Canada Moves to End Tax Loophole Used by Doctors and LawyersBy
Government expects to raise at least C$250 million annually
Morneau targets those who are ‘unfairly exploiting’ the rules
Finance Minister Bill Morneau is proposing tax changes that would close loopholes often used by doctors and lawyers to reduce their tax burden, part of the Canadian government’s pledge to level the playing field for middle-income earners.
In an Ottawa press conference Tuesday morning, Morneau detailed the proposals reported by Bloomberg Monday that were billed as ensuring “fairness for the middle class.” The government plans to crack down on “sprinkling” income to spouses and adult children and other practice the government described as legal but unfair.
“Many of the richest Canadians are unfairly exploiting the tax rules designed to help businesses thrive,” Morneau said in a written statement. The government wants to make sure rules don’t “give unfair tax advantages to certain -- often high-income -- individuals.”
Prime Minister Justin Trudeau’s Liberals have long pledged to tighten rules that allow high earners to incorporate in order to reduce their tax rate. The tactic is often used by doctors, lawyers and other professionals, and Morneau hinted in May that a crackdown was coming. The Liberals pledged in the 2015 election that corporate tax rules, particularly the small business rate, shouldn’t be “used to reduce personal income tax obligations for high-income earners rather than supporting small businesses.”
The Liberal platform cited an estimate by University of Ottawa Professor Michael Wolfson that the government would collect C$500 million ($394 million) more annually by restricting the ability of incorporated professionals to split income and lower tax bills by paying spouses and adult children, as many currently do. The figure refers to both federal and provincial tax revenue and hinges largely on how governments could measure, or enforce, work done by a spouse or adult child, Wolfson said.
The income sprinkling changes would raise C$250 million annually, according to the government. There are no estimates for other two measures. The changes are aimed at privately held domestic corporations and don’t affect public companies in Canada.
The tactic targeted by Morneau is widely used. “It becomes economic for a taxpayer in the right situation to do this. It’s sort of, ‘you’re dumb not to,’” Wolfson, a former finance department and Statistics Canada official, said in an interview Monday before the details were announced. His estimate was based on research from 2011 tax filings. One option would have been to propose banning certain professionals, like lawyers and doctors, from incorporating at all, he said.
“That would be fairly straight forward but will also rock the boat an awful lot,” he said. “I can only infer that there’s been a spirited back-room pushback to all of this stuff.”
Morneau has said the government found “issues” around professionals who incorporate. Three problems include income “sprinkling” to family; holding money inside a corporation to shield it from personal tax rates; and using capital gains rules to further cut tax bills.
The government proposed Tuesday to act on all three topics. It will add a “reasonableness test” for relatives who draw revenue from a corporation, with stronger rules for 18-24-year-olds. It will tighten rules on retaining “passive investments” to avoid higher tax rates for high earners, going forward only. Finally, it is proposing changing rules to prevent conversion of dividends and salary into lower-taxed capital gains. The government said the detailed proposals are open for consultation until October.
The number of corporations in Canada has increased eight-fold since 1972 but the population has only grown by 60 percent, the government estimates.
Trudeau’s government has targeted high-income earners since taking power late in 2015. One of its earliest moves was the creation of a new, higher tax rate for incomes above C$200,000, which was accompanied by a cut in the rate for middle-income earners. It also canceled personal income-splitting, and overhauled child benefit payments to direct more funding to low-income families and exclude high-income ones.
“We raised taxes on the wealthiest 1 percent and lowered them for the middle class,” Trudeau said this month in Hamburg, when asked about anti-capitalist protests outside Group of 20 meetings. “Trade has led to growth but it hasn’t automatically distributed its benefits properly. So, yes, people are anxious, and yes, people are angry.”
Morneau’s 2016 budget lamented “the ability of high-net-worth individuals to use private corporations to inappropriately reduce or defer tax.” The 2017 budget renewed the pledge, saying “the government will continue to study, identify and address tax loopholes and tax planning schemes,” while ensuring that corporations continue to benefit from competitive tax rates.
— With assistance by Greg Quinn