Taxation: The hunt for cash

Governments looking to boost revenue also are trying other strategies, including closing long-standing loopholes, tightening compliance and collection efforts, and selectively raising taxes where they can get away with it.

It’s a tough balancing act, trying to achieve policy goals while taking account of political realities. That leaves most governments with few appealing options.

“You can try to tax the rich, but there are not too many of them,” says Mike Moffatt, assistant professor in business, economics and public policy with the Richard Ivey School of Business at the University of Western Ontario. “You can try to tax the poor, but they have no money. And the middle class is where all the votes are, so governments are reluctant to raise taxes on them.”

Many economists and tax experts suggest that from a policy point of view, consumption taxes are the fairest, least economically disruptive way to raise a lot of revenue quickly. However, governments are loath to raise consumption tax rates.

“Generally speaking, any tax that people see everyday is just going to annoy them,” Moffatt says. “If you raise gas taxes or you raise the GST, or you raise something very visible, the consumer is reminded of that every time he or she goes to Tim Hortons.”

And although governments could raise corporate tax rates, the overall trend over the past few years has been for governments to lower those taxes. In fact, the Department of Finance Canada has gradually lowered the federal corporate tax rate to 15% from 21%, where it stood in 2007.

“To attract foreign investment and to remain competitive with low corporate-tax rate jurisdictions such as Hong Kong and Singapore, governments have been compelled to lower rates,” says Kiridaran Kanagaretnam, professor of accounting and financial-management ser vices at the DeGroote School of Business at McMaster University in Hamilton, Ont.

Governments also are feeling the pressure from voters, who are bearing the brunt of publicspending cuts. That has led to the call, in some quarters, for higher rates on the wealthy, whom, some feel, should be contributing more.

In April, the Ontario government announced a new “deficitfighting” high-income tax bracket with a provincial rate of 13.16% – an increase of two percentage points on individual taxable income above $500,000 a year in 2013. (For 2012, the rate has gone up by just one percentage point, to 12.16%.) Ontario also has an existing 56% surtax, so the top provincial rate on annual income above $500,000 will be 20.53% in 2013 – an effective increase of 3.12 percentage points vs 2011.

The Ontario government expects the new tax to result in an additional $280 million of tax revenue for 2012-13 and $470 million in 2013-14. The province intends to return to the 11.16% rate once the budget becomes balanced in 2017-18.

Although seemingly popular with the public, the tax increase has received negative reviews from both tax experts and economists, who believe the tax hike is likely to raise much less revenue than the government projects.

“It makes the assumption that people who have access to the best tax and accounting advice will ignore it,” says Kevin Milligan, associate professor of economics at the University of British Columbia in Vancouver.

Economists and tax experts suggest that although the tax hike affects relatively few Ontarians (an estimated 23,000), the rushed way in which it was conceived and introduced doesn’t send the right message to taxpayers.

“This kind of ad hoc policy-making doesn’t show any kind of long-term thinking about what the economy needs to grow and expand,” says Robin MacKnight, tax expert and partner with Markham, Ont.-based law firm Wilson Vukelich LLP. Taxpayers, especially entrepreneurs and investors considering new ventures, need a some degree of certainty in tax policy before they consider making investments, he adds: “People start to wonder, ‘What are these guys doing? Are they doing any thinking about this?'”

@page_break@ There also is much skepticism among tax experts and economists that the government will be able to balance the books as quickly as it projects, or that lower rates will be restored.

“Previous experience suggests that once taxes are introduced, they’re slow to be removed,” says Jason Safar, a partner in the tax services practice with PricewaterhouseCoopers LLP in Mississauga, Ont. “People adjust to the higher tax, and then there’s little political incentive to remove it.”

Over the previous several federal budgets, Finance Canada also has looked at putting an end to what it considers overly generous tax planning strategies, or loopholes, such as the tax changes it made in the 2011 budget affecting donations of flow-through shares to charities.

In general, tax experts applaud the federal government for closing loopholes, but these experts caution that every new piece of legislation simply makes a complicated tax system more so.

“It sometimes seems that the government is working to add loopholes as fast it takes them out,” Moffatt says. “For every loophole removed, we get a child tax credit or a fitness credit or some other credit. I think there’s a real need to clean up the tax act.”

Because raising taxes can be so difficult and there are only so many loopholes to close, tax agencies globally have begun to take a more aggressive approach to compliance as a way to generate revenue.

In Canada, the Canada Revenue Agency appears to have been boosting its auditing efforts and applying penalties in situations in which the agency might have showed leniency once.

“I think it’s easier for governments to try to collect the money that way,” Moffatt says. “There is a little less sympathy for people who owe taxes. It’s more politically palatable than raising them.”

For more stories on current issues in Canadian taxes, see the special BYB section in this issue.

Working around the surtax

Ontario’s recently introduced deficit-fighting high-income tax bracket means top-earning Ontarians are likely to face a stiffer tax bill, starting this year. (See story on this page, but beginning on page 1.)

Although there aren’t too many ways to plan around the rate increase, tax experts say, there are a couple of strategies that individuals can use to mitigate its effects.

“The more money you make and the more complex your financial structures, the more you’re able to do,” says Jason Safar, a partner in the tax services practice with PricewaterhouseCoopers LLP in Mississauga, Ont.

Taxpayers who have corporate structures, such as an investment holding company, might choose to leave income in the structure rather than taking it out. (See story on page B6.) That’s because corporate tax rates will be lower than the highest personal rates in 2013 and thereafter, giving these taxpayers the opportunity to defer taxes.

“All private-business owners have the ability to set the level of income they wish to receive,” Safar says. “Why would you pay yourself more than $500,000 now if you have other sources of wealth to fund your lifestyle?”

As a consideration in the short term, high-income taxpayers might consider receiving income in 2012 rather than delaying until next year, to avoid the full rate hike.

“Any time that you know for certain that rates are going to go up the following year, you try to advance income to the current year,” says Jamie Golombek, managing director of tax and estate planning at Canadian Imperial Bank of Commerce’s private wealth-management division.

And it’s always possible for taxpayers to leave Ontario and move to a lowertax jurisdiction. “If you’re contemplating the sale of a company or exercising some stock options, it may be a consideration, in the year that you sell, to move to another jurisdiction and have that entire gain taxed there,” Golombek says. “Depending on the size of the gain, you could save yourself hundreds of thousands of dollars.”

In fact, the possible tax savings as a result of relocating from Ontario to Alberta, where provincial taxes are set at a flat 10%, could leave at least a few high net-worth individuals considering a move westward, Safar suggests. On a $1-million income, barring any other tax planning, total federal and provincial taxes in Ontario would result in a $451,000 tax bill vs $376,000 in Alberta, a difference of $75,000.

“This [Ontario] tax is targeting a segment of the population that has mobility,” Safar says. “It’s not that hard for people of wealth to change residency.”

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