October 16, 2019 Update: This blog has been updated to include information released since the original publication. These updates have been noted where applicable.
The 2019 federal election is fast approaching, and the national political parties are busy releasing platforms outlining their respective visions for Canada. One of the most impactful areas on the lives of all Canadians addressed in these documents is, of course, the proposed tax changes. Accordingly, the purpose of this blog is to analyze and compare the tax changes promised by each party, and get a sneak preview of the tax policies that may shape the lives of Canadians for the coming decade.
This election is particularly interesting because of the bold new tax ideas thrown around: net-worth tax, the so-called robot tax, and of course, the debate around capital gain inclusion rates. Based on what the parties have so far released, we have prepared a table to help everyone keep track of each party’s tax promises, as well as the estimated financial impact to the government for each proposal, as analyzed by the Parliamentary Budget Officer (“PBO”).
Click below to download table:
Let’s strip away the campaign rhetoric, dive into some of the highlights, and see how these proposals might impact your pocketbook.
Federal Personal Tax
Tax rate changes
Personal income tax rate changes are always the most visceral aspect of a tax platform because every working adult is familiar with the sting of personal taxes.
The Conservatives are proposing to reduce the income tax rate of the bottom bracket ($12,069 to $47,630) from the current rate of 15% to 13.75% over three years, starting in 2021. Since Canada has a marginal rate system, everyone above the bottom bracket will also benefit from this rate cut. For an individual who makes $47,630 and above, the federal tax savings under a Conservative Government will be as follows (note that the savings progressively decrease for income below $47,630):
- $185 in 2021
- $379 in 2022
- $482 in 2023 and subsequent years.
The Liberals took a slightly different approach by promising to increase the federal basic personal amount to $15,000 from $12,069, phased in over four years for Canadians earning under $147,000.
The federal basic personal amount is a tax exemption that every Canadian individual is entitled to, meaning the first $12,069 of income is always tax-free. The basic personal amount increases each year with inflation, and the Liberals will accelerate this increase to ensure the amount reaches $15,000 by 2023. The Liberals claw back these tax savings once taxpayers earn over $147,000, and eliminate them for taxpayers who earn an income of $214,557 or more.
What’s the bottom line under a Liberal Government? For someone who makes between $15,000 and $147,000, the tax savings will be as follows:
- $138 in 2020
- $186 in 2021
- $232 in 2022
- $287 in 2023 and subsequent years.
Although the annual tax savings from these cuts are relatively small individually, they are very costly for the government. According to the PBO, the Conservative tax cut will cost the government $14 billion over the next four years, while the Liberal tax cut will cost $18 billion over the same period.
The NDP plans to increase the tax rate for taxpayers in the top income bracket ($210,372 and above) from 33% to 35%. Putting this into context, the increase would push the top combined federal and provincial marginal tax rate over 50% for 10 of the 13 provinces/territories, hitting highs of 56% in Nova Scotia and 55.5% in Ontario.
The People’s Party promises to extinguish Canada’s deficit in two years and then, like the Liberal Party, increase the personal exemption to $15,000. Further, the People’s Party plans to reduce the number of personal tax brackets from five to two. Income of $15,001 to $100,000 will be taxed at 15% and income over $100,000 will be taxed at 25%.
Capital Gain Inclusion Rate
Canada has always had preferential tax treatment for capital gains. In fact, before 1972, capital gains were not taxed at all. Canada started taxing capital gains in 1972 at a 50% inclusion rate. The inclusion rate went up to 66.67% in 1988, and to 75% in 1990, before dropping back to 66.67% in February 2000 and then to 50% in October 2000.
Why the preferential treatment? After all, the Royal Commission on Taxation (the last comprehensive review of the tax system conducted in Canada) recommended in 1966 that capital gains be fully taxed, because “a buck is a buck.”
There are several arguments for preferential treatment. For instance, the appreciation in the value of an asset could be partially or entirely due to inflation, where the owner of the appreciated asset is no better off economically. This is a key reason for the exemption of capital gains on principal residences.
For example, given the hot real estate markets in Toronto and Vancouver, if a Torontonian or Vancouverite were taxed on the gain on the sale of their home, the after-tax sales proceeds would not be enough to purchase another home of similar value. Another reason for preferential treatment is to compensate for the fact that earning a dollar of capital gain typically requires more risk than earning a dollar of interest income, for example. Investments grow the economy and add jobs, and thus should be encouraged. Arguably this preferential treatment also attracts investment capital to Canada.
The People’s Party aligns with these arguments wholeheartedly, promising to make capital gains completely tax-free. On the other extreme, the Green Party promises to tax 100% of capital gains, but only for individuals with a net worth over $3 million and corporations (excluding small businesses). The NDP will increase the capital gain inclusion rate from 50% to 75%, bringing the effective tax rate on capital gains generally in-line with that of dividends.
The Liberals and the Conservatives are silent on capital gains in their election platform, presumably satisfied to leave the inclusion rate at 50%. However, the Liberals did indicate in their policy platform document that they will undertake a comprehensive review to ensure “wealthy Canadians do not benefit from unfair tax breaks” – prompting speculation by some political watchers that a post-election increase to the capital gains inclusion rate may be in the cards.
It will be interesting to see where this issue ends up. Capital gains taxation is an issue that pretty much all voters pay attention to because it impacts almost all Canadians. It is likely fair to say that regardless of which party wins the 2019 election, this will not be the last time the tax treatment of capital gains is in the spotlight.
Employee Stock Options (Updated 10/16/19)
While technically employee stock options are employment income as opposed to capital gains, they have long enjoyed similar treatment to capital gains through a 50% deduction. The presumed intent of this preferential treatment is to help cash-strapped startup businesses acquire top and increase overall employee engagement.
In Budget 2019, the Liberals introduced a $200,000 cap on the amount of stock options eligible for the 50% deduction for employees of “large, long-established, mature firms.” Further information was released on this proposal in June 2019 including the exclusion of CCPC’s from this cap and a deduction for employers in respect of options exercised that were ineligible for the stock option deduction. These new rules are effective for options granted on or after January 2020.
The Conservatives have not addressed employee stock options in their platform, so if the Conservatives or Liberals are elected, we could likely expect the recent Liberal changes to apply as-is for the foreseeable future.
The NDP and Green Party have taken this one step further by proposing to disallow the stock option deduction altogether, resulting in the entire exercised amount being fully taxable as employment income.
The Conservative Party’s Proposed Partial Reversal of the 2018 Anti-Income Splitting Rules for Owners of Private Businesses
The “tax on split income” (TOSI) rules introduced by the Liberal Government in 2018 were a punitive change that mostly affected middle-class business owners, leaving high-income earners untouched. These rules are notorious for their complexity and for the punishing effect they have on small business owners. The general thrust of the TOSI rules is to prevent family business owners from taking advantage of the lower tax brackets of family members who have not actively worked in the business.
This might be a sensible policy objective, particularly in situations where family business dividends are paid to young adults still attending school. However, the TOSI rules extend much beyond that.
For example, consider this common fact pattern: Mr. Apple and Mrs. Apple are 50/50 owners of a corporation that runs a neighbourhood barbershop in Ontario. They each receive $40,000 of dividends from the after-tax earnings of the corporation in 2018. Mr. Apple works full time in the business, but Mrs. Apple stayed home and managed things on the home front so Mr. Apple could focus on the family business. Mrs. Apple was never directly involved in the business and never directly invested cash into it.
Before TOSI rules, the corporation would pay tax on its earnings, and then pay dividends to the family. The family would pay approximately $3,000 of personal income tax on the dividends. But now, after the implementation of the 2018 TOSI rules, the family tax bill has skyrocketed to approximately $20,000, unless Mrs. Apple can somehow justify her dividend to CRA as “reasonable.”
This represents a tax increase of over 600%.
To understand the complexity of the rules, take a look at our blog released earlier this year, which discusses the TOSI rules and highlights some of the grey areas. Note that wealthy families whose family members are already at the top marginal tax rates were not affected by these rules. This was a tax grab aimed squarely at small family businesses.
The Conservatives are proposing to exempt spouses and common-law partners from the application of the TOSI rules, but presumably, keep the rest of the rules intact. This will lower the Apple family’s personal tax bill for dividends paid from after-tax corporate revenues back to approximately $3,000.
The 1% Wealth Tax
The NDP and Green parties propose that Canadian resident “economic families” with a net worth over $20 million pay an annual net wealth tax of 1%, calculated based on all of the assets and liabilities of the economic family. But lottery lovers rejoice! Lottery winnings are explicitly exempt from this tax.
Canada has never had a true wealth tax, but this proposal is conceptually similar to municipal property taxes. With property tax, the tax you pay is a percentage of the value of your house (or in this case, your wealth), so the richest pay more. And while new to Canada, wealth taxes are used elsewhere in the world. For instance, the Netherlands has long had a wealth tax, but the concept of a wealth tax really gained traction in North America as part of the US Democrat primary race.
The idea is not without merit. Wealthy families typically hold assets that have appreciated over a long period, and until the accrued gains on these assets are realized (dividends or a sale of the family business), taxation of that wealth is deferred. Since such families would often only realize (for example, by paying dividends out of the family business) the income needed to cover their personal consumption, the personal income tax they pay each year may not reflect the extent of their wealth.
A wealth tax would force the family to pay tax every year based on that wealth irrespective of realization, similar to municipal property taxes. However, the devil is in the details. From what we can tell, the NDP’s wealth tax proposal will simply be an incremental tax, creating straight-out double taxation for affected families.
Let’s use an example to illustrate: Mr. MoneyBags owns a business and has a net worth of $50 million. Since Mr. MoneyBags earned his wealth, rather than winning it in a lottery, he is subject to the new 1% wealth tax, which amounts to $300,000 a year (being $50 million minus $20 million, multiplied by 1%). Unfortunately for Mr. MoneyBags, he will be subject to personal tax again on the same value when his business pays him a dividend or when he ultimately sells the business (or upon the deemed disposition at his death).
A well-designed wealth tax would inherently require complete structural reform of the Canadian tax system to avoid distortions such as this. In the Netherlands, for example, their wealth tax generally does not result in double taxation because capital gains are generally exempt on assets subject to the wealth tax, and any tax on dividends received reduce the wealth tax. We don’t believe layering a wealth tax on to our current income tax regime, without comprehensive tax reform, makes good policy sense.
Additionally, a wealth tax may be challenging to implement. For example, how would assets like shares of a private corporation be valued, and does the value of the shares change depending on whether you are a minority or majority shareholder? Is Mr. MoneyBags’ business worth $50 million, $30 million, or $100 million? Also, defining an “economic family” will be difficult.
An NDP or Green government would need to find the right balance between tracing wealth to a true family unit and preventing families from circumventing this tax by moving assets around. That said, just because something is hard doesn’t mean it we shouldn’t do it. The government should consider a wealth tax when, or perhaps if, Canada eventually conducts a comprehensive review and reform of the tax system (and neither parties are committing to real comprehensive reform). Blindly rushing into bold tax changes may not be the best idea.
The Conservative’s Green Homes Credit
As most tax advisors will tell you, personal tax credits are the bane of our existence. The actual tax savings they typically generate are usually too small to justify the amount of paperwork they create. The NDP, Conservative, and Green parties have all proposed a handful of well-meaning personal tax credits to promote desirable activities and habits, and you can review them in our comparison table.
There is one particularly big-ticket tax credit that sticks out. If elected, the Conservatives will introduce a new Green Homes Credit, where the government will refund 20% of the cost of energy-saving renovations between $1,000 and $20,000 for 2020 and 2021. This works out to a maximum benefit of $3,800 each year, and the credit is “refundable,” meaning that you will get a cheque for this amount even if you otherwise have no income tax due. This is quite generous, but how well it will be received may depend on how difficult it is for renovations to qualify.
Carbon Tax and Certain Other Sales Tax Proposals
According to the fountain of all knowledge (Wikipedia), a consumption tax is a tax levied on consumption spending on goods and services. The GST/HST system of Canada is a prime example of a consumption tax. Most economists agree that our tax system is too reliant on income tax, and not enough on consumption taxes (e.g. GST/HST).
There are many pros to a consumption tax, including a relatively stable tax base compared to income taxes, as consumption generally fluctuates less than income does. As well, there are fewer opportunities for taxpayers to engage in planning to reduce consumption tax (whereas income tax can be deferred by delaying a sale, for example). Some also believe that high-income taxes discourage investments because they significantly reduce the net rate of return on investment, while a hefty consumption tax does not (it will discourage consumption, but theoretically not investments).
We are not economists, however. So, we will leave it at that.
Here are some of the consumption tax highlights in the parties’ platform:
The Conservatives will repeal the federal carbon tax. This will lower heating bills and fuel costs for Canadians. For example, the carbon tax has now added 4.4 cents to each litre of gasoline, and this is expected to increase if not repealed. Furthermore, the Conservatives promise to remove sales tax on home heating and energy bills, which will further reduce these costs.
Both the NDP and the Green parties will remove sales tax on zero-emission vehicles to encourage the adoption of these vehicles. Also, the NDP will waive sales tax associated with the construction of “affordable rental units” (whatever that means), whereas the Green Party will exempt sales tax related to the conversion of condos into rental apartments to encourage increases to the rental housing inventory in Canada.
Going the other direction, the Liberals will introduce a new 10% sales tax on certain luxury goods: cars, boats and aircrafts worth more than $100,000. Commercial vehicles will be exempt from this new sales tax. The NDP has proposed this luxury tax should instead be 12%. Not to be outdone, the Green Party will introduce a new 10% sales tax on sugary drinks (note to ourselves: better stock up on sodas for the Moodys’ office cooler). (Updated 10/16/19)
Federal Business Income Tax
Corporate tax rate changes
Corporations are subject to income tax on their profits. In a way, corporate income tax is like a downpayment on taxes, because the corporate earnings will be taxed again when they are eventually distributed to the shareholders (who will then pay personal tax on those dividends). Lower corporate income tax means more business earnings are retained to reinvest back in the business, distribute to shareholders, or to invest in other businesses.
Some economic theories propose that corporate income tax should be eliminated, and tax should be collected only when earnings reach the shareholders. While the idea is interesting, we are unlikely to see this in our lifetime. Such a bold proposal would be political suicide and may create issues given the potential longer-term deferral of tax by business owners, simply by not paying out dividends. So, for now, we will have to make do with corporate income tax.
The NDP and the Green Party will increase the corporate tax rate across the board. The NDP will increase it from 15% to 18%, whereas the Green Party will increase it to 21% (but neither party will change the small business tax rate of 9%). A 21% federal corporate tax rate matches the US federal corporate tax rate, but we must note that all US states have significantly lower state corporate tax rates than Canadian provinces and territories. In addition, the Green Party promises to add an extra 5% surtax on the income of banks and levy a 0.2% tax on financial transactions.
The Liberal and the Conservative platforms don’t promise any sweeping changes to corporate tax rates, but both offer targeted tax cuts for green industries. The Liberals will cut the income tax rate in half for companies that develop and manufacture zero-emission technology, and the Conservatives will cut tax rates by two-thirds for income generated from green technology developed and patented in Canada.
The Conservatives will also reverse the 2019 corporate passive income rules introduced by the current Liberal Government. These rules target private corporations that have savings that generate more than $50,000 of investment income per year. This results in the small business tax rate being phased out for these corporations and eliminated at $150,000 of investment income. The rationale for this policy is that corporations that have substantial savings should not be entitled to the small business tax rate.
Many Canadians have criticized these rules. Private companies save up cash to ride out tough business cycles and, since entrepreneurs generally don’t benefit from pension plans, this is one way for businesses to save for the owner’s retirement. It has also been pointed out that these rules do not apply to public and large businesses and are solely targeted at small businesses (because the small business rate is eliminated in any case for those businesses with over $15 million in capital). The Conservative Party’s promise to reverse these rules could yield a maximum federal tax savings of $30,000 per year for private business (more if provinces/territories follow the change).
Both the NDP and Green Party have vowed to remove the 50% deduction for meals and entertainment expenses incurred by corporations. Sole proprietors and “small businesses” will be exempt. Maybe they had trouble getting a lunch reservation at their favourite spot? (Updated 10/16/19)
International tax measures
The Liberal, NDP and Green parties have all paid lip service to cracking down on offshore tax planning:
- The Liberals will “modernize” anti-avoidance rules to prevent companies from shopping for low tax jurisdictions;
- The NDP will compel companies to prove the economic substances of offshore transactions, and
- The Green Party will require companies to prove that their foreign subsidiaries are carrying on substantive economic activities, and
- The Liberals, Conservatives, and NDP have all proposed a 3% value-added tax on various digital giants of varying criteria. (Updated 10/16/19)
We don’t have room in this blog to unpack these promises, but we want to add a few comments. Can the international tax system be improved? Certainly. The OECD’s Base Erosion and Profit Shifting (BEPS) project, of which Canada has been an active participant and key contributor, has been looking at this and all OECD countries have committed to it (with many of the changes being implemented as we write this).
As a responsible global citizen, we believe the right thing for Canada to do in this area is to work with the OECD and implement the recommendations which are relevant to our country. Indiscriminately demonizing offshore transactions or approaching reform in this area in a haphazard fashion, could materially damage Canada’s ability to attract investment from outside the country, or to allow Canadian investors to grow their businesses outside of Canada. In fact, on October 9, 2019, the OECD published its proposal to develop a unified approach to taxing multinational enterprises, including digital companies. The OECD warned the 134 participating countries that unilateral action by individual countries might have negative consequences to an already fragile global economy. (Updated 10/16/19)
While there certainly are bad actors who are hiding funds offshore and evading tax, this does not characterize the everyday offshore transactions and planning that goes on. However, there is a need for the OECD’s digital tax initiative to conclude, so that Canada, together with the international community, can quickly move forward with policies that recognize the changes to how business occurs in the digital economy.
Limitation on Interest Expense
For corporations with net interest expenses of more than $250,000, the Liberals will limit the amount of interest a corporation may deduct in computing its income to no more than 30% of its income before interest, taxes, depreciation and amortization (EBITDA). This measure is intended to address companies over-leveraging with debt, and reducing corporate income with interest expense.
The NDP has jumped on the bandwagon, proposing to limit interest deductions to 20% of EBITDA for companies with net interest expense of more than $150,000. (Updated 10/16/19)
This will be a major change in our corporate tax regime, and details are needed to assess the impact this will have on Canadian businesses. One observation we will make is that when the US adopted similar limitations on interest deductions, the US concurrently cut the corporate income tax rate from 35% to 21%. The Liberals are proposing a similar interest limitation without the accompanying corporate tax rate cut.
Green Robot Tax
The Green Party will introduce a new tax for large corporations, the amount for which will equal the income tax that would have been paid by employees laid off due to artificial intelligence (AI). One can sort of see where they are coming from on this. There is a possibility that AI will take over jobs in the future, and the laid-off employees will no longer receive a wage, and the government will lose out on the personal tax on those lost wages.
However, the design of this tax appears to result in double taxation, since the employer would at the same time pay corporate income tax on the amount of wages that it no longer has to pay since this would have otherwise been a deductible expense from taxable income (and eventual personal tax on additional dividends that the employer will pay to the shareholders). There would be a lot of other implementation issues. For example, what is AI? Does an excel spreadsheet with macros that replaces a data input clerk subject the employer to this tax? What if AI simply reduces someone’s hours?
Back to that pesky discussion of tax reform. As noted above, the last independent, comprehensive review of the Canadian tax system was completed in 1966 by the Carter Commission. That was 53 years ago. Anyone who reads and advises on tax legislation regularly can tell you that tax reform is sorely needed to simplify our tax system and make it more accessible and understandable to every Canadian. Understandably, layering on change after change in the legislation for 50 years has complicated things and created a strangely disjointed tax system.
So, where do our national parties stand on this political hot potato? The Liberal and NDP parties have committed only to reviewing certain tax credits and expenditures that “do not benefit everyday Canadians.” The Green Party has done slightly better by promising to have a federal commission analyze our tax system for fairness and accessibility, however, this does fall far short of the Conservative proposal to engage an expert panel tasked with undertaking a comprehensive, system-wide review to modernize the tax system, while ensuring it is simple and fair.
With the Liberal Party looking for re-election, it is relevant to look back to their 2015 campaign promises and evaluate their work. While the Liberals did not realize two of their main promises of electoral reform and balancing the budget, they successfully legalized marijuana and fulfilled their promises concerning changes to income tax and benefits programs. For example, they did indeed raise the tax rate on income over $200,000 to 33% and reduce the 22% tax bracket to 20.5%.
The 2015 campaign was titled a “Strong Middle Class” and promised to “help families.” Interestingly, the delivery of these promises included cancelling credits such as the children’s arts and fitness credits and the Universal Child Care benefit, replacing those programs with the Canada Child Benefit, which completely phases out after family income of $140,000.
In July 2017, Finance Minister Bill Morneau expanded on the promise to cancel income-splitting along with “other tax breaks for the wealthy” with a set of complicated proposals to combat perceived “loopholes” in the tax system that were seen to benefit private business owners. After an outcry from the business, accounting, and tax community with regards to the “unintended impacts” of these proposals, adjustments were made, and some proposals were abandoned. However, the government passed a large majority of these tax proposals into legislation in one form or another.
While it is fun and intellectually stimulating to consider the proposed tax changes, based on past experience we know that if a party is elected, the tax changes in their platforms as detailed above are more likely than not to become a reality (and if it is a tax increase they are planning, it is a safe bet that it is going to happen).
As a taxpayer, vote “tax” wisely.