Closing tax loopholes for professionals who incorporate

By Mark Bourrie July 19, 201719 July 2017

Closing tax loopholes for professionals who incorporate

 

Canada’s finance minister is taking aim at professionals who use personal corporations to avoid income tax.

Mentioning lawyers and medical doctors specifically, Bill Morneau said the federal treasury is missing out on about $500 million per year because of the way professionals are handling their corporations. There has been an eight-fold increate in the number of corporations created in Canada under federal and provincial laws since 1972, Morneau said.

The minister said the government will close loopholes that all corporation owners to dodge taxes three ways:

  • “Income sprinkling”, where the corporation pays the family of the corporation owner salaries as a way to spread the amount drawn from the company to reduce the over-all tax liability. The government will extend income-splitting rules that now apply to minors to the spouses of professionals who engage in this practice. Income-sprinkling can save a family earning $200,000 as much as 35% of its income tax bill, Department of Finance officials said. Morneau says Canada Revenue Agency officials will apply a “reasonableness” test to determine if family members really work for a corporation.

 

  • The claiming of professional income as capital gains. These are taxed at a much lower rate than dividends paid by a company.  Canada will also target individuals who claim regular business income as capital gains as opposed to extracting funds from their businesses as a dividend.

 

  • Using corporations for “passive investments.” Rather than re-invest profits into the actual business, people who use this loophole leave the money in the corporation, which invests it in assets and equities that are not connected to the purpose of the business. The money from these investments is drawn out later, when the corporation owner believes there’s less income tax liability. Passive investments are usually made after all other tax deferral system, such as RRSPs, are maxed out.  Morneau was unclear on how the tax system would decide which assets were useful to the b

 

Morneau said the government is keeping its promise to the middle class to make wealthier Canadians pay their share.

"This is about people using a corporate structure to shield their income and gain a tax advantage," Morneau said at a press conference in Ottawa on Tuesday. “Canadians expect the government to curtail people using "fancy accounting schemes" to lower their tax burden, he said. "We want a tax system that is fair."

While the plan to go after family corporations that Finance officials handed out Tuesday seems detailed and definitive, Morneau said the government is open to consultations until October 22. After that, it will issue the new tax rules that will be implemented through legislative and regulatory changes.

Morneau, who made millions on a temporary work and recruiting agency, said he used these loopholes to limit his own tax liabilities and is prepared to pay more taxes.

"What you can know for sure is I was successful in business, and I had a number of different corporate structures that I used. I have not done my homework on how I will be impacted, but I expect the implication will be I will pay more taxes over time. I have always paid my appropriate amount of taxes, based on the rules, and I will continue to do so.” Morneau told reporters, who often came back to the issue.

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Comments
Barbara Worndl 8/9/2017 4:55:18 PM

I am very disappointed in the headline of this article. Incorporating is not taking advantage of a loophole. It is permitted by law and entirely consistent with good tax planning. Your article reinforces the wrong message. It provides credence to a very wrongheaded proposal by Finance that seeks to equate the taxation of employees (ignoring the benefits of defined benefit plans) with business people who invest capital, take risk and employ people.


DCBlack 8/8/2017 4:56:27 PM

This is great but what is the CBA doing about this?

The statistic that corporate registrations have increased 8x in 45 years is not surprising. In fact, it would be expected. How many of the corporations incorporated in 45 years are still active?


Mark Newton 8/10/2017 9:41:37 AM

I agree with Barbara - this is not a loophole. It is a tax strategy based upon clear and unambiguous provisions in the ITA. In addition, from a policy standpoint, it should be an acceptable practice for lawyers who provide services through personal corporations, to build up passive assets in the corporation in order to deal with variations in income from year to year. This is called prudent financial planning. This is in sharp contrast to our federal and provincial governments that typically have deficit budgets.



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