CTF Policy Conference on Tax Planning Using Private Corporations (September 25, 2017): Questions from Participants

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1 1 CTF Policy Conference on Tax Planning Using Private Corporations (September 25, 2017): Questions from Participants A. General 1. On what date will the new passive income rules become effective? When can we expect to see the proposed legislation? 2. Has anyone from the Department of Finance quantified the professional fees required to deal with the transitional rules? 3. Why are only private corporations subject to the new rules? Why aren t trusts that invest in passive investments subject to the same tax? 4. Has Finance considered the implementation of an LLC model and a flowthrough approach? 5. Is it fair to equate business income with employment income? 6. To keep the pipeline changes fair, should the proposed rules apply to deaths after July 18 or to deaths after 2017? 7. Is the decision to incorporate subject to governmental control? 8. A recent article in the Globe and Mail suggested that scaling back governmentindexed benefit plans would generate more tax revenue than these changes. Has Finance considered the fairness of government pensions?

2 2 9. Is Finance contemplating a gift tax to supplement the denied realization of capital gains from gifts? 10. What is the purpose of the phrase "regular, continuous, and substantial" as opposed to the usual phrase ("regular and continuous")? Is a higher standard intended? 11. Will Finance consider extending the time frame for subsection 164(6) to three years in order to reduce the likelihood of double taxation upon death? 12. It seems that the reasonableness tests may be difficult to apply. Will that mean years of litigation whose costs the taxpayers will have to bear? 13. How will the contribution made by family members be determined? Will more tax litigation result, with additional costs for family businesses? 14. Dividends are a return based on share ownership, not on "contribution" to a business. If I own shares of the Bank of Nova Scotia, the dividend that I am paid is based on my share ownership. Is this dividend not paid even though I did not "contribute" to the business but bought the shares in the after-market? 15. Is the consultation period reasonable in light of the scope of the proposals and their likely impact on the current income tax regime? Will the consultation period be extended to allow for the development of a panel of experts who are representative of all taxpaying stakeholders? 16. Does fiscal policy not affect the economy? Is there some concern that these proposals may negatively affect the economy?

3 3 17. Our GDP growth is significant enough to warrant a recent interest rate increase to cool the markets. Can this be reconciled with the introduction of tax proposals that are designed only to raise tax revenues? 18. Certain tax advisers are suggesting that capital gains should be realized prior to December 31, 2017 in corporations. Is there still a reason to do this? Doesn't section 246.1, as drafted, curtail the benefit of this step? 19. Will the difference in corporate tax rates between public companies and private companies cause the decision makers on public-company pension funds to invest in public companies at the expense of private companies? 20. Should the owner-manager of a business be left to decide what quantum of retained funds is necessary for his or her particular business? 21. Every Canadian has a choice: (1) to incorporate and become an entrepreneur, with all of the risks and rewards of doing so (including the tax incentives); or (2) to accept a job with less risk (and fewer tax incentives). Why has this become an issue, after 45 years of the current system? 22. Will these proposals result in business families opting to sell or liquidate their businesses, with consequent loss of jobs and security for their employees? 23. Does the July 18 shift in tax policy prevent many Canadian taxpayers from pipeline planning or section 164(6) planning if the death occurred more than a year before?

4 4 24. Not all income earned by private (and non-private) corporations is derived from the work done by shareholders. Should all dividends now be taxed at the highest marginal rate? 25. Given that July 18, 2017 is the effective date for sections and 84.1, and given the view that double tax should be avoided, will formal statements be made to suspend these rules so that taxpayers now caught in these rules can manage their current situations? B. Taxation of Investment Income 1. What about planning to mitigate the "triple tax" in an estate plan? For instance, passive corporations that have assets with significant unrealized gains often realize a pre-mortem disposition or achieve a step-up in basis. Depending on the facts, this could include a related-party sale. Is denying the CDA appropriate, if fairness is the goal? Given the number of CCPCs that have significant passive assets, this appears to be a significant issue. 2. If the shares of an active business cannot sell and the corporation must sell its assets, must the assets be fully taxed immediately (as proposed), even though the proceeds of the sale of shares can be tax-free in a person s hands? 3. Corporations allocate capital according to where it can achieve the best return, and they may invest passively while awaiting a good opportunity for acquisition. Should there be a time frame say, three years for the initial accumulation of passive investment, in preparation for these opportunities?

5 5 4. If the notions of neutrality and equity are to be properly analyzed and applied, shouldn t the analysis be focused not on employees but on the entities that compete with private business? 5. If the tax system is designed not to distort investment decisions, why is the QSBC deduction restricted to a lifetime exemption (among other restrictions), whereas principal-residence exemptions have no such limits? 6. Most small business owners save later in life than do employees with smoother income. Is there any data on the extent to which the deferral advantage will be offset, reduced, or eliminated? 7. Table 10 in the consultation paper indicates that the benefit is reduced by 38 percent if active income is taxed at the general rate. Can an election to forgo the SBD be used to avoid the proposals? 8. Both the passive income proposal and the proposal to end the pipeline effectively position insurance products to become one of the best (if not the best) corporate taxplanning vehicles. Insurance companies are already marketing this. Is this the right policy? 9. Slide 15 of Kevin Milligan s material shows that the proposals result in underintegration in about the same degree as the current over-integration. Is this appropriate? 10. Faced with a choice between leaving money in the corporation or paying tax personally, many business owners will prefer to leave the money as a GIC inside the

6 6 corporation rather than to take the risk of investing. Is this good for the economy or for investments? 11. The consultation paper says that there was $27 billion of private corporation investment income in Is it possible to estimate the annual revenue impact of the proposals? 12. With respect to savings for retirement via retained earnings within a CCPC, can t the owner invest in an individual pension plan (IPP)? Should CCPC owners have even more generous tax treatment for even larger amounts of tax-assisted retirement savings? 13. Would existing cash sitting in a holdco be protected against the new surtax once the rules are imposed? 14. What will be grandfathered? Assets purchased prior to implementation date? Retained earnings at implementation date? 15. Is it correct to suggest that the retained earnings within a holding company become the small business owner's pension? The ability to save in this fashion is a natural result of the initial lower tax applied to small business income, and it has become part of every small business owner s ability to save for retirement. 16. Is it fair to limit the retirement savings of business owners (who lack the guaranteed pensions of federal employees) to RRSPs and TFSAs?

7 7 17. If neutrality is the objective, why do the proposals target passive income, which is already neutral in terms of timing and rate, as opposed to active income, which offers a timing advantage? Further, don't the proposals create new distortion between active and passive investment? 18. Is it wrong to save for retirement in a CCPC? Why does it have to be a business asset? 19. Transition under the new proposals would surely be challenging, but it would be even more complex under a more comprehensive reform (for example, one that involves the abolition of the SBD). Are we simply stuck with the status quo? 20. Is withdrawing a pool of capital (held by CCPCs) beneficial for the economy as a whole? 21. Why are we comparing the retirement savings of employees, who create no jobs, with those of business owners, who create jobs and need to bank funds (not available for consumption) for future investments, which will be taxed at a later date? Large corporations pay only a 26 percent tax rate. What is the incentive for a business owner to work and expand if his tax rate exceeds 50 percent? 22. Should small business owners be provided with some additional fiscal incentives? 23. A refundable dividend tax on hand (RDTOH) that is denied in a CCPC has a disproportionately stronger effect on shareholders who are not in the top tax bracket. Does this factor hurt the so-called middle class?

8 8 24. Assume that the taxpayer s father has a brother, the taxpayer's uncle. Is the uncle's wife the taxpayer's aunt, before and even after the uncle's death? 25. Will public companies (which are currently entitled to an overall federal and provincial tax rate of about 25 percent, with the dividends that are paid to their shareholders subject to eligible dividend rules) be subject to the same passive investment rules as private corporations? 26. Do the proposals which could result in a combined tax burden of close to 70 percent on distributed corporate income (a premium of almost 17 percent above the top personal tax rate) promote tax equity? 27. Mr. X can sell shares to a company owned by an outsider and receive cash, but he cannot sell shares to a company owned by his children without having section 84.1 apply. What is the policy behind preventing intergenerational sales? 28. The proposals may have unintended implications for the middle class and for essentially all small businesses. Might the section 84.1 proposals result in double/triple tax for estates? Are there plans to alleviate this result? 29. What does it matter what a small business owner does with accumulated funds so long as he or she does not use them for consumption? Many clients accumulate funds through their small businesses and pay dividends to holding companies that have invested in rental apartments. The rental market in Vancouver is in crisis; if the small business owner has no ability to accumulate funds, these rental apartments will never be built. Does the government plan to build these units itself and accept the risk?

9 9 30. The consultation paper uses average tax rates, does not account for provincial differences, and does not allow for the possibility that companies may not use the SBD. On a flowed-out basis, are we now worse off than in the high-rate-employee example? 31. A bank will often not allow small businesses to withdraw funds from their corporate accounts while loans are outstanding. Does this not require accumulation? 32. Isn t more tax revenue raised from 85 cent after-tax dollar investments in a corporation than from 50 cent after-tax dollar investments by an individual? 33. Do the proposed rules apply to all private corporations whether or not they claim the SBD? 34. Is it being proposed that corporate savings be forced out of the corporation and taxed personally? Over-integration results from the dual policies of lower corporate rates and higher personal rates. 35. With respect to the grandfathering of passive investments, would Finance consider a one-time tax election on surplus, similar to the tax-paid undistributed surplus on hand (TPUS)? 36. Given that only 10 percent of Canadians max out on their RRSPs, are ownermanagers "doubling up" on their savings when they save in CCPCs?

10 The number of small businesses in the lower-income category is over 850 but the total number in the higher-income category is less than 80. Are these proposals not an attack on small business? 38. When a dividend is paid to a specified individual, how do we calculate the part attributable to business as opposed to the part attributable to passive income? 39. Does the broad application of section potentially penalize a CCPC for trying to fix the "problem" of passive investments held in a corporation by a potential taxable dividend on the appreciation instead of a capital gain under section 246.1? C. Income Sprinkling 1. Do these new rules take account of the fact that a spouse who stays at home makes a contribution to the business? 2. How will the income-sprinkling rules apply to a business that earns all of its income from property for example, from a specified rental corporation? 3. The proposed rules on income sprinkling apply the top marginal tax rate to funds accumulated prior to January 1, 2018, thus jeopardizing the retirement of many Canadians, especially active and inactive spouses and those who have already retired. Will existing corporate assets be grandfathered for the purposes of the dividendincome-sprinkling rules? 4. The practical effect of these changes is to make shares held by family members nonparticipating with respect to both dividends and (in many cases) capital gains on a

11 11 sale. Is it safe to assume these shares have no value and can be dealt with accordingly? 5. Does income splitting not in fact leave more capital for the business? It allows the family to pay less tax to fund its living expenses, leaving more money for investment in the business. 6. The current proposals impose the highest marginal rate on an expanded split income and may discourage the use of corporations for any purpose. If the problem is income splitting, should the income-splitting rules be expanded by a shift in the income tax base rather by the imposition of the highest marginal rates? 7. In light of the income-sprinkling proposals, should there be amendments to section 74.4? Does the absence of a change result in double tax? 8. When it comes to the policy on income splitting, should we adopt the simpler approach of allowing "families" to file tax returns for the family unit? 9. The proposed expansion of the kiddie tax applies even to the sole shareholder of a corporation: the specified-shareholder concept deems a taxpayer to own shares owned by a person with whom the taxpayer does not deal at arm's length. Was it intended to extend the kiddie tax to sole shareholders? What is the intended policy scope? Is it meant to apply (1) only when members of the same "family" own shares of a company? (2) only when non-arm's-length individuals own shares of a company? or (3) to every individual owning shares of a company even if there is only one shareholder?

12 New split-income provisions in sub-subclause (1)(g)(iii)(A)(III) (1) and (2) can effectively recharacterize a capital dividend as a taxable dividend that is split income. Is there a policy concern regarding such income splitting? The capital dividend account (CDA) is a corporate attribute and its tax-free nature should be maintained; the CDA does not represent taxable corporate surplus that can be shifted to lower-rate family members and subjected to the expanded TOSI rules. 11. According to Finance, the government has made it clear that the proposals will not affect current holdco wealth involved in planning for retirement. Is it not necessary, then, that section be clarified to exclude such wealth as of July 18, 2017, and all future growth thereof? 12. In the absence of economic-impact studies from Finance itself, should the proposals be analyzed by a royal commission studying all aspects of the taxation of private corporations? 13. Do the proposals aim to tax sprinkled income at the highest rate from the first dollar, regardless of the profits or distributions of a corporation? 14. Do the new TOSI rules not only attack business owners with CCPCs but also impose the reasonableness test on partnership income? 15. Do the new proposals on de facto control eliminate many SR & RD refunds? 16. Will small business owners with some income-splitting ability reduce their overall income for the sake of better work-life balance?

13 Are there estimates of the reduction in tax revenue that would result if the TOSI rules were simply extended to children years of age who are full-time students, with no application of the reasonableness test and the other complexities? 18. The proposals significantly increase corporate tax on a CCPC s investment income, on a fully distributed basis. Is this fair? 19. How should we interpret the restrictive test in subparagraph (1.1) (e)(iii) for individuals years of age? Do both of the two conditions mentioned in this provision need to be met, or only one or the other? 20. Can one age group be taxed differently than other age groups, in the context of the Canadian Charter of Rights and Freedoms and the Human Rights Act. Isn t it discriminatory to make the rules different for Canadians aged 18-24? 21. There has been a comparison of two one-income families, one of them a "sprinkling" family, the other not. Is there a comparison involving a family that has two incomes but pays less tax than either of the one-income families? Is there a plan for a singleincome family that pays more tax? 22. Should the income-sprinkling rules apply to individuals with no income-splitting goals (for example, 45-year-old brothers or 75-year-old parents in family corporations)? Should their application be limited to children 24 years old and younger? 23. Are the rules on the withdrawal of income from a corporation earning passive income retroactive?

14 With respect to income splitting, should the proposals apply only to shares whose dividends do not accrue any capital? 25. A CCPC earning $150,000 that splits income between members of a married couple saves $15,480 of tax in Ontario if all income is fully distributed. Do the proposals affect the middle class? 26. The proposals seem to conflict with the policy purposes of the LCGE in respect of farm and fishing properties and intergenerational transfers. Will this be addressed? 27. Is it fair, in the light of TOSI, to stop pension-revenue splitting for retired taxpayers? 28. Will claiming a capital gains reserve in 2017 expose the remaining capital gain to the possibility of TOSI treatment in 2018 and subsequent years? 29. Do the anti-avoidance rules in the TOSI proposals affect prescribed rate loans to a spouse or child or a family trust that is for the benefit of the spouse or child? 30. Will TOSI apply to the payment of dividends by an investment holdco that does not have or own an operating business (for example, an investment holdco that realized proceeds from the sale of an opco)? 31. Must shares owned by a trust cease to qualify for the LCGE when the taxable capital gain allocated to beneficiaries is subject to the reasonableness test? 32. Is it unfair to split income among family members who are shareholders if the capital is "split" on an apportioned basis? The "alphabet shares" appear to be an issue, but

15 15 shouldn t a family member be allowed to receive a return commensurate with his or her capital accretion? 33. Under the income-sprinkling proposals, will the $10,000 from a top 1 percent income earner be given to lower-income Canadians? 34. Assuming that an income-sprinkling problem exists, how does one measure "reasonableness" of returns on capital for a non-active shareholder, given that a business is intended to generate returns beyond those that could be earned by an employee? 35. Is there a simpler way to restrict income splitting? 36. Does proposed section exclude dispositions made before July 18, 2017? 37. Is there an intention to compensate for the "negative deferral" that occurs when an individual contributes large amounts of capital to start his or her business? D. Surplus Stripping 1. Have the surplus-stripping rules (effective July 18) stranded taxpayers across Canada who are in various post mortem situations? 2. What is the policy rationale for denying the ability of a trust to allocate capital gains from the sale of a QSBC so that a beneficiary, who satisfies the new reasonableness tests, can claim the LCGE?

16 16 3. Trusts are put in place to protect assets to protect against family-law issues. Should persons actively involved in the business be penalized and expected to forgo LCGEs merely because they hold their shares through a trust? 4. The existing reasonableness test concerns the deductibility of expenses. Is there a reasonableness test in the real (non-tax) world in respect of investment ownership? 5. Is it necessary to state that shares owned by a trust do not qualify for the LCGE? The gains must be allocated to beneficiaries in order for the LCGE to be claimed, and the TOSI/reasonableness already seems to apply to those beneficiaries. 6. Does proposed section apply to any capital dividend paid, even in circumstances where the capital dividend account arose years ago, before there was any view to extracting surplus from the corporation? 7. Does proposed section (applicable to an amount received or receivable) apply even to proceeds from the disposition of shares under a section 85 election? If so, is the amount to which it applies the elected amount or the full amount actually receivable? 8. Is any extraction of profit from a business unreasonable (according to the reasonableness test) if the owner-operator already pays himself a reasonable wage? For example, Opco was operated by Father for many years, but then he froze his shares and is no longer involved in the business. At the time of the freeze, Adult Son (30 years old) subscribed for common shares for $1 and now runs the business on a full-time basis. Adult Son is paid $150,000 a year, and it is determined that an arm's-

17 17 length employee would be paid $150,000 to do the same work. Profit from the business is $200,000 before payment of the $150,000 salary, leaving $50,000 of profit. Is the $50,000 paid as a dividend to Adult Son unreasonable? Can Adult Son ever extract profit from the business without its being considered unreasonable? Can the son ever realize a capital gains exemption? 9. Can tax neutrality be reconciled with the result of the proposals in a post-mortem context (70+ percent effective tax rate on an integrated basis)? 10. Does new section apply to payments on a promissory note that was created in a surplus-strip transaction that occurred before the announcement date? 11. Why were the explanatory notes not explicit in indicating the effect of section 84.1 on post-mortem planning? 12. Will subsection 164(6) now apply to eliminate the taxable dividend proposed to be deemed under new subsection 120.4(4)? 13. What constitutes a "disappearance" of assets? In the technical notes, what did the government mean by "third parties" purporting to be dealing at arm's length? 14. Will section apply when subsection 55(2) recharacterizes a dividend as a capital gain between non-arm's-length parties? 15. Section 246.1, which is very broadly worded, seems to indicate that (1) the payment of a capital dividend and (2) the repayment of a loan are subject to tax as taxable dividends. Does this rule apply in all cases or is it limited to avoidance situations?

18 18 Will this result in tax on (1) capital dividends resulting from the sale of corporate real estate to third parties and (2) the repayment of shareholder loans resulting from the sale of corporate real estate to third parties? 16. How is the disposition of passive assets to a related-party company in a pre-mortem context viewed if it is intended to eliminate possible triple tax (on a non-bumpable asset such as a commercial property)? Can the vendor corporation pay out the various attributes or would section apply? If section applies, how are passive assets integrated if they cannot be bumped (or are subject to various bump issues)? 17. Does proposed section tax a return of capital or the repayment of an existing shareholder loan as a dividend? 18. Is it intended that the dividend reasonableness test apply to redemptions of fixedvalue preference shares for example, from an estate freeze transaction? How is reasonableness to be determined? 19. If a CCPC that holds only an investment portfolio sells certain of its investments (triggering a capital gain) and pays out a capital dividend, is the capital dividend subject to section 246.1? Is it correct that "tax otherwise payable" has not been avoided by the payment of the capital dividend?