The Liberal Fiscal Plan and the Wolfson Estimate

Published by David Thompson

The fiscal plan upon which the Liberal Government was elected is set out in Growth for the Middle Class – The Liberal Fiscal Plan and Costing.[1]

Based on that document, and various speeches made during the election campaign, many small business owners and, in particular, professionals, are dreading the March 22, 2016 Federal Budget.  They fear the Liberal Government may restrict the small business deduction for active business income earned by some Canadian-controlled private corporations.

They would be far more concerned if they reviewed Private Companies, Professionals, and Income Splitting–Recent Canadian Experience,[2] an article recently co-authored by Michael Wolfson of the University of Ottawa.[3]

The Liberal Party specifically referred to Professor Wolfson in Growth for the Middle Class – The Liberal Fiscal Plan and Costing.[4] In that document, the Liberal Party referred to Professor Wolfson’s estimate that the Federal government loses approximately $500 million per year in tax revenue to income splitting, much of it resulting from high-income individuals using Canadian-controlled private corporations as an income splitting tool. The analysis behind that estimate is presumably based on Professor Wolfson’s article.

My review of the article is restricted to the provisions of the Income Tax Act, something I know about, as opposed to the statistical analysis, something I know nothing about. This limitation should be kept in mind.

Professor Wolfson’s article describes income splitting via private corporations as “a fruitful area for aggressive tax planning.”[5]  In support of this, Professor Wolfson refers to a statement made by a Revenue Canada official in the early 1990s concerning the use of family trusts and professional corporations:

“Our view is that these arrangements are extremely offensive. In fact, this is arguably the most abusive scheme I have ever seen.”[6]

This quotation was earlier reported in an article that I wrote in 2005.[7]  On the same page as this quotation, my article referred to:

  • Interpretation Bulletin IT-189 “Corporations Used by Practicing Members of Professions” in which the Canada Revenue Agency acknowledges its acceptance of professional corporations; and
  • two Supreme Court of Canada decisions[8] which support the effectiveness of income splitting by private corporations paying dividends.

Further, my article goes on to describe the legislative limits on income splitting through private corporations consisting of:

  • the normal income attribution rules that prevent income splitting;
  • the corporate attribution rule which can subject a taxpayer to a penal rate of tax on “phantom income” simply for setting up an income splitting structure utilizing a corporation regardless of whether the structure is actually used; and
  • the tax on “split income” (commonly known as “kiddie tax”) which prevents income splitting by private corporations paying dividends to minors.

Given the official position of the Canada Revenue Agency, let alone the two decisions of the Supreme Court of Canada, and the rigorous legislative regime in the Income Tax Act that limits income splitting through private corporations, how can this possibly be described, as Professor Wolfson does, as aggressive tax planning?

Professor Wolfson complains that the Canada Revenue Agency’s concern about professional corporations has “further given way to the CRA’s providing advance rulings that go in the opposite direction by enlarging access to preferential tax treatment for some professions.”[9]

The advance income tax rulings in question relate to the use of “central service companies.”[10] These advance income tax rulings, like all other advance income tax rulings, simply confirm how the provisions of the Income Tax Act work. All that these particular advance income tax rulings do is rule on the difference between a professional corporation being a member of a partnership versus not being a member of a partnership. [11]

Professor Wolfson states that “We have had access to an anonymized specimen of such a ruling, as well as private communications.”[12]  In fact, the Canada Revenue Agency has published approximately 100 advance income tax rulings of this nature.  All are publicly available.  All are anonymous.

Professor Wolfson posits, as a sensitivity analysis, that 10%, 30% or 50% of income paid by the private corporations in their study are amounts in excess of fair market value remuneration for work actually performed and that this constitutes tax evasion.[13] This is a very serious allegation. Tax evasion is a criminal offense and a mere charge of tax evasion is often a life-altering event to the person charged.

Professor Wolfson does not appear to understand what tax evasion is. In his article he states:

In the case of T4 income, legally all such income must comprise legitimate payments in respect of work actually performed and remunerated at a fair market value wage rate; anything else amounts to tax evasion.[14]

If this was true, then a tax evasion charge could follow every time a taxpayer was reassessed additional tax.

Nevertheless, based on his assumption of endemic tax evasion by incorporated doctors and lawyers, Professor Wolfson estimates an annual revenue loss to the fisc of between $72,000,000 and $1,714,000,000.[15] This stunning accusation is based on a newspaper article which provides advice that few tax practitioners would agree with.[16]

In any event, excessive non-arm’s length salary payments have absolutely nothing to do with income splitting through a professional corporation. The analysis misses the point that the same opportunity to pay unreasonable salary exists for unincorporated professionals as exists for incorporated professionals. Why is this relevant to the question whether professionals should incorporate?

Professor Wolfson states that the rationale for the small business corporate tax rate is to provide incentive for job creation and compensate for difficulties in accessing capital markets. However he then states that “these arguments seem hard to apply to the professional practices of doctors and lawyers.[17] Later, he states that the small business tax rate should only accrue to “bona fide small businesses.”[18]

Professor Wolfson clearly thinks that neither doctors nor lawyers have employees or need to make significant investments in their practices.  He thinks that they are not bona fide small businesses. This no doubt comes as a great surprise to professionals who employ numerous people and make large ongoing investments in their practices.

Professor Wolfson concludes by stating “Why should an employed scientist or manager [or perhaps a tenured university professor?] with comparable education and skills have to pay more taxes than an incorporated lawyer or doctor receiving similar income?”  Professor Wolfson believes that there is no difference between being a salaried, employed professional as opposed to an incorporated professional who operates his or her practice requiring significant investment, the employment of employees and day-to-day economic risk.

Could the Liberal Government possibly share Professor Wolfson’s views?

[1]           Growth for the Middle Class – The Liberal Fiscal Plan and Costing,

[2]               Michael Wolfson and Scott Legree, Private Companies, Professionals, and Income Splitting–Recent Canadian Experience, (2015) 63:3 Canadian Tax Journal 717-737.

[3]               Ibid, page 10.

[4]               Growth for the Middle Class – The Liberal Fiscal Plan and Costing, supra note 1, at page10.

[5]               Michael Wolfson and Scott Legree, supra note 2, page 719.

[6]               Ibid, page 731.  This statement was made in the context of a series of audits of incorporated professionals in which the auditor advised me that, notwithstanding the law, these audits were a matter of philosophical importance to him.

[7]               Ibid, page 731, footnote 26.

[8]               McClurg v. MNR and Neuman v. MNR.

[9]               Michael Wolfson and Scott Legree, supra note 2, page 731.

[10]             Ibid, page 733.

[11]             These advance income tax rulings simply address professional partnerships in which partners who share income dissolve their partnerships and form significantly different economic relationships which did not involve any sharing of profit. Different rules in the Income Tax Act apply to one type of relationship as opposed to the other.

[12]             Ibid, page 733, footnote 34.

[13]             Ibid, page 729.

[14]             Ibid, page 729.

[15]             Ibid, page 730.

[16]             Ibid, page 729, footnote 17. When the Canada Revenue Agency reassesses a taxpayer in respect of the payment of unreasonable salary, double taxation arises because the payor loses the deduction and yet the payee is still taxable because he or she received the salary.  The standard applied in unreasonableness cases is simple – what would you pay a third party to do the same thing.

[17]             Ibid, page 720-721.

[18]             Ibid, page 737.