Off Target: Assessing the Fairness of Ottawa’s Proposed Tax Reforms for “Passive” Investments in CCPCs

In July 2017, the Department of Finance launched consultations on a series of tax proposals affecting owners of Canadian-Controlled Private Corporations (CCPCs). The proposals on the treatment of “passive income,” from investments such as equities and government bonds, have attracted particular controversy. The proposed regime would end passive investment income-tax refundability for CCPCs – ie., 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. 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. 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? Our tax simulations show, overall, it is not – when benchmarked against the tax treatment afforded to personal retirement savings. Saving for retirement in tax-assisted plans – on a “consumption-equivalent” tax basis with a steeply graduated tax rate structure – is widely accepted in principle and in practice, because such treatment does not discourage saving as a pure income tax would do. Considering that additional administration, accounting, and tax compliance costs need to be incurred in corporate accounts, one could reasonably conclude that passively reinvested smallbusiness earnings receive a tax treatment similar to that of RRSP/TFSAs in a variety of possible portfolio compositions. Besides, successful businesses earning income above the small-business threshold enjoy no significant tax “advantages” on passively reinvested earnings. 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. Further, the playing field with respect to tax-assisted saving opportunities is already largely unequal. Outdated current tax rules allow career defined-benefit (DB) pension plan participants, particularly in the public sector, to end their careers with tax-assisted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. 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.