Interpreting tax changes

The government’s proposed changes to the taxation of small business has heated up considerably.

Opposition by those small businesses most affected, including farmers, has forced the government into sober second thought.

Part of the opposition has been stimulated by a belief that the government was making unfair reversals of past tax policies designed to recognize the risks taken by small businesses in contributing to employment and additional tax streams to government.

Interpretation of the words the government is using throughout the proposed tax changes will become paramount to how the changes are deployed.

Income sprinkling and the taxation of passive investments are two examples.

Income sprinkling is really in-come splitting, which is allowed under the Tax Act in certain circumstances.

Another vague guideline relates to (directly or indirectly) salary, wages, remuneration and dividend payments, which must be distributed to children only if it is reasonable in the circumstances.

The government suggests the term “reasonable” is when children are either “actively engaged” or “involved” in the business, without defining what the terms mean. This leaves the interpretation to Canada Revenue Agency.

As to passive income, in some cases it is estimated that a recipient will pay a combined 73 percent tax after it flows from the tax paid at the corporate level to the personal tax on the dividends. This has not been clarified because no rates have been announced yet.

Placing passive income in a slightly different light, when do working capital or cash reserves become “excess”?

Farmers see good years and bad. To ensure the ongoing security of the farm, annual operating profits are accumulated in good times in anticipation of poor ones.

Who has the right to determine when working capital or cash flow becomes excess? Unfortunately, it will probably fall to the courts, at considerable cost and time to the farmer.

Working capital and/or cash reserves, while technically determined on a case by case basis, are generally limited to one operating cycle. Farmers have a longer view than one operating cycle, which means incidental income earned from working capital or cash reserves should not be subject to the holding of passive investment income under the new proposals.

When it comes to capital projects, farmers who have documented and planned capital projects that require more working capital or cash reserves beyond their annual operating cost should not be unduly taxed under this new proposed legislation.

This suggests, at the very least, that government isn’t sympathetic to the business needs of this tax-paying community or just doesn’t understand the nature of the business.

The government announced Oct. 18 it would allow a $50,000 threshold on passive income. That would imply $1 million in savings or cash reserves, based on a five percent rate of return.

This might be sufficient for some but not all.

Also fuelling opposition is the government’s characterization that changes were necessary be-cause taxpayers were abusing the system. With this flawed argument, the government is risking the trust of Canadians by blaming them for insufficient funding of government spending programs.

Grant Diamond is a tax analyst in Saskatoon, SK., with FBC, a company that specializes in farm tax. Contact: fbc@fbc.ca or 800-265-1002.

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