Tax laws’ terrible toos: Changes too complex, consultation too short

  • October 18, 2017

On July 18 the federal government quietly dropped a bombshell whose concussive effects included debate, discussion and much division – more of each than the government might have anticipated with a consultation paper aimed at “tax fairness” issued in the middle of a rainy Canadian summer.

The proposals were deliberately positioned to provoke a “little guy against the fat cats” reaction – the government talked about “loopholes” and “fair shares” while doctors and lawyers and business people, about whose work there is the perception of wealth, complained about what it would mean for them.

Without a sound foundation in tax law or accounting, it’s hard to find an objective viewpoint on the matter.

That’s why it’s interesting to read the three submissions from the CBA-CPA Canada Joint Tax Committee dealing separately with each of the three main targets of the consultation paper: income sprinkling; passive investments and capital gains. These submissions touch only lightly on policy issues: the Joint Tax Committee says that the 75-day consultation period is “too brief in view of the overall magnitude of the proposed changes,” and adds that it would have been preferable if the government hadn’t presented the proposed amendments as the “closing of loopholes.” Other than that, these submissions look only at the technical aspects of the proposed amendments, and their effects on Canadian-controlled private corporations in general – irrespective of who the individual taxpayers might be.

There are a number of messages running through all three submissions: that the proposals overall would add a tremendous – and expensive – amount of complexity to the rules for taxpayers; that making changes of this magnitude requires more than a 75-day public consultation period; that the consultation paper’s premise – that employment and business income should be taxed at the same rate – runs counter to longstanding public policy that deliberately encourages incorporation as a way of encouraging risk-taking by limiting liability.

“No mention is made (in the consultation paper) of the deliberate policy choices, both in tax law, and other branches of law, to encourage risk-taking. Rather, it is implied that incorporation is merely a feature of tax planning that somehow confers an inappropriate advantage on business owners, as compared to employees. In our respectful submission, this perspective is too narrow, and does not accord with longstanding trends in public policy in Canada, and in other jurisdictions.”

In the submission on converting income to capital gains, the Joint Tax Committee notes that the proposed changes “will further complicate the Act as it concerns corporate distributions, and produce significant uncertainty regarding the tax implications of common transactions. “ In the guise of protecting the fairness of the tax system, it says, the proposals simply introduce a different level of unfairness.

“In summary, we believe that the proposed amendments … represent a fundamental change to longstanding tax policy. While it is open to the government to do so, the Joint Committee believes that it would be prudent to take some additional time to consider the potentially adverse effects of the proposals and possible alternative measures or approaches that could be adopted. Accordingly, we recommend that the current proposals be withdrawn, and that an Advisory Panel be engaged to study in a comprehensive manner, in consultation with all relevant stakeholders, the treatment of distributions to shareholders of private corporations.”

What becomes clear through all three submissions is that no one is saying the tax system shouldn’t be overhauled. What they are saying is that past governments (of all stripes) had policy reasons for crafting tax laws and rules as they exist – they served a particular purpose. And while it is in the current government’s purview to change those rules, the changes must be done in a systematic way, respectful of the impact that changing a highly complex tax structure will have on the law-abiding taxpayers who have managed their affairs in a particular way based on existing law, whose plans could be upended by the proposed changes.

A perfect example of this is the submission on income sprinkling, the majority of which deals with the “reasonableness” tests in the proposed definition of “split portion” in the draft legislation.

“The test contained in subparagraph (b)(iii) is extremely subjective, complicated, and difficult to interpret and apply to a particular set of facts and circumstances. We are concerned that the reasonableness test may result in substantial additional compliance costs to many owners of private businesses. … We are concerned that the CRA, in applying the subjective reasonableness test, may conclude that a particular payment is unreasonable. Taxpayers will then be subject to the usual reverse onus that applies in tax cases, and it may be extremely challenging, stressful and costly to prove reasonableness.”

What follows is page after page of examples of the lack of reasonableness in the reasonableness test when talking about tax on split income or what happens in the case of minors receiving dividends, or when the founder of the incorporated business dies. Adding  that uncertainty to an already complex law creates a host of unintended consequences that could discourage anyone from incorporating, however good the business reasons for doing so might be.

This submission suggests a number of legislative alternatives to the tax on split income and capital gains proposals that would be easier to apply and administer.

These legislative amendments should “not be enacted unless and until the underlying tax policies, design issues and competitive and macroeconomic consequences of such measures have been thoroughly studied by an Advisory Panel or similar body that includes representatives of all affected stakeholders,” the Joint Tax Committee says. “We believe that this subject is too important to rush, particularly when … it is not clear there is a problem. “

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