Income sprinkling changes could affect many families adversely: PBO report

The income-sprinkling change was among a handful of measures Ottawa insists will target wealthy people who use corporate structures purely as a way to reduce their taxes.

The Liberal government says the income-sprinkling measure is designed to prevent higher earners from distributing income to their children or their spouses within the business when those family members aren’t actively engaged in the business. About 3% of private corporations — or fewer than 45,000 firms — will see an impact from the income-sprinkling rule, the government has said.

Frechette’s analysis found about 11% of the households affected by the changes earn less than $150,000 per year, while 83% of them make less than $500,000 per year and 2% bring in more than $1 million per year.

The budget office laid out several scenarios and its preferred estimate says the changes could generate a tax windfall for Ottawa of about $400 million a year — double the $200-million a year projected in the recent federal budget.

The report, however, notes that the numbers crunched for the budget office estimates differ from those used by the Department Finance of Canada. The budget watchdog also didn’t account for potential changes in behaviour by business owners to avoid a tax increase.

Mostafa Askari, the deputy parliamentary budget officer, said the changes will present a challenge for the Canada Revenue Agency.

“There are so many rules and exemptions that it would be extremely difficult for the CRA to implement this _ there are still a number of loopholes and exemptions,” Askari said. “So, how the companies, the firms will respond to this and how that will affect the overall result, that’s something that we cannot do at this point.”

Frechette’s report also predicts the income-sprinkling change will bring in about $230 million in additional tax revenue for provincial governments in 2018-19, with Ontario easily taking the largest share with a $160-million increase.

The Liberals’ income-sprinkling measure was part of Finance Minister Bill Morneau’s controversial tax-reform proposals for private corporations, which came under fire for months following their release last summer.

The vocal backlash, including public criticism by some Liberal backbenchers, included warnings the changes would hurt the very middle class the Trudeau government has claimed to be trying to help. The pushback forced Morneau to eventually back away from some elements of his plan.

In December, Morneau announced tweaks to the income-sprinkling proposal in an effort to establish clear tests to determine whether a relative has made a meaningful contribution to — or investment in — the family business. The government said relatives who make meaningful contributions to a company will not be affected by the changes.

When asked about the PBO findings Thursday, Morneau said the government pursued the changes because some Canadians were lowering their taxes by sprinkling income to children or their spouses in a private corporation, even though those family members weren’t actively engaged in the business.

“What we found is that most Canadians understand it’s not fair that people can lower their taxes just because they’re privately incorporated,” Morneau said in Halifax. “We don’t think it’s appropriate that they are reducing their income, and therefore their taxes, just because they have children or a spouse.”

Finance Canada gave businesses until Dec. 31, 2018 to adjust to the rule, which includes new qualification guidelines for family members — such as substantial capital investments as well as minimums for age and the number of hours worked.

The Liberals vowed to simplify the income-sprinkling proposal amid concerns about the added complexity of trying to prove the involvement of family members.