The 2016 Federal Budget

Last Tuesday, the Minister of Finance, Bill Morneau, delivered the Liberal governments much anticipated 2016 Federal budget.

While much of the budget had been floated and/or proposed during the election and confirmed in part on December 7th (the middle-class tax cut and 4% increase in tax rates for high income earners) by Mr. Morneau, there were some still some surprises.

In January, I wrote a blog post on how the "Top 1%, are not Happy Campers". I would suggest they are still not (see my CBC National News interview on this topic here and the story of this high earner leaving Canada). Yet, I think between all the trial balloons and rumours, from raising the small business tax rate to 26.5%, to a possible increase in the capital gains rate from 50% to 75%, many of the "Top 1%" felt they escaped tax Armageddon to some extent. However, if you are a small business owner or professional, there were many under the radar changes that may significantly impact your future tax planning and depending upon your fact situation, potentially result in even more income taxes. If planned, it was an excellent job of misdirection from the government in respect of high income earners.

The "middle-class"are the winners here. However, I still want to reserve judgment as to how big a win certain people had. The "middle-class" has lost the family tax cut worth $2,000 to some people. In addition, much of the "middle-class" gain revolves around children, so if you are single or do not have children or only say one child, your benefit is not quite as large. Finally, the new Canada Child Benefit ("CCB") starts to phase out on adjusted family income in excess of $30,000, so many families will have a reduction in their child tax benefit. So while most people will be net winners, some middle-class people may not benefit as much as they anticipate. This Toronto Star article
presents some interesting numbers on how the federal budget affects everyday Canadian families.

Business Changes

The budget contains several proposals that will close down many popular tax planning techniques used by high income earners. These include:

a) The transfer of personal life insurance policies to private corporations that allow the shareholder to extract tax-free funds. New measures will reduce or eliminate these transfers effective March 22, 2016. For those who transferred policies prior to the budget date and took back tax-free shareholder loans, essentially the new proposal will cause the tax-free capital dividend received by the corporation upon your death, to be reduced by the tax-free loans you took from your company while alive. 

b) Many partnerships created structures whereby the partners had corporations that provided services to the partnership allowing them to potentially access the $500,000 small business exemption. For taxation years that begin after March 21, 2016, the budget will change the rules to catch this type of service income. I am surprised it took this long to eliminate this type of planning.

c) It is somewhat common for the spouse of a high income earner to incorporate a company that provides services to their spouse's corporation. This planning can often allow both spouses corporations to access the $500k small business deduction. Also applicable on or after March 22, 2016, the budget will deem the service income to not be eligible for the SBD where the shareholders or a person does not deal at arm's length (such as spouses). Thus, combined, the two related corporations can only claim $500k SBD in total.

Other Business Changes

1. The small business tax rate reductions legislated by the Conservative government will be frozen at 10.5% for 2016 and beyond.


2. The Eligible Capital Property regime (such as goodwill, customer lists and licences) will now be replaced with a new capital cost allowance class (Class 14.1) with a 5% declining balance. The CEC balances will be transferred effective January 1, 2017. This is very complex, but will be less beneficial than the current regime in many cases as active income is now being turned into investment/property income.


3. There will be significant changes to transfer pricing and anti-surplus stripping and various foreign transactions which are beyond the scope of this post (meaning, way too complicated for me and you need a non-resident specialist).

Miscellaneous Personal Changes

1. The budget proposes the elimination of the children's fitness tax credit, arts tax credit and education and textbook tax credits as of January 1, 2017. The children's fitness tax credit and arts tax credit will be halved for 2016 and you can continue to carry forward unused education and textbooks credits. The Federal tuition credit is unchanged.

2. The family tax cut will be eliminated for 2016 and subsequent years.

3. The child tax benefit and universal child benefit will be combined into one non-taxable Canada Child Benefit ("CCB"). The CCB will provide annual benefits of up to $6,400 per child under six years old and up to $5,400 per child six through seventeen. On the portion of adjusted family net income between $30,000 and $65,000, the benefit will be phased out at a rate of 7 per cent for a one-child family, 13.5 per cent for a two child family, 19 per cent for a three-child family and 23 per cent for larger families. Where adjusted family net income exceeds $65,000, remaining benefits will be phased out at rates of 3.2 per cent for a one-child family, 5.7 per cent for a two-child family, 8 per cent for a three-child family and 9.5 per cent for larger families, on the portion of income above $65,000.

The budget proposes to provide an additional amount of up to $2,730 per child eligible for the disability tax credit.

4. The retirement age for Old Age Security will be rolled back to age 65.

5. Many mutual funds have been structured to allow "switches" among the funds (known as corporate class funds) to avoid triggering tax. The budget proposes that for dispositions after September 2016, a taxable disposition will occur when you switch among mutual funds with the exception of switches between series of shares within a class (i.e.: the shares within the class are essentially the same funds).

6. There was no budget proposals in respect of stock options, a pleasant surprise, given the Liberals had discussed restrictions being implemented.

7. The Conservative governments proposal to allow the donation of real estate or private corporation shares will not proceed.

The budget contained multiple proposals, but I have only touched on a few. For many of the proposals, the devil will be in the details.

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.

The Top 1% are not Happy Campers

A large percentage of my client base is made up of Canada’s “top 1%” of wage earners. They have been vociferous is expressing their unhappiness with the announced marginal tax rate increases for high income earners. They are also very concerned a second shoe will drop, that being the possibility the government will eliminate the small business deduction for many of their corporations.

So who are the “top 1%”? According to a 2013 report by Statistics Canada, Canada's top 1% earned an average income of $454,800. To be considered in the top 1% of income earners in Canada for 2013, a tax-filer would need to have a minimum total income of $222,000.

The 50% Psychological Barrier

On December 7, 2015, Finance Minister Bill Morneau confirmed that for Canadians with incomes over $200,000, their marginal tax rates will increase from 29% to 33%. If you live in Ontario and make more than $220,000, this means you will be paying 53.53% on any dollar earned over the $220,000. I am not a psychologist, but it is very clear to anyone who deals with high-net-worth individuals, that once marginal rates go beyond 50%, they break an invisible psychological barrier that impacts taxpayers thinking, if not their actions. Simply put, you are now paying more money to the government than you keep.

Potential Restriction on Claiming the Small Business Deduction

Currently, small business owners that carry on an active business pay corporate tax at a rate of 15.5% on the first $500,000 of taxable income (subject to various restrictions and sharing of the limit with related corporations). If a corporation is not eligible to claim the small business deduction ("SBD"), they would be subject to a 26.5% tax rate, an 11% increase. [Note: To be clear. This 11% increase is only an increase in the taxes you would pay at the corporate level. So instead of deferring say 38% when you leave money in your corporation (53.5%-15.5%), you would now only be deferring 27%. The absolute income tax increase to you when you when you flow your corporate money to yourself as a dividend or a salary is very small].

As discussed below, the Liberals have floated placing restrictions on the use of the SBD. This has many small business owners anxious that they may have to pay the higher 26.5% tax rate.

In a prior blog post, I noted the following comments made by Prime Minister Justin Trudeau in this article  by the National Post. The Prime Minister stated “that several studies have shown that more than half of small business owners are high-net-worth individuals who incorporate…to avoid paying as high taxes as they otherwise would”. The Post noted that “in that group are doctors and lawyers, groups that may find themselves squeezed by the policy Trudeau loosely outlined this week”.

Mr. Trudeau went on to say that “We want to focus on helping small business owners who are working hard, who are creating jobs for members of their community and serving their community. We are committed to evidence-based policies and I will make no apologies for that.”

Some tax pundits suggest that the Liberals will implement legislation similar to Quebec. In general, Quebec’s legislation says the following corporations would be eligible to claim the small business deduction: 

1. any corporation that employs more than three full-time employees in its business throughout the year or that would usually have used the services of more than three full-time employees had financial, administrative, maintenance, management or other similar services not been provided to the corporation in the year by a corporation associated with it; and

2. any corporation in the primary or manufacturing sector.

My Observations and Experience

I personally cannot ever recall my clients being so vocal over a tax increase and concerned about the possible changes to the small business deduction. I have had several voice their displeasure about these measures. I asked a couple of them if I could discuss their situations in general and they agreed.

One client is a serial entrepreneur in northern Ontario. At a very young age, she built up a hi-tech company and sold a division of the business to a major corporation. At that time she had over 75 employees. She subsequently rebuilt her original company with a new product and incorporated a very successful second company. Following the announcement of the increase in tax to almost 54%, she has started implementing a departure plan, with the intention to set-up offshore and leave Canada within the next ten years. There are several reasons why she wishes to leave Canada, many being philosophical in nature (I would like to list them, as they are very sound and interesting objections, however, we agreed to limit my discussion to her general situation), but the tax increase was the straw that broke the Camel’s back so to speak.

Most people would probably agree, this is not the type of person you wish to chase from Canada.

A second client is a professional nearing retirement age. He basically said to me that why should he continue to work when he does not need the money. He says he is now planning to retire early. He also told me, he had recently attended two Christmas parties and all the room was talking about was the personal tax increase and the possibility many professionals will lose their access to the small business deduction.

The above is an example of tax law changing behaviour in a non-productive way. 

What the Youth of the World have to Say

During a recent dinner, the tax issue was brought up by a guest (not by me, I have enough of this issue at the office). My children who are young adults had this to say:

1. Are individuals who want to leave Canada being selfish? They make a lot of money, so why do they mind paying income tax?

2. If individuals could tell the government what buckets to put their tax dollars towards, would that make it more palatable?

I found both of these comments very insightful, although said through the prism of youth.

Are you selfish if you are willing to leave a country because you do not wish to pay high levels of income tax? Since this discussion would be a book on its own, I will only say the following. I think that every person has and is entitled to, their own marginal income tax “breaking point”. In addition, as noted above, I would trivialize the discussion by saying income tax increase alone may cause some people to leave Canada. While that may be the case for some, I would suggest for most others, while income tax increases maybe a trigger for them considering leaving Canada, it is only one of several considerations.

I loved the tax bucket idea and would suggest many individuals who would consider leaving a country because of taxes would possibly reconsider if they could actually allocate their tax dollars to where they think would be the most useful. However, since this is a fanciful notion and would essentially eliminate the need for government, it is a bit of a non-starter.

The issue of high marginal tax rates is very contentious. This short blog post cannot do the topic any justice. However, it is clear that taxing the wealthy can lead to splits among socioeconomic status, political leanings and philosophical differences on taxation and the common good. What I can tell you is: there is significant unhappiness amongst the top 1%, and probably the top 20%, and if and when legislation comes in restricting the small business deduction, I think it may manifest itself further. Here’s hoping sound business decisions do not become clouded by tax considerations.

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.