Finance Minister Bill Morneau is proposing to close loopholes that allow wealthy Canadians to avoid higher tax rates, largely by targeting people who incorporate themselves and then draw income from their businesses while paying lower corporate taxes.
There has been an eight-fold increase in the number of corporations in Canada since the 1970s, while the gap between personal tax and business tax rates has grown significantly. As of 2017, there is a 37.2 per cent gap, meaning income derived from a business faces a much lower tax burden.
Morneau wants to curtail so-called “income sprinkling,” a tax move that allows business owners — often professionals like doctors and lawyers — to distribute money to family members who earn less, allowing income to be taxed at a lower rate.
Morneau plans to impose a “reasonableness” test so this does not punish legitimate family businesses. That test will determine just how much work a family member actually does at a business, and if they can really lay claim to profits. An estimated 50,000 Canadian families will be affected by this change, Finance Canada estimates.
The measure is meant to level the playing field, and to avoid advantages business owners have over employees who earn money from a salary.
A business owner, using sprinkling tactics, can pay up to $35,000 less in taxes by distributing income to family members under the current tax structure.
The government will continue to consult on these measures before introducing legislation in Parliament.
Proposed capital gains crackdown
Finance Canada will also target individuals who claim regular business income as capital gains as opposed to extracting funds from their businesses as a dividend.
Only 50 per cent of capital gain is taxed at a person’s federal tax rate. Dividends face higher taxes. This loophole is being widely circumvented, officials said, and future legislation will aim to crack down on this sort of creative tax planning.
Another proposed measure targets passive investment income held by a private corporation.
Individuals can park money in a business, investing in stocks or other financial products, and then withdraw profits later while only paying the lower corporate tax rate. That disadvantages an individual investor who does not hold funds in a business.
Lower tax rates are meant to encourage businesses to invest and create jobs, not pay lower rates on a retirement portfolio, for example.
Finance Canada has not yet determined how it will close this loophole but expects to collect substantially more revenue in the future.