Ottawa targets income ‘sprinkling’ loophole that lets wealthy Canadians reduce tax bill

Proposed reforms to be unveiled by Finance Minister Bill Morneau on Tuesday would crack down on those who use private corporations to spread income among family members, according to documents obtained by the Star.

 

Thestar.com
July 17, 2017
By Robert Cribb

A new federal blueprint for closing tax loopholes unfairly benefiting the wealthy will target Canadians who use private corporations to “sprinkle” income among family members to lower their collective tax burden, according to a Department of Finance document obtained by the Toronto Star.

 

Finance Minister Bill Morneau is scheduled to unveil a package of proposed reforms at a press conference Tuesday morning, part of an ambitious commitment to crack down on tax avoidance and evasion that emerged in the aftermath of the Panama Papers.

 

“There are signs that our system isn’t working as well as it should, specifically when it comes to private corporations,” writes Morneau in an opening letter contained in the 63-page report. “There are worrying trends. There is evidence that some may be using corporate structures to avoid paying their fair share, rather than to invest in their business and maintain their competitive advantage.”

 

The government is launching a 75-day public consultation on the proposed measures that are designed to target tax advantages not available to most Canadians.

 

“Over the last decade, the number of such private corporations has increased substantially and evidence indicates that a significant share of taxable income has been shifted from the personal to the corporate tax base,” reads the report.

 

Income sprinkling is a key method of shifting the tax burden from individuals to corporations, the report says.

 

Wealthy Canadians can now legally reduce their tax obligations by routing their incomes through private corporations. They then pay salaries to family members, such as their children, who are subject to lower personal tax rates or none at all.

 

The government is working on new rules that would “help to determine whether compensation is reasonable, based on the family member’s contribution of value and financial resources to the private corporation,” reads the report.

 

Morneau writes: “When the rules are used for personal benefit, they are not contributing to growing our economy. Rather, such practices can undermine confidence in our economy by giving tax advantages to a select few. We don’t think that’s fair.”

 

As an illustration, the government report presents the hypothetical comparison of two wealthy Canadians who both earn $220,000.

 

One of them, an employee, pays $79,000 in annual taxes.

 

The other, who owns a private corporation, pays $44,000.

 

That $35,000 tax break takes advantage of an accounting trick. The private corporation owner pays lower small-business tax rates and “sprinkles” a portion of the profits to a spouse and two children through low-tax dividends.

 

The report does not address the issue of a public registry of corporate ownership in Canada - a measure widely considered to be an important step in the fight against tax evasion and avoidance.

 

A Toronto Star investigation in January detailed the culture of corporate secrecy in Canada that can make it impossible to know the identity of real business owners - or “beneficial” owners.

 

Britain adopted a public registry of “beneficial” corporate owners last year. It has been hailed by law enforcement and transparency advocates internationally as a breakthrough in removing the corporate veils that facilitate secret money flows.

 

While absent in the report, a public corporate registry remains on the table, said Dan Lauzon, a spokesperson for Morneau.

 

“It is definitely not on the back burner,” he said. “It just is not a part of this paper.”

 

In a May speech in Toronto, Morneau talked about the lack of Canadian corporate ownership transparency as a “blind spot.”

 

“We know we need to improve the availability of beneficial ownership information here at home to ensure law enforcement and tax authorities have timely access to this information to combat money laundering, terrorist financing, tax evasion and tax avoidance,” he said. “We can’t sit back and wait for another Panama Papers to tell us whether or not someone may be trying to hide their income from taxation.”

 

Achieving that will require provincial co-ordination, he said, given that only 10 per cent of Canadian companies are federally incorporated - the rest are in provincial registries.

 

The issue was on the agenda at a June meeting of finance ministers in Ottawa.

 

“We discussed ... ways to work together to develop a national strategy aimed at improving the availability of beneficial ownership information,” reads a Morneau press release following the meeting.

 

Lauzon said Morneau’s initiative on the registry was “well received” by provincial finance ministers at the table.