Budget 2017: Shots across the bow – and some direct hits…
By: Michael Goldberg
The lead-up to the March 22, 2017 Federal Budget (“Budget”) was filled with fear and trepidation that the Trudeau Liberal Government (“Government”) would use the Budget to grab more taxes from Canadians to pay for their platform promises. In particular, in advance of the Budget, there was concern that capital gains inclusion rates were likely to increase significantly from the 50% inclusion rate to 75% or possibly even more. The good news for taxpayers…at least for now… is that the Budget did not make any particularly significant tax rate changes at all.1 Unfortunately, that is not to say that the Budget was a tax non-event.
Shots across the bow
Tax professionals are always worried about something. It seems to be an occupational hazard or perhaps a deeply ingrained socialized character flaw. Perhaps it is that we’ve adopted Bruce Cockburn’s song “The Trouble with Normal (is it always gets worse)” as our theme song – or maybe that’s just me. In any case, it appears this Budget has left us with reason to be worried.
Contained deep in the Budget papers2 under the heading “A Tax System That’s Fair for Middle Class Canadians”, is a discussion about “Tax Planning Using Private Corporations”, setting out the theme that high-income individuals are using corporations to avoid paying their fair share of taxes. Some of the variety of strategies that the government notes it is concerned about include using private corporations to:
1) allow high-income individuals to shift income to lower income family members or other non-arm’s length persons that can reduce (or even eliminate) overall taxes in a non-arm’s length group;
2) cause passive income to be taxed at much lower tax rates than if the income had been earned personally; and
3) convert regular income into capital gains, which because of the high tax rates on dividend income can significantly reduce the integrated tax rate in connection with earning income through a corporation as opposed to if such income had been earned personally.
In short, the Government is not amused. Stay tuned for more developments – which may be coming in the form of a report in the next few months. Some other shots fired in the Budget include commitments made to collaborate with the provinces to ensure transparency regarding beneficial ownership, which is in keeping with broader anti-money laundering initiatives carried on by the Government. In addition, as if taxpayers didn’t have enough to worry about, the Budget proposes investments of more than half a billion dollars in the Canada Revenue Agency – which the Budget projects will result
in revenue of $2.5 billion over five years.
Direct Hits
Some of the direct hits fired in the Budget, while disappointing, were at least foreseeable.
A number of strategies used by taxpayers to manage their tax situations and/or to benefit from certain fact patterns took direct hits in the Budget. For example, the use of straddle transactions (“straddles”)3 to manage a taxpayer’s taxable income appear to have been effectively eliminated in respect of straddles entered into on or after the date of the Budget. Also, the “de facto control” test, a test that is critical to
causing a number of provisions in the Income Tax Act (Canada)(“Act”) to become applicable, including the association rules4, is proposed to be broadened significantly. The change to this test is intended to legislatively override recent case law that the Government obviously did not agree with.5
On the other hand, I don’t know any advisors who foresaw the elimination of the so-called “billed-basis accounting” deduction available to professionals who elect to defer the value of their work-in-process (“WIP”). Assuming that this proposal is enacted, professionals will be required to determine the lesser of the cost and fair market value of their WIP each year (“WIP Amount”) and, beginning in the taxation year ending after the particular professional’s current taxation year, the professional will be required to take into account 50% of the WIP Amount at year-end into income for that taxation year (for professionals with calendar year-ends, the relevant period for this first inclusion will be the taxation year-ended December 31, 2018). Thereafter, the professional will be required to include the full year-end WIP Amount in income, subject to claiming deductions for the WIP Amount included in the preceding year.6
The government has touted this change as being capable of raising nearly half a billion dollars of tax revenues over the next three years.7 Sadly, I can’t imagine that in the current political/class warfare environment the general public will have much sympathy for the professionals being forced to pay these additional taxes.
While the elimination of billed-basis accounting is likely to impact all professionals to a certain degree, it would appear to especially hurt lawyers and accountants, who often carry large WIP balances at year-ends. This is particularly the case for any professionals who work on a contingency basis.
Assuming the billed-basis accounting proposals are enacted, the future battle ground for professionals seeking to defer taxation of their WIP will shift to the valuation of WIP, since it is the lesser of the cost and fair market value of the WIP that will be taxable. However, that is an article that can be written8 on another day.
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1 The Budget does contain significant tinkering with various credits and other tax attributes that will impact individuals and corporations. In addition, although for
now services such as Netflix have dodged the bullet, a new Uber tax has scored a direct hit by extending GST/HST to ride-hailing services so that they are treated in a
manner similar to traditional taxi services.
2 See page 199 of the Budget Plan.
3 Straddles generally involve a taxpayer taking opposing positions (short and long positions) and managing them in a manner that will result in one position being in a gain position and the other in a nearly identical loss position. The taxpayer can then choose to time the realization of losses in a manner that would allow those losses to offset current year income and move the gain position into a subsequent taxation year. Similar transactions can be put in place year after year. The proposed changes are intended to defer the ability to realize the loss position to the extent that the gain remains unrealized.
4 Association has a number of consequences, including causing associated corporations to have to share certain Canadian controlled private corporation benefits such as access to the $500,000 small business deduction limit and SR&ED benefits. The association rules are found in section 256 of the Act.
5 McGillivray Restaurant Ltd. v. R, 2016 DTC 5048.
6 Assuming WIP Amounts are constant over the first two post-Budget taxation years of the professional, effectively 50% of the WIP Amount will be included in income in each year. Subsequent increases or decreases in year-end WIP Amounts will give rise to net income inclusions or deductions, as the case may be.
7 It has been noted that this change may lead to many more professionals incorporating their practices, which generally appears to be sound advice. However, given the potential for ongoing changes to the taxation of corporations (not just corporations earning passive income – we tax advisors worry about there being further changes to the taxation of professional corporations too!), it is unclear whether such a strategy will be appropriate for all professionals in the long run.
8 By someone else.