RMT in the Financial Post
DECEMBER 1, 2017
Both the Federal and Ontario government has made a great deal of noise about helping entrepreneurs by reducing the corporate tax rate. What they didn’t mention was:
- the dividend tax rate has gone up so that the owner is no better off once the money is paid out by way of dividend to the owner
- historic retained earnings are also subject to a higher rate
RMT Managing Partner Jeff McRae spoke with the National Post’s Jesse Snyder about the impact of proposed small business tax cuts. See the full article below or click here for the Financial Post link.
OTTAWA — Business owners will face higher taxes on retained earnings after Ontario lowers its small business rate, following a similar move in Ottawa that has led to higher taxes on some corporate dividends, according to analysts.
On Nov. 14 Ontario announced it would reduce its small business tax rate from 4.5 per cent to 3.5 per cent to counteract its recent minimum wage hike, one month after Ottawa made a similar cut.
The tax cuts were widely welcomed by the business community, but experts say the changes come at a lesser-known cost: an increase in the personal income tax rate on so-called “non-eligible” dividends paid out by Canadian controlled private corporations (CCPCs).
“It effectively means that your total rates will be going up,” said David Malach, a tax litigation lawyer at Aird & Berlis LLP in Toronto.
In its fall economic statement, Ontario also said that its tax credit on non-eligible dividends would be reduced alongside the reduction in its small business tax rate, effectively raising overall tax rates on those dividends by one per cent.
The Ontario finance department said Wednesday it would be lowering the tax credit “in effect, over-refund corporate tax.”
Ottawa’s changes mean that tax rates on non-eligible dividends for a person in Ontario earning $50,000 will now increase from 17.4 per cent to 19.3 per cent, according to an estimate by Allan Lanthier, a former chair of the Canadian Tax Foundation and now-retired partner at Ernst & Young. For Ontarians in the highest income tax bracket, taxes on non-eligible dividends will rise from 45.3 per cent to 46.8 per cent.
Ontario’s plan to reduce its small business tax rate will further increase taxes on non-eligible dividends, experts say. Already, taxes on non-eligible dividends for the highest tax bracket will rise in every province between 2017 and 2019, according to accounting firm EY, due to the reduction in overall corporate rates.
The adjustment is a result of a concept in tax policy called “integration,” which effectively aims to create a balance between personal and corporate taxes on an aggregate basis.
“This isn’t a surprise to us—we’ve been down this road before,” said Jack Mintz, a tax expert at the University of Calgary’s School of Public Policy. “When there has historically been a reduction in the small business rate, it does then require an adjustment in the dividend tax credit.”
Tax professionals interviewed by the Financial Post agree that the balance has been tipped in recent years toward personal tax rates, in turn disadvantaging corporations — a phenomenon known as “under-integration.”
“There is a bit of unfairness right now in that we don’t have perfect integration in that sense,” Malach said.
The federal government’s tax hike on the dividends was first mentioned in the footnote of a document released Oct. 16, the day the Trudeau Liberals announced the small business tax reduction from 10.5 per cent to nine per cent in 2019. The footnote said there would have to be an “adjustment” in non-eligible dividends. In a later document dated Oct. 24, it released more details about the impact of the changes, which resulted in a roughly one-to- two-per cent increase on non-eligible dividend rates.
Finance Minister Bill Morneau’s decision to reduce the small business rate was widely viewed as an attempt to appease CCPC owners, some of whom were deeply opposed to the minister’s proposed tax changes on private corporations.
“We will make sure this small business rate is effective in encouraging businesses to grow, buy new equipment and hire more workers,” Morneau said in a written statement when he announced the corporate tax reduction.
Jeff McRae, a managing partner at Rosenswig McRae Thorpe LLP in Toronto, said the dividend change will impact smaller businesses earning less than $500,000 annually, because they are eligible for the lower small business tax rate, and therefore pay the higher, or “non-eligible,” rate on dividends.
He said the change will be felt most acutely by business owners that are nearing the end of their careers, and will soon begin pulling money out of their CCPCs. Such business owners will have paid the higher corporate tax rate over the life of their CCPC, but will now also be exposed to the higher non-eligible dividend rate.
“The downside is all of your old retained earnings, all of the money you’ve built up over the years in your company, will all get taxed at the new, higher personal rate,” McRae said.
However, Dan Kelly, the president and CEO of the Canadian Federation of Independent Business, said his organization still supports the small business tax reduction, saying on the whole it will benefit most of its members. The CFIB says the corporate reduction will loosen up hundreds of millions in available revenue for small businesses.
The CFIB has been deeply critical of the other changes proposed by Ottawa, particularly a higher tax rate on some passive investments inside CCPCs.
“Of the many concerns we have about tax changes, this one is quite low down the list,” Kelly said.
The Conservative government promised to lower the small business tax rate in 2015 from 11 per cent to nine per cent over four years. In March 2016 the Liberals froze the rate at 10.5 per cent, before pledging to follow through on the cut to nine per cent in October.
The small business tax rate was also reduced in 2007 from 12 per cent to 11 per cent. In each case, tax rates on dividends were raised in order to integrate personal and corporate taxes.
Personal tax rates on dividends have risen sharply in recent years. In 1989, the highest rate on dividends was 32 per cent, while personal income tax rates were around 46 per cent. The highest rates on dividends stayed around that level until 2007, when they began increasing steadily to just over 48 per cent today. Personal tax rates for top-bracket earners, meanwhile, are currently just under 54 per cent.