This tax commentary briefly summarizes certain tax proposals of the newly elected Liberal Government based on the election platform of the Liberal Party of Canada (the "Liberals"). It expands on Fasken Martineau's previous commentary on the pre-election platforms of the major federal political parties - Politics of Tax: 2015 Federal Election Primer dated October 14, 2015.
Corporate Tax Rates
Canadian corporations are generally subject to a 15% general federal corporate tax rate. A corporation that is considered a Canadian-controlled private corporation ("CCPC") is eligible for a small business deduction which effectively lowers this rate to 11% on the first $500,000 of active business income earned in a given year.
The Liberals have proposed to maintain the 15% general federal corporate income tax rate and to reduce the small business tax rate to 9% by 2019. It is unclear how quickly the reduction in the small business tax rate will be implemented.
Effect of Proposed Changes
The Liberals have made various claims about the effect on employment in Canada (and, more broadly, overall economic performance) that these rate changes will bring, however, the relationship between employment and corporate tax rates is difficult to verify.
The Liberals have also claimed that their corporate tax rate proposals are competitive with other countries (especially when compared to the US corporate tax rate of 35%). However, it should be noted that the rates described above are federal tax rates and thus do not include the tax rates applicable to each province. The various provincial tax rates would add 11% to 16% to the federal general rate (raising the combined federal and provincial general rate to 26% to 31%) and 2.5% to 8% for the small business rate (raising the combined federal and provincial small business rate to 11.5% to 17% by 2019).
Current Tax Treatment
The tax rules relating to employee stock options in Canada, generally provide for no tax payable at the time that options are granted and only result in the employee recognizing 50% of the benefit or gain arising from the exercise of the qualifying stock options issued by public companies. This amount is taxed in the year of such exercise. Stock options issued by CCPCs, provided certain conditions are met, are eligible for a further benefit in that the tax payable by the employee is deferred until the employee disposes of the shares acquired through the stock option. The result is a "capital-gains" tax like treatment of the increase in the value of the shares. This favourable result is implemented by way of a deduction from employment income rather than taxing the stock options as a capital gain.
The Liberals have stated that they will cap the amount that can be claimed under the available stock option deductions to $100,000. In discussing the cap on stock option deductions, the Liberals did not differentiate between public company options and CCPC options so it is not clear if the proposed cap will affect both types of stock options. However, the Liberals have indicated their plan would not affect employees with up to $100,000 in annual stock option gains.
Effect of Proposed Changes
The Liberals have stated that the current tax treatment of stock options permits senior executive employees and the wealthiest of Canadians to benefit disproportionately from the 50% deduction on gains from stock option dispositions. The Liberal Fiscal Plan and Costing Plan notes that the Department of Finance estimates that 8,000 very high-income Canadians deduct an average of $400,000 from their taxable incomes via stock options. This represents three quarters of the fiscal impact of the stock option deduction, which in total cost $750 million in 2014. Furthermore, the Liberals have suggested their stock option plan, including the $100,000 cap, would raise $500 million or more in government revenue.
Opponents of the proposed changes contend that the current tax treatment of stock options is vital to the Canadian start-up sector. Start-up companies depend on the current stock option regime to attract talented employees because their budgetary constraints prevent employers from offering competitive salaries. In the start-up sector, employees are generally willing to assume financial insecurity and lower pay in exchange for stock option incentives, which they hope to redeem in the future at a significant gain. As a result, opponents believe the proposed changes to the taxation of stock options, put forth in the Liberal fiscal plan, would have a significant negative impact on the growth of the Canadian start-up sector.
It is unclear when the Liberal stock option plan will be enacted, however, it may be prudent to exercise stock options in 2015, if possible, in order to take advantage of the current favorable tax treatment.
Personal Income Tax Rates
Current Tax Treatment
At the present time the middle-tax bracket covers personal income ranging from $44,701 to $89,401 and has a federal tax rate of 22%. The highest marginal tax bracket covers personal income in excess of $138,586 and has a federal tax rate of 29%.
The Liberals have pledged to reduce the middle-tax bracket to 20.5%, an overall reduction of 1.5%. In addition, the Liberals have pledged to introduce a "high-earner" income tax bracket which would result in the Liberals taxing income of $138,586 to $200,000 at the current federal rate of 29%, and income of $200,000 or higher at a federal rate of 33% (i.e., a 4 percentage point increase over the current top federal rate).
The Liberal Fiscal Plan and Costing Plan projects $2.8 billion in revenue in 2016/17, and $3 billion in 2019/20, from its proposed changes to the personal income tax rates.
Effect of Proposed Changes
The proposed Liberal "high-earner" tax bracket of 33% when combined with provincial taxes, increases personal income tax rates to more than 50% in Manitoba, Ontario, Quebec, and PEI and would cause the majority of provinces in Canada to have a rate higher than 50%. In particular, New Brunswick would realize the highest rate at 58.75% with Nova Scotia coming in second at 54% and Ontario coming in third at 53.53%. In response to the proposed Liberal "high-earner" tax bracket, New Brunswick has stated that they will undergo a review of their personal tax rates to determine whether a provincial rate reduction is needed.
It is interesting to note that the Carter Commission (1966), a Royal Commission report that made recommendations on the most effective ways of taxing Canadians, noted that the personal income tax rate in Canada should not exceed 50%. The Commission noted that there is a psychological barrier that will cause a decrease in saving and profitable investment when the government can take more than half of the potential gain.
More recently, several economists, including those working for the Department of Finance, have warned that a rate at or over 50% will encourage tax avoidance through tax planning and could lead to high income earners leaving Canada to avoid such a rate. A personal tax rate over 50% was recently repealed in the United Kingdom (the "U.K.") and according to HM Revenue and Customs lead to an increase of nearly 9 billion pounds in tax revenue. This increase was reported to be a direct result of the highest personal tax rate being cut from 50% to 45%. One of the reasons that the high rate in the U.K. was repealed was because, while the personal tax rate was at 50%, the U.K. believed it had lost high income earners to emigration and saw the high income earners who remained in the U.K. use tax planning strategies to declare less income then when the rate was low.
It appears that the Liberals are aware of these concerns as they have noted that they will increase enforcement resources for the CRA in order to eliminate an increase in the use of tax planning strategies by high income earners. It is unclear, at this time, how the Liberals plan to increase the enforcement resources and whether such enforcement would be effective. Furthermore, an increase in enforcement measures would not necessarily address the competitive disadvantage for Canada to attract entrepreneurs and professionals compared to jurisdictions like the U.K. and the U.S. which have substantially lower personal tax rates.