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Small Business Owners' Kids Are 'Fair' Game Under Proposed Tax Changes

I think it's unethical to say, "I'm sorry but the money that your parents set aside for your education is only worth a fraction of what it was before."

09/06/2017 09:47 EDT | Updated 09/06/2017 09:49 EDT

Is the federal Liberal government acting in an unethical way? I, like many other Canadians, believe that they are and that they must be stopped.

The Income Tax Act (ITA) is an extremely complex set of rules. When it was first introduced (as a temporary measure) in 1917 it was 10 pages in length. Today, it's 2,660 pages in length (I guess we haven't reached the end of the temporary period).

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Each year Canadian individuals and corporations are required to report their income to the Canada Revenue Agency and pay the appropriate tax. In basic terms, the ITA defines what can and can't be done by both individuals and corporations. If you take a close look at the ITA, most rules relate to corporations, not individuals.

To further complicate our tax system, we have existing rules, pending rules and proposed rules. When trying to plan one's affairs, the only thing you can be certain of are the existing rules. Pending rules may not get final approval, and proposed rules are just that — proposed.

The Income Tax Act should not be used to trap people. Tax legislation should not penalize law-abiding citizens in a distorted effort to appease a prime minister who made campaign promises he's trying to keep. Let's examine one example of how the proposed tax changes, which look to eliminate income sprinkling to adult-age children, are going to unfairly trap thousands of Canadians.

When Registered Education Saving Plans (RESP) were first introduced, private business owners had a choice. They could pull money out of their company and set up RESPs for their children, or they could leave the money in their company and fund their children's education through dividends.

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The advantages to setting up an RESP were:

  • The Canada Education Savings Grant
  • Tax sheltered growth
  • Income and grant money was taxable to the child (income splitting, or "sprinkling" as Finance Minister Bill Morneau calls it)

The disadvantages to setting up the RESP were:

  • You had to pay personal tax on the money to get it out of the company
  • You were limited by the contribution amounts

For many private business owners, it was beneficial to leave the money in their company, pay corporate taxes and use corporate dividends to fund their children's education.

In most cases, this was a benefit to the private business owner but it certainly wasn't aggressive or illegal.

If they can't fund their children's education with dividends and they don't have RESPs, how can the government consider this "fair?"

I can understand why Mr. Morneau wants to change the way that private business owners are income splitting with their adult children, but I object to the way he's proposing to implement these changes. By drawing a line in the sand and saying that no income splitting will be afforded to any family members without an active role in the company, you are immediately reducing the value of many education savings accounts.

I think it's unethical to say to thousands of future students, "I'm sorry but the money that your parents set aside for your education is only worth a fraction of what it was before."

If the income splitting rules had been changed when the RESP was first introduced, private business owners could have been saving using RESPs. Now, if they can't fund their children's education with dividends and they don't have RESPs, how can the government consider this "fair?"

This government seems to believe that children of private business owners should be punished for the plans their parents made to fund their education. Neither they nor their parents did anything wrong, but Mr. Morneau and Prime Minister Justin Trudeau think in the name of "fairness" that they should be penalized.

If Mr. Morneau really was interested in the concept of fairness (when it comes to education), he would allow business owners to fund their children's post-secondary education using dividends.

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I propose a solution:

Since Mr. Morneau is attempting to target adult children who are receiving substantial remuneration, why not set a limit to the amount an adult-age child can receive and tie that amount to specific education expenses?

Every post-secondary institution issues form T2202A which outlines the tuition, education and textbook amounts incurred by that child for post-secondary. As a starting point, why not limit income splitting allowances for a specific tax year to the total amount outlined on form T2202A, plus a nominal amount for living expenses. Living expenses can be set each year at a fixed amount (say $10,000 or $20,000).

This will result in a situation where the children of business owners are not left with a fraction of what they would have otherwise had available for education purposes. Mr. Morneau would see his principle of "fairness" remain intact, as this essentially affords the same opportunity as an RESP.

Another option would be to phase out this type of "dividend sprinkling" over the next seven years, which allows for double-up contributions into RESPs for those who had not contributed in the past. This would allow business owners to transition into an RESP model for tax-deferral and income splitting, rather than the current model of tax-deferral and income splitting that was put in place by past governments (now deemed "unfair").

I urge Mr. Morneau to give private business owners the same opportunity as employees to save for their children's education. If he wishes that more Canadians take advantage of the free money provided by the government using RESPs and student loans, at least allow some time to plan ahead.

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