What Is the “Fair” Corporate Tax Rate?

Many people believe that corporations should be subject to much higher rates of tax than they are.  After all, they are not people and probably evil.  The whole idea speaks to how poorly informed people are and in many cases to their ideological biases.

When these people seize objective reality, they will notice that no corporation pays taxes.  They may send money to the government, but as surely as the customers pay for the products and services, they pay for the taxes too.  The question is obvious, “How then would higher corporate taxes benefit the people?”

In Canada corporate taxes are integrated with personal taxes.  A corporation that earns $500,000 is subject to tax at 15% in Ontario.  Above that the rate is higher.  26.5%.  A little more than $200,000 payable. As long as the after tax money stays in the corporation no more tax is due.  When the owner takes it out as a dividend, the individual effectively pays tax on the original corporate income at their personal rate and gets a credit for the tax previously paid by the corporation.  The integrated tax is about equal to the tax that would have been payable if the corporation did not exist.

The idea of lower rates is that the corporation needs money to grow, buy equipment and buildings, do research and support inventory and accounts receivable growth.  While the government gets less now, they will likely get more later.  They effectively invest a little in the business.

While a general rule in taxation seems like a good idea, this one is has defects.

Not every corporation has an automatic need to invest in the business.  Take a manufacturer earning $1,000,000 per year and assume a 45% rate on personal income.  The tax deferral by incorporating is $150,000 on the first $500,000 and a little less than $100,000 on the excess.  $250,000 saved does not go far when growing.  One machine or less.  Less than 3,000 square feet of building.  Inventory and receivables for less than $1,000,000 of sales increase.  Nice but not all that significant.

At the other extreme are businesses that need almost nothing to grow.  A professional corporation, a brokerage operation, restaurants and much of retail need little capital.  They accumulate financial assets.  The $250,000 saving is added to the investment portfolio.  The income from the portfolio is taxed at much higher rates, more like the personal rate, but there is still the added capital that works in favour of the owner.

The alternative is more complex, but also more fair.  It recognizes that business financial structures vary.  So instead of a gift, earn the low rate. Buy a production machine for more than the deferral.  Keep it all.  Buy term deposits, lose it all.  Maybe have a bonus for full time job creation.  There are lots of ways to deal with it and many incentives to build in.

In this system, the corporate rate could be zero if you invest in productive assets.

Incentives should relate to what you want.  If jobs and efficient world class businesses are the choice then corporate tax is a hindrance.  If ideology matters and you like high rates, then you lose business growth.  An integrated personal/corporate system with the ability to earn a lower corporate rate should satisfy everyone that thinks about it.

Don Shaughnessy arranges life insurance for people who understand the value of a life insured estate. He can be reached at The Protectors Group, a large insurance, employee benefits, and investment agency in Peterborough, Ontario.  In previous careers, he has been a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business.

Please be in touch if I can help you.  don@moneyfyi.com  866-285-7772

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