Minister Morneau, don't throw the baby out with the bathwater on tax reform.

Dear Minister Morneau

I am the managing partner of a small marketing agency that employs 21 full-time, permanent people and provides contract income to just as many freelance specialists in the greater Montreal area. I also coach and invest in start-ups and small businesses. Like many business owners, I am the first to celebrate paying more profit tax on a given year, because it is a sign that my company actually made profit. I pay myself a salary, and again, I pay my faire share of taxes on that income. If and when it is possible to free up earnings in the form of dividends, I pay taxes on those dividends. In other words, I pay taxes. As you know, the taxes that other business owners and I pay are completely on par with the taxes paid by any of our salaried neighbours*. If productive dialogue is to continue on this matter, the Prime Minister and you, the Minister of Finance, would be well advised to change your rhetoric. In good faith, many small business people have legitimately structured their finances in accordance to the rules that have been made available to them. They have planned their family’s financial security and retirement savings strategy around a promise from their elected officials that the rules will not arbitrarily change in mid-stream. No good comes from antagonizing people by branding them as elite, loop-hole profiteers or tax cheats in front of their fellow tax payers.

*The Canadian income tax system is designed so that the combined corporate and personal tax paid on income earned through a corporation and distributed as a dividend to an individual shareholder is roughly equivalent to the income tax that would have been paid if the income had been earned directly by the individual. This is commonly referred to as "tax integration". - source: Department of Finance Canada

Perspective on Passive Investments: 

Payroll costs represent 80% of my company’s overhead and I pay my employees every two weeks, while client revenues only come every 30, 60 or sometimes 90 days. Retained earnings, held in a holding company, are a highly important and strategic management tool that are ultra-necessary for the healthy management of cashflow in a business environment that is cyclical. In down-times, many entrepreneurs need to be able to re-inject funds into their companies and don’t want to have to be forced to borrow to do so. I understand that a salaried person socking otherwise taxable money away in an incorporated trust is perhaps your target here, but realize that many holding companies with passive income exist for a purpose that is much more honorable, as a buffer to manage cash-flow and avoid the high costs of dealing with the banks. When retained earnings are not needed, any wise manager is going to invest that money so that it makes interest while it is undistributed. When it is re-injected, that manager is going to structure its repayment over time and charge a reasonable amount of interest for the trouble. In each case, the government already taxes the interest the holding company makes - which is fair.  Please be very careful in the way passive income is framed and I would suggest that in changing the rules around the way a holding company functions, that you make every effort to not throw the baby out with the bathwater!

Sprinkling: If my family collectivley makes $100 000 from one salary and another family makes collectively $100 000 from two 50K salaries, then my family is unfairly taxed versus the other because my family is taxed in a higher bracket.  Your glass is half empty, mine is half full, but it is the same glass.  Income sprinkling levels the playing field from a  household income perspective. 

Perspective on income sprinkling:

As with many small business owners, the last person in my business to be paid is me. I pay suppliers, employees, lease-holders, governments, banks and, if anything is left over, I pay myself. Like many entrepreneurs, I have worked hard to grown my business to get it to a point that it can pay me a regular salary and, in good years, a bit of profit. It was not always the case. In the beginning, I supported myself with my own savings; then I graduated to sporadically paying myself when there was enough profit to allow it; after a few years, the business was stable enough for a small, regular salary. Fourteen years later, I can comfortably say that I have some financial security, but the first 3 or 4 years were inconsistant and lean. What's more, a bad turn in the economy, and I am back to square one. I assume the risk, but so too does my family. In fact, had income sprinkling existed at the time, my wife’s salary, which was in a higher tax bracket, could have been shared more fairly across our household in those lean years.  Starting a business is a household decision, with impacts on all family members. It involves risk and sacrifice of the entire household. How many entrepreneurs are able to put all their added energy into starting their business because their significant other stays home to take care of the family? Who has earned that income ultimately?

In fact, some could argue that income sprinkling is a much fairer way to tax the modern family and should be applied universally to all households.

I fail to see a loophole in income sprinkling. In fact, some could argue that income sprinkling is a much fairer way to tax the modern family and should be applied universally to all households. The difference in our perspective is that you compare two individual earners and leave out the rest of their families when you describe the dynamic at play. If my family collectivley makes $100K from one salary and another family makes collectively $100K from two 50K salaries, then my family is unfairly taxed versus the other, because my family is taxed in a higher bracket.  Your glass is half empty, mine is half full, but it is the same glass.  Income sprinkling levels the playing field from a household income perspective. It is disingenuous of you to frame income sprinkling only from the perspective of the higher income earner of a given household.  Sprinkling is, after all, only an advantage if one or more members of the household are in a low income bracket. It is hard to convince me that you are targeting the 1% when the plan only works if, by your own admission, there has to exist 1) an income inequity within the household; and 2) the incentive to sprinkle income literally goes away the minute one person makes more than two times the lowest limit of the highest tax bracket (the potential advantage is on a curve, not a straight line to infinity). This change will not affect the truly wealthy in any significant way whatsoever, but will grab taxes from a large swath of upper middle income earners, most of whom are the key drivers of the economy and are the future employers of the people who vote for you.

Perspective on Capital Gains:

On this issue, I invite you to tread VERY carefully. In good faith, business owners across the country have sacrificed short term gains (salary and dividends) to create potential value in their businesses. Value that will one day be rewarded with the transfer of the business and the promise of capital-gain exempt dollars (if they are lucky). This is not a small consideration. Less short term salary means a reduced capacity to invest in RRSP’s and other vehicles reserved for those salaried individuals to whom you like to compare business owners. When you play with capital gains, you are effectively playing with people’s retirement savings. These are not short-term schemes put in place on a whim. After 15 or 20 years in business, an entrepreneur cannot simply shrug off a change in the rules and go back to the drawing board. Changes to capital gains rules can have potentially devastating impacts on the very people that your government is counting on to grow our economy. 

Using a shotgun to kill a fly

We can all agree that the goal of closing loopholes is honorable and that rules should be put in place to eliminate tax cheaters. In changing the rules, the wise government should take a page from our own justice system. The rules of law in Canada state that an individual is innocent until proven guilty. Why? Because we, as a society, have said that we would rather let the odd guilty person go free rather than imprison even one innocent. How many honest, tax-paying business owners and economy-growing entrepreneurs is this government willing to throw under the bus under the banner of rounding up a few tax cheats of their own creation? 

Yours sincerely,

Dan Nielsen