Summary Overview: Consultations on Tax Planning Using Private Corporations

Introduction

The Government of Canada is working to create a healthy and growing economy that works for the middle class and those working hard to join it.  One of its first actions was to cut taxes for the middle class while raising them on the wealthiest Canadians.  The Government then replaced the previous system of federal child benefits with the Canada Child Benefit, which is simpler, entirely tax-free, more generous, and better-targeted to those who need it the most.   The Government of Canada also worked with the provinces and territories to strengthen the Canada Pension Plan so that workers today and future generations can look forward to a more secure retirement.

In addition, the Government took decisive action to improve the fairness of the tax system through measures to prevent underground economic activity, tax evasion, and aggressive tax avoidance.  Budget 2016 and Budget 2017 made significant investments to support the Canada Revenue Agency's efforts to crack down on tax evasion and improve tax compliance, and announced measures to close tax loopholes that result in tax advantages for some at the expense of others.  These actions help give Canadians greater confidence that the system is fair to everyone.

The release of this consultation paper is the next step in the Government's plan to bolster confidence Canadians have in their Government and in their economy.  The Government is asking Canadians what actions should be taken to ensure that high-income individuals cannot use strategies involving private corporations to gain unfair tax advantages.

Context

Canada has a highly competitive corporate tax system, and the Government is committed to maintaining the advantages of this system for those corporations that are investing in ways to grow their businesses.

However, the current tax rules provide opportunities for those who own private corporations to legally, but unfairly, obtain tax advantages that are not available to other Canadians.  Individuals who take advantage of these opportunities are effectively paying less than their fair share for the essential services that Canadians rely on, including health care, housing, child benefits, Old Age Security, and other important programs. With these consultations, the Government will be asking Canadians what actions should be taken to address this situation.

Focus of Consultations

The Government of Canada is consulting Canadians on three tax practices that are being used to gain unfair tax advantages:

1. Income Sprinkling

Income sprinkling involves diverting income from a high-income individual to family members with lower personal tax rates, or who may not be taxable at all.

Take, for example, an individual living in Ontario, making $220,000 a year, and paying roughly $79,000 in income tax.

Now compare this with that person's neighbour, who makes the same income, but who owns a private corporation and sprinkles the income between themselves, their spouse and their adult child.  In many cases, the family is involved in the business, and their earning income from it is completely appropriate; the family members are legitimately earning income upon which they are paying personal income tax.

However, in other cases, the spouse or child to which income is sprinkled has no role in the business. As set out in the illustrative example in the consultation paper, as a result of the sprinkling, the neighbour operating a corporation is effectively paying roughly $25,000 less tax than his or her neighbour even though the income involved is comparable.

2. Passive Investment Income

Canada's competitive corporate tax system, including a corporate income tax rate that is second lowest in the G7, encourages business investment and economic growth.

However, some individuals gain an unfair benefit by retaining passive investments in a corporation, taking advantage of the fact that corporate income tax rates are much lower than personal tax rates for higher-income individuals. This is a problem when an individual holds money inside a corporation, not to invest it in growing the business, but simply to shield it from the higher personal tax rate.

Since this sort of arrangement is not available to someone who collects a paycheque every two weeks, it can mean gaining an unfair tax advantage over them.

3. Capital Gains

Converting a private corporation's regular income into capital gains can also provide an unfair opportunity to reduce income taxes, this time by taking advantage of the lower tax rates on capital gains.

Income is normally paid out of a private corporation in the form of salaries or dividends to the principals of the corporation, who are taxed at their respective personal income tax rates.

However, if these forms of income are converted to capital gains, this can result in a significantly lower tax rate, providing an unfair tax advantage.

Next Steps

The attached consultation paper sets out the nature of these issues in more detail, outlines some potential solutions to address them, and invites input from Canadians.

The Government is committed to increasing the fairness of the tax system, while ensuring that the system is competitive and supports growth.  Canadians' views will be taken into full consideration as the Government moves forward to address the issue of tax planning using private corporations.

The deadline for submissions will be October 2, 2017.