into law with the same effective date as initially announced," said Marion Howard, a Milton, Ont., tax lawyer who has conducted an in-depth review of the proposals. "To simply assume it won't pass, or that the effective date will be changed, is not an option."

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In practice, tax experts say this means considerable uncertainty for individuals dealing with winding down a family business or dealing with life insurance payments related to the death of a business partner.

On Thursday, 35 business groups announced they have formed a new alliance called the Coalition for Small Business Tax Fairness. The coalition sent a letter to Finance Minister Bill Morneau asking him to completely withdraw the proposals and start a new consultation from scratch.

Liberal MPs are also speaking out, noting that they have been getting an earful from constituents over the summer and are planning to pass those concerns along to Mr. Morneau when the Liberal caucus meets next week in Kelowna, B.C.

Nova Scotia MP Darrell Samson held two town halls in his province this summer regarding the tax changes, one of which drew 200 people and had people spilling out into the parking lot.

"It's definitely the talk on the street these days about what these changes may mean, and how they can have input into this before our government makes any changes," Mr. Samson said.

He said he's heard particular concerns about the tight time frame of the consultations as well as the language being used to describe the changes.

"It's not a loophole if it's legal to do it. So we have to be concerned about that," he said.

Mr. Morneau announced the changes on July 18, presenting them for public consultation until Oct. 2. He said the changes are aimed at ensuring Canadians are not creating small businesses simply as a way of paying less tax. The changes restrict how business owners can "sprinkle" income to family members to reduce the total amount of tax the family pays; restrict the use of private corporations as a vehicle for making passive investments and limit a business owner's ability to convert income into capital gains.

Some experts say the draft legislation will effectively terminate a commonly used tax strategy known as a "pipeline" that allows for the investment assets of a deceased person's company to be transferred from his or her estate into a new company in a way meant to avoid double taxation – both on capital gains and the payment of dividends – as the estate is settled. This can be used by a widowed parent to transfer company assets to his or her children.

There is an alternative strategy that would still be allowed, but it must be used within 12 months of the death. That means people who chose the pipeline option are now in limbo and it may be too late to use the alternative.

A Finance Department official said the government has received submissions on so-called pipeline transactions and is considering them as part of the consultation process.

Another issue identified by Ms. Howard is the taxation of life insurance benefits upon death if the policy owner and beneficiary are corporations.

When a private company holds a life insurance policy for the purpose of buying out the shares of a deceased shareholder, the payment of the proceeds of the life insurance to the estate was previously not subject to tax. Ms. Howard said it appears those payments would become taxable once paid out to the estate, dramatically reducing the value of the life insurance payments.

Ms. Howard said she would advise clients currently in such a situation to retain the proceeds of the insurance policy in the company and delay making payments to the estate until the government provides more clarity on its plans in this area.

Mr. Samson, the Nova Scotia MP, said the changes could particularly affect Atlantic Canada's medical professionals, who made up in the majority of town-hall participants.

Montreal MP Francis Scarpaleggia, the Liberal caucus chair, said he's been meeting with small-business owners and medical professionals throughout the summer. He said most are looking for clarity about the complex tax changes, including whether they will be applied retroactively, and he will bring it to the attention of Mr. Morneau next week at the Liberal caucus retreat.

"I've assured them that I will bring their concerns to the minister at caucus," Mr. Scarpaleggia said. "That's what caucus is for, it's for the government to hear from all MPs about what their constituents are telling them at the riding level, and it's an opportunity for MPs to share what they're learning with each other."

Toronto MP John McKay said he's also been hearing a lot from his constituents about the proposed changes, including retroactivity, as well as how the issue has been framed by the government as targeting those who are taking advantage of the system.

"There is a lot of confusion as to what this means," Mr. McKay said. "There is an element of heightened emotion about it."

Mr. McKay said he'll be bringing a message to Mr. Morneau that "there is a lot of angst about this" and ask that the changes be clarified.

"There is a perceived element of unfairness," Mr. McKay said, but added that he's not yet prepared to ask the government to reconsider the proposal.