Nope. He may be going after you; you just don’t realize it yet.
Two highly technical proposals in his new budget take dead aim at ordinary investors and small business owners. The reason they haven’t received a lot of media coverage is that few people understand them.
The first deals with a subtle change to the dividend tax credit that will affect small businesses. When these owners take money out of their companies in the form of dividends, they are classified as “non-eligible”, which means they get a reduced tax break. That reflects the fact that small businesses pay a lower rate of corporate tax — 11 per cent at the federal level versus the 15 per cent general corporate rate. Provincial corporate taxes are extra.
The budget proposes to amend the formula for calculating the tax credit earned by non-eligible dividends, to the detriment of small business owners. Based on my estimate, the value of the credit will drop by 22 per cent when the new system kicks in next year.
Don’t own a small business? Mr. Flaherty may still wring some extra cash from you. A second technical change aims at eliminating “character conversion transactions.” Most people have never heard the term, but you may own mutual funds or ETFs that actively use this strategy. In fact, it has been around for years.
Character conversion is a form of financial engineering that magically transforms highly taxed types of income, such as interest, into more tax-friendly forms like capital gains, only half of which are taxable. This is done through the use of forward derivative contracts, or “forwards” as they are called in the industry, and the practice is widespread.
In fact, some funds exist solely to exploit this complex methodology. One example — and there are many — is the Fidelity American High Yield Capital Yield Fund. It invests in a portfolio of high-yield bonds that would normally generate interest income, taxed at your marginal rate. But through the use of derivatives, payments are received by unit holders in the form of capital gains. In 2012, the B units of the fund paid out $0.3837 per unit, all of which was treated as a capital gain for tax purposes.
The tax saving to investors using non-registered accounts (e.g. outside an RRSP, TFSA, etc.) is significant under the current system. Let’s say you own 1,000 units of the B shares of the American High Yield Capital Yield Fund and have a marginal tax rate of 40 per cent. You would have received $383.70 in capital gains distributions last year. Your tax bill would be $76.74. Unless Fidelity figures out a way to get around the proposed rule changes, your tax liability on that same amount in 2014 will be $153.48 — exactly double what you’re paying now.
Ottawa expects to collect $175 million in additional taxes over the next five years as a result of this move. Fiddling with the dividend tax credit will add another $2.34 billion from small business owners. That’s more than $2.5 billion in total.
And how much does the Finance Department expect to collect from cracking down on international tax evasion? They don’t have a clue. That line in the budget annex is left blank. The government won’t even hazard a guesstimate, a clear indication that they have no idea of how much money, if any, is out there.
So despite the rhetoric and the introduction of a controversial snitch line, it’s not the millionaires that Mr. Flaherty is counting on to provide more tax revenue. It’s us, folks.
Original Article
Source: thestar.com
Author: Gordon Pape
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