Why Politics on Both Sides of the Border Could Cost You at Tax Time

The federal government has no plans to adjust capital gains taxes, but Canadian business owners need to be aware of other potential changes on the horizon

Written by Armando Iannuzzi

Observers of American politics were surprised last month when the bill to repeal and replace the Affordable Care Act—or Obamacare—went down in flames after Republicans failed to muster enough support to pass the Trump administration’s first major piece of legislation.

That may have been great news for Americans in need of insurance, but it could be a precursor of tax troubles to come for Canadian entrepreneurs—especially after the relief some business owners no doubt felt after the cautious federal budget here at home left key tax measures such as capital gains rates untouched.

In the lead up to the budget, analysts had business owners country-wide in a mild panic over the possibility that Finance Minister Bill Morneau would introduce a substantial capital gains tax increase. That didn’t happen, but Morneau’s budget did promise a review of tax-planning measures utilized by many entrepreneurs.

Despite the lack of tax hikes, this seemingly benign budget could be a harbinger of changes to personal and corporate taxation for entrepreneurs in the months ahead. Why?

Read between the lines of the Liberals’ no-drama budget and one could infer that they were holding tight until Trump unveils his upcoming fiscal plans, which had been rumoured to include measures such as a border tax on imports, as well as huge corporate and personal income tax cuts.

Now, the Republicans’ epic failure to pass a bill through Congress—that they currently control, no less—could adversely impact business owners on this side of the border. And it all comes down to politics.

Alan Rappeport made this salient point in the New York Times:

“Mr. Trump’s inability to make good on his promise to repeal the Affordable Care Act has made the already daunting challenge of tax reform even more difficult. Not only has Mr. Trump’s aura of political invincibility been shattered, but without killing the Affordable Care Act, Republicans will be unable to rewrite the tax code in the sweeping fashion that the president has called for. The grand plans of lower rates, fewer loopholes and a tax on imports may have to be scaled back to a big corporate tax cut and possibly an individual tax cut.”

If that analysis is correct, then the 20% border tax and a massive corporate tax cut from the current U.S. corporate rate of approximately 35% on corporate income in excess of $335,000, is now uncertain. That’s because it’s highly debatable whether Trump can get any significant tax overhaul through Congress.

Ottawa’s wait-and-see approach to enhancing the fairness of the tax system—a.k.a. a clamp down on legal tax-planning measures for wealthier Canadians, which will inevitably take aim at entrepreneurs and business leaders—has a much greater chance of becoming reality. How ironic that Trump’s failure likely provided cover for Trudeau’s diametrically opposed Liberals.

In the days after the budget dropped, Morneau clarified that he has no plans to hike capital gains taxes. However, a key passage in the budget outlines a crucial Liberal beef—specifically, tax-planning strategies using private corporations that the government says are providing business owners with €˜unfair advantages.’ They include:

  • Distributing corporate income (e.g., via dividends or capital gains) to family members who are subject to lower personal tax rates (or who may not be taxable at all)
  • Holding a passive investment portfolio inside a private corporation
  • Converting a private corporation’s regular income into capital gains, which can reduce income taxes by taking advantage of the lower tax rates on capital gains

Make no mistake, business owners across Canada will be left scrambling to amend their tax-planning strategies if the government attempts to reverse any of these commonly utilized—and currently legal—tax-mitigation measures. And that may well happen if the threat of overwhelming tax cuts by the Trump administration has been mitigated.

Just how big a problem would this be for Canadian business owners? To use a Trump-ism: Huge!

Take the €˜sprinkling’ of income among family members. The tightening of the rules around family distribution of corporate income could send effective tax rates skyrocketing for many Canadian SMEs, and eliminate a tool that many use to help pay for essential costs such as their children’s university tuition or to help offset the risk and capital costs associated with running their business.

At this point, of course, the government’s plans are pure speculation. The Trudeau Liberals may move to rollback some, all or none of the tax-planning irritants highlighted in the budget. But the fact that the Finance Department went out of its way to cite these three strategies means they’re very much on its radar. In addition, Trump could still manage a more sweeping tax cut than some expect. Much remains to be seen.

What we do know is that an injection of funds to enhance Canada Revenue Agency enforcement is happening, so get ready for more audits and scrutiny of even the most meticulously prepared tax returns.

Until we learn more, business owners should hold tight and take their own wait-and-see approach as they prepare (at least emotionally) for the tax tinkering that may lie ahead. Who knew that the resuscitation of Obamacare would cause headaches for Canadian entrepreneurs?

Armando Iannuzzi is a tax partner at Kestenberg Rabinowicz Partners LLP, a Markham, Ont.-based firm that provides strategic tax, accounting and finance services to entrepreneurs.


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