The hidden costs of uncertainty in Canada’s tax system

Government regulation and taxation are fundamental parts of any economy. These rules act as a guide for businesses and individuals to make informed short-, medium-, and long-term decisions when executed effectively.

For the better part of our history, Canada’s economic advantage can be attributed to being a safe, predictable, and stable place to do business. In other words, there has been certainty. Organizations and individuals have built and invested in Canadian businesses despite the potential for higher costs because they knew they could expect a stable tax regime with clear, predictable, and fairly administered legislation.

However, changes in tax policy over the past seven years have diminished this advantage and increasingly challenge the attractiveness of the Canadian market.

MNP works with businesses, farms, and professionals that power Canada’s economy from coast to to coast — including more than 180,000 businesses and 19,000 farms. This provides our network of nearly 10,000 professionals in 130 offices across the country with a unique perspective on how business owners are feeling — and it is clear to us that sentiments have shifted in recent years.

This shift has become especially apparent in 2024. A constant stream of complex regulatory and legislative changes in Canada’s tax system in combination with the added administrative burden outside of tax on business owners is creating a climate of uncertainty. This manifests in a lack of trust and confidence in the tax system, which negatively impacts competitiveness, innovation, investment, and productivity. To get back on the right path, policymakers need to adopt a different approach to tax reform.

Cumulative regulatory challenges since 2017

Tax measures

Changes to Canada’s tax system cannot be considered in isolation, and we have summarized significant tax changes from the past seven years below to paint a fuller picture. Many private companies and their owners have been adversely impacted by more than one of these measures — and the cumulative impact of these measures have proven damaging to businesses based on our experience.

Taxation of Canadian-controlled private corporations

The federal government introduced a package of measures specifically targeting the taxation of Canadian private companies in 2017, including:

1. Tax on Split Income (TOSI) rules: These rules were introduced to target income sprinkling and are restrictive in nature, generally failing to recognize the total contribution of family members to support operating a family business. The legislation itself is subjective in nature and has created uncertainty as to how it may apply to particular situations. More than 50 income tax rulings have been issued by the Canada Revenue Agency (CRA) on these rules to date and this number is expected to increase as taxpayers seek clarity on how these rules apply.
2. Discouraging holding passive investments within private corporations: Private company business owners rely on passive investments within the corporation to save for retirement and to help fund capital expenditures in the business. These tax changes have been detrimental to business owners who rely on access to the small business deduction. The changes force them to decide between saving for the future — whether for personal or business use — and managing their tax costs and related cashflow each year.
3. Preventing conversion of income into capital gains through the use of a private corporation: The rules were overly broad when initially introduced. While the government did not go through with this measure as originally proposed, it appears to have taken a different route to achieve this through subsequent tax changes.

Trust reporting (T3) requirements

The federal government first introduced proposed legislation for new trust reporting requirements in 2018, to be applicable to tax years ending on or after December 31, 2021. However, the effective date for the reporting requirements was delayed to December 31, 2023. This is presumably due to the complexity and widespread impact of these proposals — particularly the requirement for bare trusts to file annual returns. Still, uncertainty around bare trusts remained.

Many taxpayers were unaware or unsure if they had a filing requirement, as a bare trust arrangement is a legal concept and is not defined in the Income Tax Act (ITA). The CRA ultimately announced that bare trusts would generally be exempt from the filing requirement for the 2023 tax year on March 28, 2024. This announcement came just before the March 30 filing deadline, when many taxpayers had already invested time and resources to meet their obligations. It remains unclear if the recent August 12, 2024 proposals impacting the enhanced trust reporting rules will adequately address the uncertainty arising from previous years.

Rules on intergenerational business transfers

Rules were introduced through Bill C-208 and enacted in 2021 to support the transition of family businesses. The previous rules resulted in higher tax costs to sell a family business to a family member than to a third party. However, the further changes introduced in the 2023 federal budget and enacted in June 2024 are far more restrictive and are expected to offer little relief to those looking to transition their family business going forward.

Underused Housing Tax (UHT)

The UHT created expansive reporting requirements for Canadian residential property owners when it was rolled out in 2022. The complex rules and extensive filing requirements created uncertainty for taxpayers.

The CRA announced administrative relief from penalties and interest on 2022 UHT returns and payments that were filed late. While this was welcome news, it highlighted the underlying complexity and uncertainty that taxpayers were facing in order to be compliant. While the government announced changes to the UHT reporting requirements in 2023, those changes remain in proposed status despite the passing of the 2023 filing deadline.

Mandatory disclosure rules for reportable and notifiable transactions

Similar to other recent legislative changes, these rules contain ambiguity in terms of who has to complete the mandatory reporting, while also creating a short time frame to complete the reporting. Multiple parties will be required to effectively gather and submit the same information to the CRA in some cases. These rules add to the heavy administrative burden already placed on taxpayers to remain compliant to avoid penalties.

The General Anti-Avoidance Rule (GAAR)

The recently enacted changes to the GAAR create significant uncertainty as they seek to override years of judicial precedents in interpreting the ITA. Clarity on how the amended rule will apply will likely only be available once it is examined in the tax courts, which is expected to take years.

Alternative minimum tax (AMT)

The federal government announced changes to the AMT regime in the 2023 federal budget. These changes, which were effective January 1, 2024, were not enacted until June 20, 2024. This left four days for many taxpayers to confirm the income tax consequences of any planning in response to the capital gains inclusion rate increase announced in the 2024 federal budget, which came into effect after June 24, 2024. 

Capital gains inclusion rate increase

The 2024 federal budget announced an increase to the capital gains inclusion rate effective June 25, 2024. Details on the draft legislation were not released until June 10, 2024, with further draft legislation released in August 2024. The short timeframe between the budget date and the effective date, as well as the lack of details on the proposed inclusion rate change made it extremely challenging for taxpayers to objectively assess their available options before the effective date.