Morneau’s goals for tax proposal tweaks won’t come easy, experts say
The finance minister has promised a long list of changes to Ottawa's tax reform plan, but from adjusting income sprinkling rules to avoiding collateral damage to investors, very few are quick fixes
OTTAWA—Tax experts say Finance Bill Morneau’s plan to adjust his controversial tax proposals is easier said than done.
Morneau has tried to calm the anger surrounding the federal government’s small business tax package with some hints on how he might address some of the concerns.
But tax experts who have studied the government’s tax proposals warn that while there are some options, delivering on many of Morneau’s tweaks will be challenging.
Even Finance Department officials have acknowledged at least one expected change is posing a major problem.
Earlier this week, as a 75-day consultation period on the three-part plan came to a close, Morneau conceded that “changes are going to be required” to the proposals he announced in mid-July.
Morneau said the government’s next steps will guided by the several “key principles” based on the concerns it received during the consultation.
He has offered a few clues on where some adjustments to the proposals might be made.
The highlighted concerns that Morneau has signalled he will seek to fix include: avoiding any change that would complicate the intergenerational transfer of family farms; ensuring women entrepreneurs will be able to put away money within their firms for maternity leaves; and making sure businesses won’t be subjected to additional, onerous administrative work.
Morneau also said this week that he would make sure angel investors and venture capitalists—whose financing so often helps start-up firms grow—won’t face “unintended consequences” from the tax changes.
The finance minister has tried to reassure owners of farming and fishing businesses on the family succession issue by saying “technical fixes” may be on the way. There are concerns the reforms could add significant costs for those who seek to keep these businesses in the family.
“Is the challenge that they’re dealing with difficult? No question,” said Kim Moody, a director at Moodys Gartner Tax Law.
“And, frankly, I don’t have any easy suggestion for them, either, because I’ve racked my brain in terms of how they could solve what they’re trying to solve.”
Officials from Morneau’s own department have also admitted that finding a fix to the succession issue hasn’t been easy.
“We’re still struggling to find another approach to this and, to the extent, when we’ve been talking to farm groups and others we’ve really been trying the emphasize the point that we’re looking for comments on this,” Brian Ernewein, the department’s general director of legislation in the tax policy branch, told a Senate committee Tuesday.
“I can’t say that we’ve…looked at all the submissions because most of them just landed with us in the last couple of days with the consultation period closing.
“We’re hopeful that there’s something in there that will give us inspiration.”
Morneau argues the proposals are designed to create a fairer tax system, especially for those in the so-called middle class. He also hopes the tax reforms will unlock cash for business investment and help lift the country’s “productive capacity.”
His proposal package includes restrictions on the ability of business owners to reduce their tax rate by sprinkling their income to family members in lower tax brackets, even if those family members do not contribute to the company.
Morneau has also proposed limits on the use of private corporations to make passive investments that are unrelated to the company. Another change would limit the ability of business owners to convert regular income of a corporation into capital gains, which are typically taxed at a lower rate.
Critics of the plan say it would hurt entrepreneurs who take personal financial risks when they decide to open a business, hire staff, save for retirement, save for maternity leave and sock away funds for economic downturns.
Tax experts, including Moody, do see a couple of ways the government can make changes to the reforms to fit the principles Morneau laid out this week.
To address a number of those issues, Moody suggested the government “dramatically simplify” the income-sprinkling rules by extending the existing regime to only allow business owners to split income with family members aged 24 and above. He also recommended that the system should continue to allow income transfers with spouses.
“I think that would be a big one,” Moody said.
“What they’ve got right now is just a whole bunch of complexity and a whole bunch of uncertainty, and both of those just are not good policy tenets.”
Jack Mintz, a tax expert with the University of Calgary who has been critical of the proposals, agrees that dropping spouses from the legislation and raising the age of family members eligible for sprinkling—even to 28 or 30—would solve some of the problems.
On the succession issue, Mintz said changes are needed to help families avoid double taxation, but making it happen will be difficult.
Mintz said some of Morneau’s other potential fixes will also be complicated to pull off, including making sure the reforms will enable women to save for leaves through their corporations.
He said there are many reasons why someone would want to retain earnings in a company and that it will be difficult to carve out selected categories.
“He’s just putting a band-aid on a bad proposal,” Mintz said.
Moody said he didn’t know how the proposals could be adjusted for women business owners. One possibility, he noted, could be making women entrepreneurs eligible for Employment Insurance.
When it comes to ensuring angel investors and venture capitalists are not hit by unintended consequences of the changes, Mintz said the government would likely have to eliminate the passive investment income proposal altogether.
He said these investors would be “heavily hit” by the new passive income rules.
“I think (the proposal) is completely unworkable,” he said.
“I would drop it altogether, but I suspect that’s not necessarily going to happen.”