– The C.D. Howe Institute is an independent not-for-profit research institute whose mission is to raise living standards by fostering economically sound public policies through research that is nonpartisan, evidence-based and subject to definitive expert review.
CANADA – Ottawa’s proposed changes for the tax treatment of income from passive investments in incorporated businesses will not achieve its goal of promoting fairness in the tax system, according to a report released today by the C.D. Howe Institute.
In “Off Target: Assessing the Fairness of Ottawa’s Proposed Tax Reforms for “Passive” Investments in CCPCs“, author Alexandre Laurin assesses the proposals from a fairness perspective and finds them lacking.
“As laid out, these proposals risk delivering a blow to the retirement planning of many small business owners, not to mention their potential negative impacts on entrepreneurship and risk taking,” says Laurin.
The proposed regime would end passive investment income-tax refundability for Canadian-Controlled Private Corporations – i.e., taxes paid on investment income in a CCPC would no longer be tracked and refunded upon dividend payments.
Although there are other versions of proposed changes, this is seemingly the one the government favours, says Laurin. Private corporations – and by extension their owners – would be taxed on their passive investment income on the same basis as if they were individual investors in fully taxable accounts.
“There would be diminished incentives to defer business consumption, and less income and business saving available for spending on capital equipment,” says Laurin. “The same is true of small business income retained for personal purposes – there will be greater incentives for immediate personal consumption of business income rather than saving it for retirement or other purposes.”
But is the current system inequitable? The report’s tax simulations show, overall, it is not – when benchmarked against the tax treatment afforded to personal retirement savings. The author finds that:
- CCPC income taxed at the general corporate tax rate and reinvested passively in the corporation enjoys no significant tax advantages over other saving options; and
- Business owners earning income taxed at the small-business tax rate and saving it in the corporation for future personal consumption enjoy a tax treatment pretty much on par with others saving through an RRSP or a TFSA.
“Considering that additional administration, accounting, and tax compliance costs need to be incurred in corporate accounts, one could reasonably conclude that passively reinvested small-business earnings receive a tax treatment similar to that of RRSP/TFSAs in a variety of possible portfolio compositions” says Laurin. “As well, successful businesses earning income above the small-business threshold enjoy no significant tax advantages on passively reinvested earnings.”
More broadly, Laurin points out that the playing field for tax-assisted saving opportunities is unequal in other ways. Outdated current tax rules allow career defined-benefit (DB) pension plan participants, particularly in the public sector, to end their careers with tax-assisted retirement wealth worth multiples of that practically achievable in RRSPs.
If the government proceeds with changes along the lines it has outlined, fairness suggests that it should level the playing field so business owners have tax-assisted retirement saving opportunities comparable to those available to most public-sector employees in DB plans and Members of Parliament, says Laurin.
The most ambitious reform would establish a lifetime accumulation limit of personal tax-assisted savings, in lieu of the current system of annual limits. A lifetime accumulation limit would ease the transition to the new proposed regime, and provide needed contribution flexibility and room to everyone, including small business owners, to accumulate sufficient retirement wealth, concludes the report.
