Why Morneau wants to tighten rules on private companies

Finance Minister Bill Morneau wants to tighten rules on private companies that he says are giving some Canadians an unfair tax break. Experts, however, say Morneau's move won't just hit the very wealthy.

Experts say measures won't hit only the wealthy

Finance Minister Bill Morneau is consulting Canadians on proposed changes to tighten the tax rules for private corporations. (Adrian Wyld/Canadian Press)

Owning a private corporation is perfectly legal and there can be good reasons to set one up beyond tax planning, such as limiting liability from lawsuits.

However, the federal finance department says it is concerned about the rise in the number of private corporations in recent years and its impact on tax revenues.

In a report entitled Tax Planning Using Private Corporations, the Finance Department said the number of private corporations in Canada has increased from 1.2 million in 2001 to 1.8 million in 2014.

"Growth has been particularly strong in some sectors," officials wrote. "For instance, the number of corporations in professional services has tripled over the last 15 years."

If a corporation's owner withdraws all the profits as dividends, they may not save much in taxes. However, if they "sprinkle" the profits among members of their family through dividends and salaries, leave the money in the company to grow or convert the corporation's regular income into capital gains, they can legally save quite a bit.

Morneau wants to crack down on those three tax savings moves — particularly in cases where salaries or dividends are being paid to 18- to 24-year-olds related to the company's owner.

The finance department estimates that tightening up on "income sprinkling" alone could add $250 million to federal government coffers each year.

While Morneau and the finance department are portraying the move as one that will particularly hit the wealthiest one per cent of Canadians and affect an estimated 50,000 Canadians, Toronto tax lawyer Peter Guselle, a partner at Fogler, Rubinoff LLP, said the impact will be much wider spread.

 'Every single small business'

"It's family farms, it's small business — your typical small business is incorporated, and these rules will impact every single small business. It's not just high net worth individuals — it's every single small business."

Guselle says the finance minister could have taken more targeted action.

"He talks about about professionals and high net worth individuals but he could easily have tightened the rules on professional corps and left small businesses alone."

David Steinberg, tax leader for EY Canada's Private Client Services, described Morneau's proposals as overly broad and "an attack on private businesses."

"I don't think (they) were intended to be as broad and affect as many people across Canada as they are affecting."

Elizabeth Thompson can be reached at elizabeth.thompson@cbc.ca