Thank you very much, Mr. Chairman.
My name is Ken Goodridge. I am the senior tax manager at Lazer Grant, a local CPA firm in Winnipeg, a position I have held for the last seven years. Prior to that, I spent 30 years in the audit division of the Canada Revenue Agency. I have a lengthy history both enforcing compliance with tax legislation and assisting taxpayers with complying with it.
What I'd like to briefly talk about today are certain recent amendments to the Income Tax Act and the effect of these amendments on taxpayers and tax professionals. I am referring primarily to the legislation that is designed to stop abusive schemes regarding the small business deduction, in particular the legislation that deals with specified corporate income, as well as the changes to subsection 55(2). Some other significant changes include the tax on split income, or TOSI, and the legislation that reduces the small business deduction as investment income increases. Sadly, or mercifully, we will not have time to discuss these, and I'll try to keep this from getting very technical at all.
The problem with the recent amendments is that they are very complex and they can have inadvertent consequences. They are also expensive for the taxpayer, because more time must be spent by practitioners researching the law and preparing tax documents. I'd like to point out that most of our clients qualify for the small business deduction.
It is my understanding that the small business deduction was originally intended to benefit small businesses by allowing them to retain capital that may be reinvested to help them grow and succeed. The small business deduction remains an extremely important incentive to small business, hence the large number of schemes designed to take advantage of it. The small business deduction reduces the federal tax rate to 9% on the first $500,000 of active business income. In Manitoba, the provincial small business tax rate is zero, while the normal corporate rate is 12%, so in total it reduces the combined federal and provincial income tax rate from 27% to 9%. There is a large incentive to take advantage of it.
In terms of federal tax, the small business deduction has much less impact than it used to have, given that the highest federal rate is now 15%, rather than 28%, as in the past. Nonetheless, it still represents a total federal tax saving of $30,000 on the first $500,000 of active business income earned by a corporation. However, given the additional restrictions that have now been placed on the small business deduction, one questions whether the government still considers small businesses to be a really important part of the economy. Schemes that allowed corporate groups to acquire access to more than one small business deduction were formerly governed primarily by the association rules. The association rules were substantially revised over 30 years ago to limit access to the small business deduction. The recent amendments extend well beyond the scope of the association rules.
Let me give you an example. Let's assume we have a corporation that provides services to another corporation. Twenty per cent of the first corporation’s income comes from these sales. The first corporation has a 1% shareholder who is related to a 1% shareholder of the second corporation. In the olden days this would not be a problem at all. However, under new legislation this 20% income would be eligible for the small business deduction only if the second corporation transfers some of its business limit to the first, thereby reducing its own small business deduction. It's not hard to imagine that the second corporation may be reluctant to do so since they're not related.
The problem here for the taxpayer and the tax practitioner is that, in order to stay onside of the rules, a person needs to know the shareholdings of all his or her related persons, which would be parents, grandparents, children, grandchildren, spouse, brother-in-law and sister-in-law. In smaller communities, it may not be possible to avoid doing business with corporations that have related persons as shareholders, which to them brings these rules into effect. The new legislation is a radical departure from the old rules, which were primarily covered through the association rules, which really don't have the concept of control. The expanded rules deal with other things.
Another problem is subsection 55(2), which was enacted for the purpose of preventing taxable capital gains from being converted into tax-free intercorporate dividends. This is very old legislation, but it's only recently been re-updated. The changes to subsection 55(2) have had a significant effect on legitimate business transactions. The amount of work that now goes into paying a corporate dividend or doing a simple restructuring has become onerous, in part because you now have to do a very lengthy calculation of something called “safe income”. The rules in subsection 55(2) must now be considered when paying intercorporate dividends for the purpose of asset protection, purifying a corporation so that the shares qualify for the capital gains deduction, and for various other transactions that were previously all considered to be onside.
The rules I have just described not only cast the net very wide, potentially capturing non-abusive transactions, but also significantly increase the cost of compliance. A colleague recently told me that he has clients who question why a simple corporate tax return used to take three hours and now takes 10. The problem is that more time is needed to gather information, make calculations, and prepare tax returns and schedules. Unfortunately for the taxpayer, tax practitioners are not able to do this for free.
Finance used to draft legislation to fix a particular problem. Recent amendments seem to indicate that legislation is now being drafted to fix problems that have not yet been thought of. I'm not advocating a return to the old system, which often seemed to be closing the barn door after the horse was gone. I do think it might be possible to draft legislation that falls in between the two extremes.
Thank you very much. I look forward to any questions.