Federal Liberals’ “consultation period” on small business tax hikes ends in 3 days

The federal government is moving ever closer to passing legislation that will change the way small businesses – and a significant number of well-run contracting firms – are able to do tax planning.

Officially, Monday (Oct. 2) is the last day before Federal Finance Minister Bill Morneau and his department begin to write the final of three pieces of legislation that will upend the way Canadian entrepreneurs are able to use professional corporations to defer or minimize taxes on their earnings/profits.

While doctors have been the one self-employed profession in Canada that has a high profile during the controversy around the proposed changes, there are many contractors, architects and other self-employed individuals in our industry who will be affected by Morneau’s plan.

There are three major parts to the overall plan.

First, “income sprinkling” will be much more difficult, if the legislation passes as proposed. Income sprinkling allows a business owner to attribute income to family members – who may not be involved in the business in a real way. Morneau’s plan foresees methods to determine if an individual is really working in the business. Many tax experts agree with this part of the draft legislation and it very well could be enacted without changes.

The government also wants to eliminate the well-known legal accounting method of converting retained earnings (profits) into dividends and capital gains, avoiding or deferring paying business taxes on those earnings. This part of the legislation has also been drafted.

The third part of the legislation, how “passive investments” are treated under tax law, is yet to be written. A passive investment is an investment within a business that is not really an investment in the business itself, but simply using the professional corporation as a holding vehicle. For example, an investment is considered to be “passive” if the corporation owner ploughs retained earnings/profits into investments like bonds, equities, real estate, etc. that are not part of the operating business per se, but held within it to defer tax – possibly for a long, long time. Business groups who have made representations to the Finance Department on this topic have pointed out that a business needs somewhere to safely store profit, that is tax deferred, other than through personal income tax devices like RRSPs – and passive investments provide this.

For more on the Morneau tax plan, see our story from last week here.