Proposed tax changes miss the boat on financial security for all

Things have been fairly quiet in the media recently on the topic of the proposed tax changes introduced by the Liberals on July 18. The truth is, however, I am becoming e-mails daily from Canadians concerned about the changes coming.

To recap, Finance Minister Bill Morneau has made it clear that the government intends to proceed with two of the three proposals announced this summer. The modifications will penalize business owners that pay dividends to spouses and kids (that the government has called “income sprinkling”) who haven’t made clear and meaningful contributions to the enterprise. Secondly, the changes will punish business owners who make passive investment income over $50,000 annually in their own businesses.

In the last couple of weeks since Mr. Morneau declared some alterations to the proposals, financial and taxation specialists have been busy crunching numbers to comprehend the impact. What’s clear, sadly, is that the Department of Finance has not done the exact same math, and yet we are anticipating Mr. Morneau to announce the last version of the “income sprinkling” rules daily, since the intention was that they would be rushing to implement these changes effective Jan. 1, 2018.

Missing the ship

The proposed changes are supposed to “level the playing field” by ensuring that business owners do not have advantages that workers can not access, which makes the system “fairer.” However, what if business owners are left worse off than workers earning the same amount of revenue?

Here’s the actual question: Can a company owner secure their own financial future in addition to a worker under these proposed changes? Forget for a moment about differences in taxes paid annually by business owners and workers. Let us talk about the capacity to make similar levels of financial security over the long run.

Can a company owner and employee collect similar numbers for retirement? All other things being equal, can they make ends meet to the same age? After all, the pursuit of financial security should be equally available to all. And it has this real-life impact the Department of Finance, focusing on short-term tax differences, has neglected to compute. The government has missed the boat entirely on the question of equivalent financial security with these suggestions.

Rushing the implementation of those proposals will throw into disarray the strategies for financial security that many small business owners have been counting on. Shame on the government for failing to do the math, and about the Liberals for caring about being seen to support the middle-class worker, than on boosting the financial security of Canadians.

The math

Consider an example like that supplied by the government in its July suggestions, comparing a worker with a company owner. Let us assume that every earns the same $150,000 annually. Both are 35, will retire at 65, and have equal lifestyles, each spending $87,000 annually (indexed), until death at age 90.

Mr. Morneau is worried about company owners paying dividends to family (which workers can not do), and about business owners building up investments within their corporations. So, let us assume that the company owner pays dividends to himself and his partner. The amount left over after paying taxes, and dividends, is reinvested in a portfolio within the corporation. The employee receives wages, participates in a defined contribution retirement program (not as generous as the MP’s defined benefit plan, sadly), and will gather Canada Pension Plan (CPP) in retirement.

Under the current rules, each will have the ability to set aside about $1.3-million for your long run. At 65, the employee will have roughly $3.5-million accessible, while the company owner is going to have roughly $2.9-million — a gap of $600,000. The difference is because the worker’s savings are within tax-deferred registered programs while the company owner’s investments are subject to already-high yearly tax rates within the corporation.

What about yearly taxes? Both will cover a similar amount of tax throughout their lifetimes. While the company owner will pay less taxation in the early years due to the ability to split income (which is mainly limited under the new proposals), the gap between the two shrinks and the company owner finally pays more tax as their investments grow in the corporation. What’s more, the worker can split their retirement income with a spouse in retirement while the company owner can’t.

Under the proposed changes, the total available to the company owner in 65 drops by $500,000, making an even larger gap compared with workers, and the company owner will run out of cash at 81. The employee will still have $2.8-million left at 90.

The Liberals will need to rethink these tax proposals, delay their execution and have a look at the dilemma of long-term financial security, not short term tax differences.

Due to the Owens MacFadyen Group for their mathematics here and their submission to the Standing Committee on Finance. Check out the detailed calculations at .

Tim Cestnick, FCPA, FCA, CPA(IL), CFP, TEP, is an author, and co-founder and CEO of Our Family Office Inc.. He can be reached at

Courtesy: The Globe And Mail

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