Liberals tighten scope of passive-income measure for private corporations

OTTAWA — The federal government is moving to pare down its controversial tax proposal on passive income so that it will only affect three per cent of private corporations.

Finance Minister Bill Morneau will be in New Brunswick on Wednesday to unveil changes to his passive investment proposal so that it only targets unfair tax advantages used by the wealthy, a senior government official told The Canadian Press.

Some tax experts believe the passive-income proposal is the most-complex and most-contentious tax reform idea in the government’s three-part plan.

The official, speaking on condition of anonymity ahead of the announcement, said Morneau will also share updated estimates showing there’s between $200 billion and $300 billion in assets sitting in the passive investment accounts of just two per cent of all private corporations.

The finance minister will also point out that the dollar figure has been growing by $16 billion a year as wealthy incorporated individuals reap what the official described as unlimited benefits from tax-advantaged savings accounts over and above RRSPs and TFSAs, the official said.

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The government wants to prevent all of this cash, which it contends is not being reinvested into the businesses or the economy, from piling up in these savings portfolios over generations, the official added.

The tweak to Morneau’s original proposal comes after an onslaught of complaints that warned cracking down on passive investments could adversely affect middle-class entrepreneurs who use their companies to save for economic downturns, sick leaves and parental leaves.

Morneau will provide more details Wednesday at an event near Saint John on the mechanics of the tweak and a timeline for the introduction of change to passive-income rules, the official said.

The announcement is part of a week-long Liberal effort to calm the anger surrounding the tax proposals, which have outraged entrepreneurs, doctors, tax professionals, farmers and Liberal backbench MPs.

Prime Minister Justin Trudeau began the week by announcing tax cuts for small businesses and plans to abandon part of one of the proposals to avoid negative impacts on the intergenerational transfer of family businesses, like farms.

Trudeau also said the government intended to move ahead with another controversial proposal from the tax package. That change is aimed at limiting the ability of business owners to lower their personal income taxes by sprinkling their income to family members who do not contribute to their companies.

The government has yet to announce how it will proceed with the remaining proposal, which is designed to limit the ability of business owners to convert regular income of a corporation into capital gains, which are typically taxed at a lower rate.

On passive income, the official said the problem isn’t with individuals, but the system, since it encourages wealthy Canadians to keep their personal money inside their corporations so they can receive tax advantages not available to everyone else.

The changes will not be retroactive, as outlined in the original proposal, and they will not affect existing savings, nor the income from those savings, the official said.

Morneau is expected to provide further details Wednesday on the changes to its passive-investment proposal, including a plan for addressing the concerns of angel investors and venture capitalists.

Kim Moody, a director at Moodys Gartner Tax Law, said the passive-income proposal is the most-contentious part of the plan, which is probably due to the fact there’s far more money at stake.

“They’re going to target the top three per cent, but those three per cent are not going to stand by idly and be subject to a 72 per cent, 73 per cent all-in tax rate — they’re not that foolish,” said Moody, who believes some wealthy business owners may leave the country if they can’t find ways around the new rules.

“They will change their behaviour to try and avoid that kind of punishment. There’s always ways.”

But he added that it would be a good development if the government can find a way to remove the impact for 97 per cent of private corporations. Moody said it would bring back certainty for those who would otherwise be worried that they won’t be able to set aside funds for rainy days, retirement or business expansion.

Greg Wiebe, managing partner for KPMG’s Canadian tax division, said the passive-income proposal troubles him the most out of Ottawa’s three initiatives.

“I hope that the answer they have is simple because the tax system in our country is very complicated now,” Wiebe said.

“And added complexity just adds costs and makes it difficult for people to comply, frankly.”

Morneau has argued the proposals are designed to create a fairer tax system, especially for those in the so-called middle class. He’s also said he hopes the tax reforms will unlock cash for business investment and help lift the country’s “productive capacity.”

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Andy Blatchford, The Canadian Press

Note to readers: This is a corrected story. An earlier version suggested the measures would only affect three per cent of small businesses.