Ottawa’s changes to the private corporation and small business tax rules have made the new regime so complex that it’s almost unworkable, tax experts said at a conference panel Monday.
Speaking at the Society of Trust and Estate Practitioners’ annual conference in Toronto, panelists said rules around associated corporations, arm’s-length individuals and various carveouts make it more difficult than ever for many private corporations to claim the small business rate.
“These rules are so complex and the cross-referencing is so difficult to work through that I think it’s pushing the boundary of what non-specialist practitioners are able to do in light of the number of clients it’s going to affect,” says Ian Pryor, founder of Pryor Tax Law in Ottawa. “I think it’s pushing being unworkable.”
Kenneth Keung, director of Canadian tax advisory for Moodys Gartner in Calgary, offered the example of a small business whose owner holds shares in another Canadian private corporation through an ETF. The relationship is subject to a carveout if the person who is non arm’s-length with one corporation holds any interest in a second corporation while providing it a certain amount of property or services.
“Let’s say a family owns a car parts manufacturer. The family patriarch happens to own an ETF, which owns Ford [Motor Company], and that car parts manufacturer earns more than 10% of his income from Ford Canada,” he said.
Keung continued: “Ford Canada is a subsidiary of Ford USA, and Ford Canada is actually considered a private corporation under the Income Tax Act—but because the patriarch owns an ETF that has Ford USA shares in it, technically, they fall under this rule, and all of the income is not entitled to the small business deduction. You can bet your booty that Ford Canada is not sharing its $500,000 [small] business limit with this car [parts] manufacturing company,” Keung said.
He said he brought the issue to CRA for its opinion and the tax agency said, “Yep, this is how we read the rules, too.”
Pryor said CRA says it can’t do anything about the complexity and it’s not likely the government will change it.
He said there are two central theories about Ottawa’s rule changes. One is whether tax professionals are witnessing the gradual phasing out the small business deduction. The second may be a government effort for more revenues through audits.
“These rules are really complex, and the government just allocated $1 billion to auditors. Maybe that’s a good opportunity for them to make some money. I hope that’s not the case, but I think the compliance on this is going to be pretty hard to keep up with for a lot of people,” Pryor said.
There are challenging ways to plan around the rules, the tax experts noted. For instance, a private corporation owner can spin out businesses so that they’re owned by different arm’s-length people, and charge cross fees.
“[But] be careful of the non arm’s-length person providing services or property,” Pryor cautioned. “I think it’s almost guaranteed that there’s going to be unintended situations that are caught.”
He’s also seeing many partnerships move to joint venture structures—though a simple legal conversion can be risky. “If you don’t change the nature of the relationship and the way the business is carried on, not to mention the accounting, I think you open yourself up to challenge,” Pryor said.