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Using Your PC To Save Taxes Will Get Harder…

By July 21, 2017June 2nd, 2022Michael's Operatory

This is just me ranting and raving… I get pissed when good, hardworking folks who try to build that ‘Canadian dream’ of having their own small business get taken to the cleaners by some far-off government people for the purposes of having SOMEONE pay for their ill-founded projects (one of which is an infrastructure plan with apparently no spending limit and another of which was a behind-closed door multi-million dollar settlement to a convicted terrorist).

And so the Trudeau Government is holding a consultation period over the summer to basically find out how to tax small business owners who legally pay family members through the use of a corporation (among other things).   In media articles, it looks like they’re going after professionals – like dentists and doctors. And it also looks like they’ll be targeting DIVIDENDS that are paid to family members.  The government has said that children in the 18-24 years age bracket appear to be best suited (given that they avoid kiddie tax rules and given that they don’t have high incomes) for income splitting strategies involving their parents.

Here’s the thing about DIVIDENDS: you can ‘sprinkle’ them on other shareholders – presumably in lower income tax brackets – in order to arrive at a lower effective tax rate on the whole (as opposed to one person taking all of the money for themselves).  For dentistry and medicine professional corporations, they are VERY restricted in terms of WHO can be a shareholder: a dentist, their spouse, their parents, their children, or the dentist or their spouse in trust for a minor child.  And guess who else can’t get dividends from dentistry and medicine professional corporations – that’s right: other corporations (because other corporations can’t hold shares in those corporations).  And those dividends could have been transferred essentially on a tax-free basis if they were capable of going to another Canadian corporation.  By the way: lawyers and accountants cannot split income using dividends with their family members (or anyone else) through their professional corporations.

So why is the government so unhappy with these dividends that are sprinkled on family members?  It’s because they can be earned AFTER TAXES have been paid by the corporation on active business income AND THEN PAID to the shareholder WITHOUT the shareholder having to contribute in any way possible to the corporation.  That’s right: a shareholder can simply sit back and collect money.  With a professional corporation, family members who are shareholders BUT who aren’t the dentist or the doctor don’t get a right to vote, so they have even less say on what happens with the corporation.

Well, apparently, the Trudeau Government doesn’t want dentists and doctors to continue to be able to sprinkle such dividends on non-professional family members without paying more taxes.  But this is so wrong for so many reasons, as follows:

  1. Dividends aren’t tied to any type of time / effort contribution by the shareholder to making profits.  They are after-tax retained earnings available (based on what the directors of the corporation want to do) to be reinvested or distributed to the shareholders.  This is the very NATURE of a dividend.
  2. Dentists and doctors study hard, pay a lot of money to get their education and license, and should be encouraged to stay and work and earn a living in Canada.
  3. Dentists and doctors are free to organize their financial and tax affairs to minimize their personal taxes (avoiding tax is legal; evading tax is illegal).
  4. Dentists and doctors hire a LOT of people and pay their salaries, mortgages, benefits, etc.
  5. Dentists and doctors support a LOT of vendors in the industry (drug and equipment suppliers, etc.).
  6. Dentists and doctors who don’t appreciate getting singled out and taxed more than the next business owner may not stay in Canada (think: brain drain!).
  7. Less after-tax dollars will mean less reinvestment in their corporation (team, infrastructure, renovations, technology, marketing, etc.), which means they will struggle to grow.
  8. Dentists and doctors with young families will be punished if their stay-at-home spouse is basically forced to get a job and send their kids to daycare instead of staying home to raise them (which I think is better).
  9. It will be bad for investors looking to put their money in Canada; all things being equal, why invest here when they can invest and keep more of their money elsewhere if there’s a similar market for their product / service, skilled labour pool, etc.
  10. The difference between the factory employee and the factory owner is RISK: the factory owner had big dreams, invested capital, and could go bankrupt if the business fails… That’s why they should be REWARDED and ENCOURAGED to grow their business.  So what about the factory employee?  They put in their hours and efforts, get paid accordingly, ‘shut-off’ after 5:00 p.m. and weekends (unlike the factory owner, who’s worried about their business) and they risk very little financially if the business fails, they’ll just look for another job.

Do we actually need new legislation?  I’m not convinced.  Why?

First, we already have a ‘reasonableness’ test when it comes to salaries paid to family members and whether the expenses to the corporation (i.e. those salaries and benefits) are considered ‘reasonable’.  If they’re not considered ‘reasonable’ in light of the family member’s contributions to the corporation, their skill-set and experience, their time spent on the job, etc., then the CRA can deny / reduce that expense and have the corporation pay more income tax.

Second, we already have rules called the Personal Services Business (discussed HERE and HERE). which basically means that if you’re nothing more than an incorporated employee, you’ll be denied the tax benefits of having a corporation.  The IT industry, for example, has been targeted heavily by this provision and the CRA has gone after so called ‘independent contractor’ IT personnel who were nothing more than incorporated employees.

There’s my rant.

Now, let’s take a brief look at what the government is proposing, shall we?  You can find their discussion paper and draft legislation, as well as submit comments up to October 2, 2017 here: http://www.fin.gc.ca/activty/consult/tppc-pfsp-eng.asp  and here: http://www.fin.gc.ca/n17/17-066-eng.asp

With respect to what they’re proposing, here’s the idea… They want to EXPAND the application of an existing tax.  That tax is called a  “Tax On Split Income” (“TOSI“).  TOSI was introduced in 1999 and it applied to income, such as dividends on unlisted shares from a business activity of a related individual, earned by minor children shareholders (those under 18 years old).  In other words: TOSI was kind of a kiddie-tax that applied to minors who received dividends through their parent’s professional corporation.  If TOSI applied, that dividend income was subject to a top flat-rate person income tax in the hands of the minor while personal tax credits (except dividend and foreign tax credits) would be denied for those amounts.

Well, the Trudeau government now wants to make TOSI apply to dividend income earned by ADULT children shareholders.  And they want to add a “reasonableness test” to determine if the income amount received by the shareholder is commensurate with what would be expected in a similar arm’s length arrangement.   Finally, they’re introducing the definition of ‘connected individual’ to determine if an adult’s income from a corporation should be treated as split income.  A Canadian resident individual with a certain measure of influence over a corporation would be treated as connected with the corporation.

In the next few blogs, I’ll be digging deeper on what these changes could mean to dentists IF they become law…