Ron Walsh and Kevin Walsh weigh in on the fallout from these sweeping reforms.
Privately owned corporations have good reason to fear the federal government’s proposed tax changes. Besides doubling the tax on death and making compliance more complex and expensive, they will weaken Canada’s competitiveness when it comes to attracting entrepreneurs and human capital. Walsh King partners Ron Walsh and Kevin Walsh recently shared their thoughts on how much business owners stand to lose.
Why are you against these proposed tax changes?
Ron Walsh: They’re a dramatic change in rules that were well thought out as a consequence of the Carter Commission in the late 1960s and implemented in 1972. It’s been done without undertaking the in-depth study the Carter Commission did. They’re incredibly poorly thought-out proposals that don’t consider the implications for many aspects of the economy.
It’s a great example of the failure to engage in a proper consultative process leading up to tax reform. Here we have tax policy rushed through with minimal and no advance consultation with folks outside the government, and a very short period for consultation, during the summertime, on a very far-reaching set of proposals.
Kevin Walsh: It’s a huge increase in tax compliance costs for businesses. Over the past 10 years, filing annual tax returns has become at least twice as complicated, and these rules are going to accelerate that increase in complexity. If they’re implemented as is, the complexity will be significantly higher for private businesses.
Who will be affected by the changes?
Ron: Every single privately owned corporation in the country will be affected to some degree by these proposals because they’re so far-reaching.
There’s also a retroactive aspect to this legislation. It can result in families having to re-create records going back decades, records that may not even be available, to determine the tax consequences of what would otherwise be routine transactions. This retroactive aspect compounds the cost of compliance and the uncertainty with respect to relatively straightforward business decisions.
What’s at stake, especially for smaller businesses across the country?
Ron: If all of these proposals get implemented, the economic risk of being in business will be significantly higher. It will be higher because of increased complexity resulting in significant uncertainty about the tax outcome of relatively routine business decisions. Increasing uncertainty increases risk. The tax cost of doing business is going to go up. The tax cost of transferring business is going to go up. The tax consequences of death could be dramatic—as high as 60 to 70 per cent of the value of a privately owned business.
All of these things will compound the risks and therefore the costs, changing the entrepreneurial equation. One assumes that at certain points, the risks and the rewards are balanced, and therefore an entrepreneur proceeds. If you raise the bar at which that balance is reached, it will deter people from proceeding with entrepreneurial activities.
How did we get here?
Ron: This seems to be a politically-driven initiative. It’s consistent with a position of perhaps wanting to be perceived as more left-wing for political considerations. If you look at the income-splitting provisions, the government’s own estimates are that the additional revenue would likely be in the range of $250 million a year. I suspect that the additional compliance costs will be far greater than $250 million a year. Relative to government revenues, $250 million is an almost insignificant drop in the bucket.
One criticism of the proposed changes is that they will mostly hurt middle-class businesspeople.
Kevin: When you look at the compliance, and they say that it’s not going to affect people earning less than $150,000, I think proportionately it will affect them much more than somebody making $2 million a year. If you’re making $2 million and paying somebody a lot to do a tax return, it’s not going to be that significant. Whereas if you’re making $150,000, because of the complexity, that same cost is huge. It’s an additional tax, basically.
Ron: The vast majority of business owners are not wealthy people. They’re people who happen to be in business, whether it’s Mario running the coffee shop downstairs or somebody running a small manufacturing facility with 20 or 30 employees.
Besides withdrawing the proposals, what should the federal government be doing when it comes to taxation of privately owned companies?
Ron: First of all, I think the government needs to define its objectives more clearly. If their objectives were to be punitive, they should be honest enough to say so. This vagueness about the government’s objectives and the adverse consequences of technical aspects of the legislation are very frustrating for people.
Once they’ve defined their objectives, I think they need to undertake a far more balanced approach to consulting with knowledgeable people, whether they’re economists, tax lawyers, tax accountants, or businesspeople. If they want to bring about a fundamental change in the tax system, perhaps they need to go back to another Carter Commission–type approach where they look at all aspects, not cherry-pick specific ones.
Kevin: Good tax policy is usually driven by a motivation to initiate change. The only stated motivation for this, if you look at the consultation paper, is fairness as they perceive it. If they approached it as “We want to drive innovation and entrepreneurship and attract young talented people from around the globe,” they could get better tax policy than starting with a vague notion of fairness to the middle class.
If the changes go through, what are the long-term implications for private companies and the economy at large?
Ron: Most businesses do not have surplus liquidity, so if someone is to pass away unexpectedly, and their estate is subject to a 60 per cent tax bill as a consequence of the death of the deceased, that might necessitate the liquidation of the business and the termination of employees. Recognizing the risk to the family of an unanticipated death encourages people to sell their business prematurely.
Another issue that’s hugely important is unfairness with respect to intergenerational transfers of business and farmland. The tax cost for a shareholder to sell their business or farm to relatives is dramatically higher than the tax cost to sell to strangers. To have a system in place that discriminates against the transfer of ownership within family groups seems to be completely the opposite of an economy that was built on family businesses.
Kevin: The existing rules are already complex when you’re selling to a family member, and now they’ve made that more complex and more punitive. There are already punitive rules in the existing Tax Act with respect to intergenerational transfers. Now it’s to the point where I’d say that you likely would not want to have a business transfer from generation to generation.
The U.S. is also looking at major changes to its tax code. How might that affect things here?
Ron: In Canada, we have increasing tax at multiple levels as a result of this government’s initiatives. At the same time, you’ve got the U.S. announcing proposals for a significant reduction in personal and corporate tax. So our biggest trading partner is moving toward a more tax-friendly environment, while we’re moving toward a tax-unfriendly environment.
The world has become a global marketplace for human capital, and people tend to be attracted to environments that are encouraging; particularly, entrepreneurs want to go where the tax rules allow them to create employment. So the U.S. moving in the exact opposite direction to Canada is not good for Canada.
From a tax planning perspective, what steps can privately owned companies take to mitigate some of the damage that could ensue?
Ron: It’s premature to speculate because there’s so much uncertainty in the proposals, and the technical implications will be specific to the circumstances. So it’s very difficult, at this stage, to plan for the future.
There will be a renewed interest in implementing estate plans sooner than they might otherwise have been. The second issue is that the risk attached to investment is increasing. So people are going to be deterred from reinvesting in their business, and they’re going to be looking for ways to extract funds.
Kevin: There are some anticipatory things where you’re paying larger dividends before December 31 of this year, and crystallizing capital-gains exemptions because those rules are changing as well, and the limitations on who can claim the capital-gains exemptions will be more significant on January 1, 2018. Otherwise, if people’s succession plan was looking to sell shares to their kids, they now need to look at selling to a third party or restructuring the sale in a manner that maybe intergenerational transfers wouldn’t have considered in the past.
Ottawa seems to have made up its mind. What can business owners do?
Ron: They have to continue writing to their MPs, writing to the finance minister, writing to the prime minister, and supporting business organizations—chambers of commerce, et cetera—in their ongoing commentary on the adverse consequences for Canada of these changes. Making their voice heard, and continuously heard, is the key thing.
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