Liberals promise income sprinkling fix, but experts say logistics still unclear

The Liberals unveiled additional changes to their small business tax reforms Monday, amid criticism that their original plan harmed middle-class Canadians more than it helped.

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Prime Minister Justin Trudeau, and Finance Minister Bill Morneau, announced that the government will lower the small business tax rate to 10 per cent in January and to nine per cent in 2019. It’s a campaign promise they faced criticism for abandoning in the 2016 budget.

“We are now moving forward with a process where we are confident that we reduce…small business taxes for hard-working Canadians right across the country without exacerbating existing unfairnesses, or even increasing unfairnesses within the system,” the prime minister said.

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2:01 Trudeau: small business tax rate cut will not be a shield for wealthy

Among the changes was a promise to simplify income sprinkling, the practice of spreading – or, rather, sprinkling — income accrued through a corporation among family members.

Trudeau did not offer details on the income-sprinkling simplification Monday, but he said it would be “made clear” as the government moves forward.

The finance minister was also largely mum, and fended off questions about his own lingering business interests.

Here’s a look at what the government has promised, and whether experts say it will solve the issue of income sprinkling.

READ MORE: Liberals to trim small business tax rate to 9% by 2019

Income sprinkling, explained

There’s nothing wrong with paying relatives who work for the company.

Right now, though, the law allows incorporated business owners to split their income with their spouse and any kids between the ages of 18 and 24, even if they had nothing to do with the company.

This tax scheme is particularly advantageous if your partner and offspring have little or no income, which places them in a low tax bracket.

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0:36 Bill Morneau not in a talkative mood as questions about his financial holdings mount

How many businesses does income sprinkling really effect?

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According to the government, income sprinkling affects about 50,000 Canadian-controlled private corporations (CCPC) — that’s only three per cent of all CCPCs.

Lindsay Tedds, an economics professor at the University of Victoria, says the move to tackle income sprinkling is about principles, not numbers.

Tedds explained that narrowing down on businesses using CCPCs as a tax model is about addressing “real fundamental issues” in Canada’s tax system.

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Reasonableness test principles already exist

The Liberal government outlined a “reasonableness test” with four principles Monday, which they said would help determine whether family members are being justly paid: labour contributions to the business, capital or equity contributions, financial risks taken, and finally past contributions in terms of capital, labour or risks.

Family members receiving money from a business will have to pass the test.

Tedds says there’s little new in the test.

“The principles are what I understood already was the expectation.”

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1:34 Trudeau says he has listened to premiers’ concerns on small business tax proposal

Does it solve the problem?

While it’s not new, Tedds says Monday’s announcement stated more overtly what the Liberals’ intentions are, and that helps.

“I think it’s just reiterating what was perhaps not as clear with their consultation documents.”

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It leaves several other unanswered questions, mainly surrounding how the Canada Revenue Agency will determine capital contributions, financial risks and past contributions.

Tedds says she “absolutely” supports the idea, “what exactly it means” in practice is unclear.

In an earlier interview with Global News, John Oakey, tax partner at Collins Barrow Nova Scotia also voiced concerns.

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In September, Oakey said the new rules would add paperwork and other costs for many businesses, as they would have to make sure that they are complying with the new regulations.

“The complexity in the rules that the Department of Finance has actually drafted is enormous,” Oakey said.

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Are the other changes really new?

Trudeau also announced Monday he will abandon at least one of the tax-reform elements: changing the lifetime capital gains rule, which is an adjustment intended to avoid negative impacts on the intergenerational transfer of family businesses, like farms.

The government is expected to announce more changes related to its tax proposals later this week.

— With files from Global News reporter Erica Alini, The Canadian Press