OTTAWA — Roughly 900 families earning less than $100,000 a year will have to pay more taxes because of federal changes to tighten income-sharing rules for owners of small businesses, the parliamentary budget watchdog said in an analysis released Thursday.
The report said measures to restrict how much income the higher-earning owners of private corporations can sprinkle to family members, as a way to save on taxes, will cost each of the 900 households an average of $2,200.
About 11 per cent of the 33,000 households affected by the changes earn less than $150,000 a year, while 83 per cent make less than $500,000 a year and two per cent bring in more than $1 million a year, the study said.
The income-sprinkling change was among a handful of measures Ottawa insists will target wealthy people who use corporate structures purely as a way to reduce their taxes.
The Liberal government says the income-sprinkling measure, which came into effect Jan. 1, is designed to prevent higher earners from distributing income to their children or their spouses within the business, when those family members aren't actively engaged in it. About three per cent of private corporations — or fewer than 45,000 firms — will see an impact from the income-sprinkling rule, the government has said.
Thursday's release by parliamentary budget officer Jean-Denis Frechette also laid out several scenarios with estimates on how much revenue the measure will produce for governments.
Its preferred estimate said the changes could generate a tax windfall for Ottawa of about $400 million a year — double the $200-million annual revenue projection in the recent federal budget.
The report, however, noted that the numbers crunched to produce the budget office estimates differed from those used by the Finance Department. The budget watchdog also didn't account for potential changes in behaviour by business owners trying to avoid a tax increase.
But Mostafa Askari, deputy parliamentary budget officer, said the rule changes — and how they will be enforced — will present a challenge for the Canada Revenue Agency.
The rule includes new qualification guidelines, or reasonableness tests, that consider family members' capital investments, age minimums and the number of hours worked.
"There are so many rules and exemptions that it would be extremely difficult for the CRA to implement this — there are still a number of loopholes and exemptions," Askari said.
"So, how the companies, the firms will respond to this and how that will affect the overall result, that's something that we cannot do at this point."
The president of the Canadian Federation of Independent Business, an outspoken critic of the measures, said the different numbers in Thursday's PBO report show just how much the new rules will "remain a confusing mess" for small business owners.
"Once the audits start in a few years from now, business owners are not going to have the documentation to prove whether or not they pass the 'bright line' or 'reasonableness' tests, resulting in added red tape and years of tax court battles across the country," Dan Kelly said in a statement.
The Liberals vowed to simplify the income-sprinkling proposal amid concerns about the added complexity of trying to prove the involvement of family members.
The PBO report also predicted the income-sprinkling change will bring in about $230 million in additional tax revenues for provincial governments in 2018-19 — with Ontario easily taking the largest share with a $160-million increase.
The income-sprinkling measure was among several controversial tax-reform proposals that Finance Minister Bill Morneau released last summer.
He faced a vocal backlash from doctors, lawyers, tax accountants, shop owners, premiers and even some Liberal backbenchers who maintained the changes would hurt the very middle class the Trudeau government has claimed to be trying to help. The uproar eventually forced Morneau to back away from some elements of his plan.
In December, Morneau announced tweaks to the income-sprinkling proposal in an effort to establish clear tests to determine whether a relative has made a meaningful contribution to — or investment in — a family business. The government said relatives who make meaningful contributions to a company will not be affected by the changes.
When asked about the PBO findings Thursday, Morneau said the government pursued the changes because some Canadians were lowering their taxes by sprinkling income to children or their spouses in a private corporation, even though those family members weren't actively engaged in the business.
"What we found is that most Canadians understand it's not fair that people can lower their taxes just because they're privately incorporated," Morneau said in Halifax.
"We don't think it's appropriate that they are reducing their income, and therefore their taxes, just because they have children or a spouse."
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— with files from Brett Bundale in Halifax
Andy Blatchford, The Canadian Press