In July, the government announced three proposals, which included restricting income sprinkling for business owners, barring the practice of transforming dividend income into capital gains and closing a loophole that allows business owners to pay lower taxes on passive investment income held in a corporation.
After facing criticism from lawyers and other professionals concerned that their wallets would be unfairly targeted by the changes, federal Finance Minister Bill Morneau altered the proposals and abandoned the capital gains reform.
The draft legislation the government recently unveiled in mid-December will curtail income sprinkling, except for a number of exemptions. Those family members who would be exempt would include spouses, as long as they had “meaningfully contributed” to the business and if the owner is 65 or older.
Others who would qualify would be members of the business owner’s family who are adults over the age of 18 who have worked at the corporation for at least 20 hours a week during any of the previous five years and those over 25 who own at least 10 per cent of the company that is not a professional corporation and earns less than 90 per cent of its income from the provision of its services.
If none of the exceptions apply, family members who are 25 and older will have to undergo a subjective “reasonableness test” to determine how much income can be subject to income sprinkling.
While the revised changes were more palatable than the original proposal to some business owners, tax lawyers say practitioners who are incorporated could still be impacted.
“The changes which are beneficial are not available to lawyers,” says David Rotfleisch, a tax lawyer at Rotfleisch & Samulovitch PC.
“So the new rules will adversely affect lawyers and other professionals as originally announced in July, as opposed to non‑professional corporations, where there are somewhat more liberal rules available now.”
Lawyers say the revised changes will also likely complicate what is already a convoluted system and create backlogs in the tax courts and Canada Revenue Agency.
Tax lawyer Jeff Kirshen, a founding partner with Rosen Kirshen Tax Law, says the new rules around income sprinkling will likely spur many disputes at the CRA over who qualifies for the exemptions.
“I think it’s going to create unnecessary havoc,” Kirshen says.
“It’s going to slow down the CRA to a crawl.”
When it comes to passive income, the federal government’s revised proposal will allow for up to $50,000 in passive income a year before higher tax rates will kick in.
Tax lawyers say the changes to passive investment rules could cause an entrepreneurial chill on lawyers, meaning that fewer practitioners will take risks to leave cushy jobs at larger firms to start their own.
Kirshen says it will not be beneficial for lawyers to take that risk with the changes, which he says will implement “punitive rates for success.”
The federal government has said the new proposals will affect only 45,000 small businesses, which it says is less than three per cent of the country’s 1.8 million private corporations.
The Parliamentary Budget Officer has issued a report supporting that claim. The report also found that, after 20 years, the passive income proposals could bring in as much as $6 billion a year for federal coffers.
At the end of the summer, the Canadian Bar Association joined a group of more than 70 business organizations — the Coalition for Small Business Tax Fairness — that has called on the government to scrap the proposals.
The coalition has slammed the government for holding a consultation period on the proposals that only lasted from July 18 when the proposals were announced until Oct. 2.
When Morneau released the draft legislation, the coalition responded by calling on the government to take more time to explore the changes before implementing them.
The new rules took effect Jan. 1, 2018.
Rotfleisch says the original consultation should have been longer and the government should have held a second round of consultations after the draft legislation was released.
“They should have provided a new consultation period, rather than giving you two weeks and bang, it’s a fait-accompli,” says Rotfleisch.
The coalition said the income sprinkling rules would make business owners cut through “burdensome interpretive red tape” and urged the government to create a blanket exemption for spouses.
The CBA, which did not provide comment before deadline, faced some backlash for not consulting broadly with its own membership before jumping into the fight.
Some members went as far as saying they would cancel their memberships in protest.
More than 180 lawyers signed a petition criticizing the CBA’s stance in favour of Morneau’s tax proposals.
The petition said the reforms would bring more fairness to the Income Tax Act.