COVID-19 Government Program Updates – Plus: Why Emotions are a Poor Guide to Investing

It is extremely challenging to write financial posts on COVID-19 as the situation is fluid. Whatever the challenge in writing, it is far more difficult for Canadians and small businesses who are adapting to changes on the fly.

The programs Canadians intend to rely upon are upgraded and changed daily by governments, who themselves need to adapt to constantly changing economic conditions. This has caused significant confusion among Canadians about the qualifying conditions and application process for these programs.

For small businesses who are facing gut-wrenching decisions on staffing, the lack of clarity has been a significant issue, as they are not sure whether to lay off staff or to hold on and hope for financial assistance.

Government Program Updates

As I write this post, the original Emergency Care Benefit (ECB) and Emergency Support Benefit (ESB) programs have been replaced by a single more generous program known as the Canada Emergency Response Benefit (CERB).

On wage subsidies, the original 10% Employer Wage Subsidy Program (EWSP) has been maintained, but a sister program called the Canada Emergency Wage Subsidy (CEWS) was announced that introduces a 75% wage subsidy. These two programs will co-exist. It is hoped the CEWS has been upgraded to a level that will allow small businesses to keep their employees on payroll, rather than laying them off, and be incentive enough to rehire employees previously let go. See this detailed article to understand the CEWS and how it works with the EWSP.

Here is an update as of April 8th for the changes to the CEWS.

There have been multiple filing and payment extensions for tax returns, from personal tax, to corporate tax to HST returns. This document is an excellent summary of all the new deadlines and extensions.

If I had to suggest one thing you should do, it would be to watch this webcast by BDO - Part 2: Cash Flow Strategies and Government Incentives in the time of COVID-19. It is an oral breakdown of all these programs with questions. Register then watch here.

There are two other important programs, the Canada Emergency Response Benefit I noted earlier (This program will provide $2,000 a month for up to four months for workers who lose their income as a result of the COVID-19 pandemic) and the Canada Emergency Business Account (loans of up to $40,000). Please check back during the week as I hope to have links or further details added in the next few days.

The pace of change is so quick that some parts of this post may be overtaken by current events by the time you read it. To stay updated, I recommend this hub of COVID-19 coverage created and updated regularly by BDO.

Why emotions are a poor guide to investing

The roller coaster ride the stock market has taken us on has been far less exhilarating than the roller coaster at your favourite theme park. As of April 3rd, the Dow is down 26% for the year and the TSX is down almost 24%. However, on March 23rd, those numbers were down around 35% and 34% respectively. 

This ride really tests our risk tolerance - see the discussion in this blog post under equity exposure - and makes many of us emotional wrecks.

I have always been interested in the emotional side of investing and this topic came up during a conference call I was part of, put on by Tacita Capital, one of the investment managers on the BDO Wealth Advisory platform. The call’s main theme was COVID-19 and the state of the market, but one slide featuring a graphic by Russell Investments really caught my attention.

The graphic’s purpose was to point out how our emotions are a poor guide to investing, which I think most of us agree is a very true statement.

We start out with optimism, and the curve starts to move upwards as we get excited and moves higher as we are thrilled. We then hit a point of euphoria, which Tacita noted is the point of maximum risk. It is also the point where many people plow more money into the market assuming the good times will continue forever.

The curve then turns downward to anxiety, keeps moving downward to fear and from fear to panic, which I would suggest many of us reached on March 23 or earlier (based on what many friends, acquaintances and clients have told me). Unfortunately, the graphic reflects one more step on the downward slope, that being despondency.

The good news is despondency is also the point of maximum financial opportunity (assuming you have cash resources available). From there we thankfully start back up the curve, from hope to relief to optimism.

Every investor is sitting at their own individual stage. Whatever your investing mood and whatever your portfolio’s performance, I keep telling everyone - including myself - that the stage of hope will arrive. Here’s hoping that it arrives sooner rather than later for all of us.

The content on this blog has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The blog cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information on this blog or for any decision based on it.

Please note the blog posts are time sensitive and subject to changes in legislation.

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Tax Planning Using Private Corporations - A Philosophical and Critical Review

I am back from my summer break. Today, I comment on the Liberal tax proposals put forth in July, in respect of the taxation of private corporations. I have a feeling I may be writing on this topic several times this year.

On July 24th, I wrote a blog post on the Liberal government’s proposals for tax planning using private corporations. As these proposals were released mid-summer, it took a while for small business owners and professionals to understand the potentially complex and punitive nature of these proposals. If you want to read an updated summary with recommendations on this issue,

this report by BDO Canada is very good.

I can tell your first hand that there is a lot of anger among business owners for what they consider a totally misguided government notion that business owners should be treated in exactly the same manner for tax purposes as their employees who take none of the business and financial risks and the implication private business owners are abusing the tax system. Opposition has been growing throughout the summer and there is a mounting backlash from professionals and small business owners against these proposals. Based on email responses I have been CC'ed on, local MPs are taking this issue seriously. Whether this pressure will cause Prime Mister Justin Trudeau and/or Minister of Finance Bill Morneau to change their stance on this issue remains to be seen.
Whether you philosophically believe these proposals are fair (and based on feedback both publicly and to my email inbox, most of my readers think they are not fair), these rules will create a very negative climate. Just as importantly, there is currently tax paralysis, as advisors are not sure what the rules are and will be and thus, they cannot properly assist their clients. One way or another, a clear path needs to be set as soon as possible.

I could provide a laundry list of reasons why I feel these proposals unfairly target small business owners and professionals, but that is not my objective for this post. What I want to discuss is the feedback I have received from those affected by the proposals, other accountants, and employees who may not feel as aggrieved.

The proposals target three specific areas:

1. Converting Income into Capital Gains

2. Income Splitting

3. Taxation of Passive Income

Converting Income into Capital Gains

When people speak frankly about this proposal, there is generally unanimous consent that the proposals for the conversion of income into capital gains are “fair”. I don’t think that if this proposal was released in a typical budget that it would cause much consternation. There is concern however; that the government has to distinguish between aggressive tax planning and tax planning that avoids double tax (such as pipeline planning upon death).

Income Splitting

When discussing this topic, most business owners and professionals feel these proposals are punitive and generally unfair save one provision (the capital gains exemption – which I discuss below). These proposals in general will prevent family income splitting (as the income will be taxed at the highest marginal tax rate) unless there is reasonable compensation and the compensation is based on labour and capital contributed.

Where I have discussed these proposals with people that are employees, in general they feel the proposals are unfair to restrict income splitting with spouses, but they tend to agree with the government that income splitting with children should be eliminated.

Business owners feel the income splitting rules are unfair is that they look at their business as a family business, not a business owned by a sole individual, even if that individual is the only one actually working the business full-time. For example, many spouses who do not work in the business either gave up a full or part-time career to enable the business owner to work the hours required. Spouses in many small businesses are sounding boards and consultants. When a spouse comes home they discuss over dinner or drinks decisions to be made regarding expansion, employee issues, equipment purchases, etc. The unpaid “consulting or sympathetic listening time” for spouses is immense. This does not even account for the family time lost due to the crazy hours worked by entrepreneurs. Children are often called in to assist with a new business in many ways for no pay and/or to have time to spend with the parent/owner.

Most business owners feel it is fair for spouses and children to own shares in a family corporation. Although when pushed, in general they feel that the $835,716 small business capital gains exemption should be restricted to spouses only and at most children over 18 years of age. Non-business owners feel that children should have no access to the capital gains exemption.

So in summary, I would suggest most business owners and non-business owners feel these proposals are extremely unfair in respect of spouses, but many non-business owners and some business owners feel the restrictions on income splitting with children are reasonable for those at least under the age of majority.

Taxation of Passive Income

As noted in my July 24th blog post, where a corporation earns less than $500,000 the company pays tax at 15% in Ontario and a similar amount in each province. This results in a tax deferral, not a tax saving of up to 38%. Where corporations earn income in excess of $500,000, or in the case of many professional corporations where access to the small business exemption is limited (they must share the $500k exemption with all their partners), the tax rate is 26.5% in Ontario and similar in most provinces, resulting in a tax deferral of 27% or so. The proposals effectively eliminate the tax deferral for all income not re-invested back into the active business.

I would say these rules have antagonized small business owners, professionals and tax advisors the most and there is unanimous consent these rules are not required and unnecessarily punitive. The reasons for this are as follows:

1. Unlike the income splitting and capital gains stripping rules, in general, these rules only result in a deferral of income tax, not an absolute saving.

2. This deferral has been used extensively by small business owners and professionals to create their own retirement fund. The fact that the government is considering removing the ability to save for retirement within a corporation has many people going apoplectic. The reason for this is essentially twofold. Firstly, business owners are furious the government is not providing any benefit for the risk they take for starting and owning a business and secondly, they look at government employees with gold plated pension plans and ask what right does the government have to prevent them from trying to create their own retirement fund?

3. Any new rules will be unbelievably complex and expensive for the business owners and advisors to administrate, especially given there is only a tax deferral and not an absolute tax savings. How do you track excess income earned between corporate use and passive use when they are often intermingled in some manner?

I have found that when you take emotion out of this issue, there is some agreement that the capital gains stripping and income splitting with children proposals were fair. However, the other proposals are considered prejudicial against high income earners, punitive, complex and totally ignore the risk that business owners must accept in starting a business. Finally, I think the Liberals are missing a very important consideration: that being mindset. When you tax people at 53% and restrict the benefits to start a business, you stunt business growth, create more underground transactions, and cause some of your best and brightest to leave the country. This does not even consider the massive spending power you are taking out of the economy by reducing the discretionary income of typically the highest spending Canadians.

Update

A couple important updates, one on this topic and one on the work-in-progress transition period announced in the 2017 Federal Budget.

In this editorial by the Finance Minister in The Globe and Mail, Mr. Morneau states the following " For those business owners and professionals who have saved and planned for their retirement under the existing rules, I want to be clear: We have no intention of going back in time. Our intent is that changes will apply only on a go-forward basis and neither existing savings, nor investment income from those savings, will be touched". This statement at least clarifies the passive income rules will at worst be go forward rules.

In this March, 2017 blog post on the federal budget, I discussed that professionals would no longer be allowed to deduct their work-in-progress ("WIP") from their taxable income and their current WIP deduction would be subject to a two year addback transition period (2018 & 2019) that would result in harsh income tax consequences for many. Late last week the government released draft legislation regarding the 2017 budget proposals and they have changed the transition period for WIP that has to be brought into taxable income to 5 years (20% a year starting in 2018 through 2022) from the initial two year proposal.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation. Please note the blog post is time sensitive and subject to changes in legislation or law.

Transfer Pricing - Common Issues & New Documentation Requirements

One of the most nefarious concepts in corporate taxation is transfer pricing. Today I have a guest post by Dan McGeown, an expert on transfer pricing discussing new Organisation for Economic Cooperation and Development  ("OECD") documentation guidelines that Canadian companies are expected to follow.

What is Transfer Pricing?

Before we get to Dan’s post, a quick primer on transfer pricing. Transfer prices are the prices charged between related parties for goods, services, assets and/or the right to use intangibles. Transfer prices also include interest on related party debt, guarantee fees and factoring fees. When a transaction involves related parties in two or more different tax jurisdictions, the tax authorities become interested, with the focus being on whether the parties are paying their fair share of tax in each jurisdiction (there are often huge disagreements between countries as they fight over what they consider their share of tax dollars being shifted to another country).

Simply put, transfer pricing revolves around the the setting of the price for goods and services sold between controlled (or related) companies. For example, if a subsidiary company sells goods to a parent company, the cost of those goods is the transfer price.

As a result, transfer prices must be set following the arm’s length principle. The arm’s length principle requires that all transfer prices, and the related terms and conditions, must be established on the same basis as would occur if the parties were not related, i.e., the prices, terms and conditions should reflect what two unrelated parties would agree to in similar circumstances.

Penalties and Traps

In Canada, failing to follow the arm’s length principle exposes the Canadian entity to a 10% penalty on any transfer pricing adjustment made by the CRA. The CRA may not impose that 10% penalty when the entity has made reasonable efforts to determine and use arm’s length prices, as evidenced by preparing and maintaining Contemporaneous Transfer Pricing Documentation.

Dan advises me that some of the common issues that most often trip up Canadian companies include the following:

1. Either no analysis/documentation to support a conclusion that transfer prices are arm’s length, or self-serving analysis/documentation for transfer prices not considered arm’s length;

2. Operating losses incurred in one or more years, with no documented loss justification based on business and/or economic reasons;

3. Fluctuating operating results that are not sufficiently analyzed and documented;

4. Inappropriate cost allocations used in the determination of management services fees, i.e. costs included that would not benefit the recipient of the services; and,

5. Royalty payments being made but lower than acceptable operating results do not justify charging a royalty.

A company’s Transfer Pricing Documentation is its first line of defense in any transfer pricing audit and, therefore, it needs to be prepared from that perspective.

Speaking of documentation, Dan’s post provides an update on changing expectations in respect of transfer pricing and he briefs us on some specific Canadian requirements. I thank Dan for his blog on this controversial income tax issue.

TRANSFER PRICING DOCUMENTATION: CHANGING EXPECTATIONS

By Dan McGeown

ERODING TAX BASES

The prolonged recession, and the difficulties many countries were and are still having in balancing budgets and managing debt loads, caused them to focus on the perception that each country’s tax base was being eroded by companies entering into activities that created tax deductions in higher tax jurisdictions with the offsetting income being reported in low tax or no tax jurisdictions, i.e., Base Erosion. In addition, many companies were moving valuable intangibles and/or value-adding activities to low tax or no tax jurisdictions to reduce the company’s overall effective tax rate, i.e., Profit Shifting strategies.

As result of this base erosion, the Organisation for Economic Cooperation and Development (“OECD”) is now calling for three distinct levels of documentation, being: a Master File; Local Country Files; and Country-by-Country Reporting (“CBCR”). For Canadian companies both the Master File and CBCR are new requirements.

Master File

The Master File will provide: a high-level overview of the group of companies; the value chain and value drivers; a description of intangibles and where they are located; financial arrangements; where functions are performed, risks are borne and assets are employed; and the consolidated financial and tax position for the group.

Local File

The Local File for a Canadian company is the Study prepared to comply with section 247 of the Income Tax Act, focusing on the specifics relating to intercompany transactions with other companies in the group. The Base Erosion and Profit Shifting (“BEPS”) impact on Local Files is that there must be more detailed analysis and documentation regarding risks, intangibles, financing and capital transactions, and high risk transactions.

Country-by-Country Report

CBCR is effectively a risk assessment tool for the tax authorities around the world. CBCR reports jurisdiction-wide information regarding the global revenues and income, taxes paid, assets employed, number of employees and retained earnings.

There is no small business exemption relating to the requirement to prepare the Master File and Local Country File. For CBCR, only groups of companies with global revenues in excess of Euros 750 million are required to complete and file the CBCR Template.

What Does This Mean to Your Canadian Company?

If your company is the parent of subsidiaries in other countries, you will be required to complete a Master File to be shared with your subsidiary companies for filing with their respective tax authorities, and you will also be required to complete a Local File to be maintained, along with the Master File, to be provided to the CRA if and when requested by the Agency at the commencement of an audit. Whether you need to complete the CBCR Template will depend on whether your global revenues exceed Euros 750 million or approximately CA$1 billion. If so, this Template would actually be filed with the CRA no later than one year after the end of the tax year in question. The CRA would share this information with the other relevant tax authorities.

If your company is a subsidiary of a parent company elsewhere in the world, you will be responsible for preparing and maintaining the Local File, while relying on your parent company to provide you with the Master File. The CBCR Template would be filed by the parent company with its local tax authority, to be shared with the CRA and other tax authorities in accordance with the guidance put forth by the OECD.

CANADIAN SPECIFIC REQUIREMENTS

The CRA issued three Transfer Pricing Memorandum (“TPM”) to provide its guidance with respect to certain transfer pricing issues: revised TPM-05R, Requests for Contemporaneous Documentation; TPM-15, Intra-Group Services and Section 247; and, TPM-16, Role of Multiple Year Data in Transfer Pricing Analyses.

From your perspective TPM-05R, clarifies the CRA’s expectations regarding your company’s response to a CRA request to provide your contemporaneous documentation to the Agency. The main take away for you and your company is that the CRA expects that some level of documentation will be prepared and maintained for each taxation year. Even if your company has a Study for its 2014 taxation year, the CRA will expect some form of documentation for 2015. That may mean the preparation of a Memo that confirms there have been no material changes in 2015 to all of the factual information in the 2014 Study, and testing the 2015 results against any benchmarks use in the Study.

TPM-15 elaborates on certain requirements for the analysis of intra-group service charges as set out in the Information Circular on transfer pricing, with more discussion about the use of mark-ups to reflect how arm’s length parties would charge fees for a given service to recover their costs plus an element of profit. Your company’s documentation may need to be revised to justify and support charging or paying a services fee that includes a mark-up.

TPM-16 confirms the CRA’s long held position that when you are setting your company’s transfer prices, and later testing and documenting them, the CRA expects you to use the results of a single year of data from comparable company information, as opposed to averaging multiple years of data.

WHAT SHOULD YOU DO?

Given the increasing focus on transfer pricing, both here in Canada and around the world, now is the perfect time to take stock of how your company sets its transfer prices for all of its intercompany transactions, and what support you have on file to support a conclusion that your company made a “reasonable effort to determine and use arm’s length prices or allocations.”

Note: I have disabled the comment/question feature of the Blog. I just do not have the time to answer questions during income tax season (this includes emails to my BBC or business email accounts). If you have questions or wish to engage Dan, his information is below.

Dan McGeown is a transfer pricing specialist and the National Practice Leader of BDO’s Transfer Pricing team, a team comprised of accountants and economists providing transfer pricing planning, compliance and controversy management services to a wide variety of companies having cross border transactions with related parties. You can reach Dan by phone at 416-369-3127 or by email at dmcgeown@bdo.ca.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.

Business Transition Planning

Planning the succession of your business is the most vital undertaking for any small business owner. When this planning involves family, the emotional and financial stress can be overwhelming.

Today, Grant Robinson of The SucessCare Program is my guest poster. Grant is one of the most respected advisors in the area of transition planning for business and family succession.

Over the last couple years, I have been told on several occasions that based on my integrated practice of accounting, income tax, wealth management and consulting, I should attend Grant's course on succession planning. I had it on my list of things to do, but never got around to it. It is really too bad I did not, as I have now gotten to know Grant and he is one of the most dynamic accountants I have ever met (yes, I know, being a dynamic accountant is not saying much, but in this case it is).

If you are a consistent reader of mine, you know that I do not compliment or endorse easily. However, if you have business succession issues and cannot seem to get out of the quicksand, I would give Grant a shout. Enough good things about Grant, let’s get to his guest post, that somehow ties in cars, highways, and succession planning.

Exiting The Business Highway

By Grant Robinson

As the owner and CEO of your business, your primary role is to move the business forward. You drive in the fast lane, covering as much distance as you can in the limited amount of time available.

Yet you know that you can’t stay in the fast lane forever. At some point you will run out of gas!

Don’t wait too long. The exit ramp is on the opposite side of the highway and it’s dangerous to cross a three-lane highway at the last minute. You’ve seen others cause some serious collisions ― some involving their own family members.

It’s much safer to gradually move over to the exit ramp one lane at a time and allow your junior driver to get the necessary experience before taking over in the fast lane.

There are some key things to know and do to ensure you change lanes safely.

• Yes you still need to run a good business by monitoring the traffic conditions and anticipating the roadblocks. It is vital that you are continually aware of possible bridge-outs in your marketplace or industry, and at the same time look for opportunities to diversify via a new highway.

• But before making any moves, you also need to signal your intentions through good communication with the next generation management and family members. Good communication will help ensure each stakeholder is going the same direction and knows what to expect. It is also critical that you check your blind spot by preparing for all contingencies.

•  Finally, you need to be in position well before that exit ramp appears. This means having a plan that preserves and protects the equity you have built up over the years and clarifies how those assets will eventually be distributed.

An integrated transition plan will ensure you address all three of these key components of a business transition.

The Integrated Transition Plan

An integrated transition plan is a focused approach to addressing the inevitable changes to the leadership and ownership of your business.

Over the years you have amassed much more than mere physical assets. Your business, your family and your community all benefit from a number of equally important, intangible assets. Preserving and transitioning both the tangible and the intangible is the foundation of an integrated transition plan.

Consequently, transitioning a business involves much more than transferring the shares of the business. It’s about ensuring the business can not only survive without the current leader but has the ability to thrive under the new leadership. It’s also about ensuring that the family remains connected, regardless of whether you decide to pass the baton to one or more next generation members or sell to a third party.

To help you prepare an integrated transition plan you must meet the needs of three key areas of your business:

•  The Family or Personal area which focuses on the continued support of individuals, the family unit and other stakeholders such as employees and their families;

• The Ownership area which centers on the preservation of the physical capital entrusted to the shareholders; and

•  The Business area which is responsible for building and maintaining the wealth engine that generates the wealth for the stakeholders. 

In the Family/Personal area, your plan focuses on developing a long-range vision that clarifies your direction and purpose for the next 120 months (or two car lease renewals keeping with our car theme). It builds on your guiding principles and philosophy to sustain and grow the social capital that is so important to both your family or partners, and the continuity of your business. This social capital includes intangibles such as your reputation in the marketplace among customers and suppliers alike. It includes the culture that keeps your employees engaged and committed. And it serves to keep your family nurtured, connected and supportive of one another. Essentially, you have a plan that defines the legacy you will ultimately leave your family and your community.

In the Ownership area, your plan should prepare both the exiting and succeeding generations for the transition of the physical assets. In order to adequately protect these assets, you must first clarify the overall ownership philosophy and put the wheels in motion to develop the appropriate ownership structures and agreements.

In the Business area, the objective is to keep the wealth engine running and determine what needs to be done to ensure the business can continue to be profitable beyond a change in leadership, and at the same time attractive to a prospective buyer. This plan includes processes to professionalize the management system, groom the next generation leader(s), transfer the knowledge and relationships to the new leaders, and ultimately affirm that the business can thrive without the current decision-maker.

Planning a business transition is just like managing any other project except that the outcome of this project is critical to the future of many people. Success is dependent upon the right investment of time and resources.

Any business owner who has successfully transitioned a business will acknowledge that it takes a long time ― possibly as much as five years or more ― to put processes in place that enable the business to run successfully under new leadership. Unfortunately, the majority of business owners believe they can wait until they are almost ready to retire to begin planning their exit. It’s not surprising that there are so many collisions on the highway as they try to move to the exit ramp when that fuel warning light comes on.

For many, transitioning a business is a “once in a lifetime” journey. It’s a new and different challenge that requires a roadmap or a GPS. You must go beyond the technical aspects of a share transfer. You and your family need to articulate what you want in order to help you through the process of developing the strategies to get there.

Grant Robinson is a business transition specialist and National Director of The BDO SuccessCare Program, a unique program for businesses and families who want to create greater choice around the future transition of their business and wealth. You can reach The BDO SuccessCare Program at 1 800 598 6400.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.