Performance figures for each account are calculated using time weighted rate of returns on a daily basis. The Composite returns are calculated based on the asset-weighted monthly composite constituents based on beginning of month asset mix and include the reinvestment of all earnings as of the payment date. Composite returns are as follows:

Minister Morneau, Your Analysis Is Incomplete…

By John Nicola, Nicola Wealth Management Chairman & CEO and Elliott Levine, Levine Financial Group President

View the PDF version of this newsletter. | A version of this article was also posted on

On September 5, 2017, the Globe and Mail published an op-ed by Finance Minister Bill Morneau, titled “Tax changes are about leveling the playing field.” In it, he wrote that he wants to make the middle class “equal” to business owners from a taxation point of view. This op-ed was written in support of a premise in his and the Federal Government’s 2016 budget that “the ability of high-net-worth individuals to use private corporations to inappropriately reduce or defer tax” is a primary concern. 

Why is his analysis incomplete?

  • By far, the majority of Canada’s 1.2 million business owners are in the middle class and not wealthy.
  • Business owners and most self-employed professionals take significant risks with respect to starting their enterprises and, in addition, are responsible for contributing 100% of the funds necessary for their retirement and benefits.
  • Conversely, civil servants face no such risk. While fairly compensated, civil servants receive benefits and pensions that are far greater than can be accumulated by the majority of incorporated business owners and professionals.

Any reasonable analysis of Minister Morneau’s conception of equality must include a comparison between an incorporated professional and a career civil servant. We have done such a comparison below, contrasting Bob, a dedicated civil servant, to Cheryl, an equally committed doctor. The results are both surprising and telling.

First, let’s provide some context. According to Statistics Canada, as of December 2015, there are 1.17 million employer businesses in Canada of which 1.14 million (97.9%) are considered small businesses – defined as having 100 employees or less – employing 8.2 million Canadians or 70.5% of the private workforce.

Minister Morneau states in his article in the Globe and Mail that “over the past 15 years… the number of private corporations has increased 50%” because small business owners, entrepreneurs (plumbers, farmers, electricians, etc.) and professionals (accountants, doctors, dentists, lawyers, etc.) have incorporated, clearly implying that this is unsustainable and unfair.

However, according to the Federal Government’s own “Benefits of federal incorporation” website, “Business corporations are taxed separately from their shareholders. The corporate tax rate is generally lower than the individual tax rate. In some cases, incorporation offers some fiscal
So, Minister Morneau, how can you make the implication that Canadians who are using the benefits of incorporation are tax cheats when the government encourages them to do so?

One of the tactics Minister Morneau’s proposal takes aim at is “passive investments”, because the Minister says there must be fairness. However, the Income Tax Act is already designed so that this passive investment income will be taxed equally when withdrawn from the company; this is “tax integration.”

The Department of Finance’s paper released on July 18, 2017, made a comparison of “ordinary” Canadians to those who have incorporated; however, we propose a comparison of ordinary Canadians to civil servants and the benefits received during a career in the civil service and when they retire.

According to Statistics Canada, there are 3.6 million public sector employees in Canada who enjoy guaranteed salaries, group benefits, paid sick leave, and paid vacations. Civil servants are also guaranteed defined benefit pension plans at retirement which is a lifetime compensation that is not reported on their tax returns.

Defined benefit pension plans provide a guaranteed income during the retirement of a civil servant based on the average of their five consecutive years of highest paid service. Upon retirement, they know what income they will receive, as the funds are guaranteed and paid for primarily by taxpayers. Unlike with an RRSP, TFSA, or corporate investment portfolio, those with indexed defined benefit plans don’t have to concern themselves with market volatility, portfolio risk, asset allocation, or management fees.

Let’s now compare the retirement incomes of Bob, a career civil servant with Cheryl, an incorporated physician.

Bob graduates from university at age 25 and begins working in the civil service with a starting salary of $40,000 plus benefits. During his career, he enjoys a guaranteed salary, 40-hour work week, group benefits, paid sick leave, paid vacation days, and a defined benefit pension plan that indexes to inflation. Bob is both dedicated and ambitious and chooses to improve his credentials by going back to school and getting his MBA. His employer (in Bob’s case,
the Federal Government) supports this decision and pays for more than half of the cost of tuition. This means that over time his salary will increase at a faster rate (as it should) and that in turn leads to a significantly higher long-term pension benefit.

Let’s explore his pension in more detail.

Bob works his way up to more senior positions and finishes his career as an Associate Deputy Minister at age 60 with a final salary of $200,000. After a 35-year career, Bob’s defined pension plan will provide him $133,000 per year indexed to inflation. The present value of Bob’s pension is $3.3 million.

If Bob had tried to build an RRSP account worth $3.3 million during his 35 years of civil service (assuming he earned a return of 4% per year after inflation and costs) he would have needed to make deposits equal to 50% of his salary. That amount is far more than he could deposit under today’s regulations where the maximum contribution rate for RRSPs is 18% of salary to a limit of $26,010 for 2017.

In 2007, the government announced those with a pension can split the pension income to reduce the overall tax bill. This means, when Bob retires he can split his pension with his spouse (common law, too). If they have no other income at retirement, they will have a joint tax bill after 60 in the range of $26,000 or 20%. This ability to income split, referred to as “income sprinkling,” is one of the benefits Mr. Morneau wishes to now eliminate for incorporated
individuals, but not civil servants.

Now let’s compare Bob’s lifetime compensation (during the working years and retirement) to his friend Cheryl, a physician.

Cheryl graduates at 25 with a science degree and then goes on to medical school for an additional four years of school. Finally, after a year of residency, she is able to earn an income as a family physician.

Cheryl graduated with $175,000 of debt which is the average for a graduating medical student. Once she starts her practice she will work 60-70 hours a week and be on call five days a month (meaning she will work evenings and weekends). Her medical practice will gross $350,000 per year, she will employ two staff who each earn $50,000 ($100,000), rent office space ($25,000), pay expenses ($10,000), provide group benefits ($8,000), and pay malpractice insurance ($5,000). She will take a salary of $144,000 to maximize her RRSP contribution of $26,000 per year. That leaves her with net income in her medical practice of $58,000 before tax or $49,000 after tax in Ontario.

As she plans on having two children, the funds saved in the corporation for the first four years will be used over the next five years as she works part-time to help raise her young family. She returns to full-time work at age 39 and is now able to add her corporate savings to her RRSP to fund her retirement.

By age 60, Cheryl’s RRSP account will be worth just over $1.5 million assuming she earns a 4% real rate of return (which means she has to earn about 6% before inflation and after investment management fees). There is no guarantee she can consistently generate this kind of return, whereas Bob’s pension returns are fully guaranteed.

The only way for Cheryl to accumulate a pension somewhat close to that of Bob, is to save money in a corporate investment account. She cannot save the funds necessary to equal Bob’s pension because she does not make that much money, but she could save $50,000/yr. Her medical corporation will pay a tax rate of 50.17% on this investment income which is the current tax rate before proposed changes.

If Cheryl earns the same rate of return as in her RRSP, less the tax she pays from age 39 to 60, she will have about $1.4 million in her corporation and $1.5 million in her RRSP. When she withdraws the funds from her corporation during retirement, she will pay a dividend tax. If the new proposals are passed, Cheryl’s tax rate on her passive income earned in her medical corporation will ultimately be 71% (combined corporate and personal tax) when she starts to receive them at retirement, compared to Bob’s 20%.

There are a few other factors that must also be considered in this comparison. First, Cheryl funds 100% of her RRSP, disability, critical illness, life insurance, and any health benefits she and her family require. Second, Bob has an opportunity for salary increases over his lifetime at the level of inflation at a minimum, but in his case considerably higher, because his skills have improved over his working career. In contrast, most physicians have seen their fees decrease in real terms.

Perhaps most important, this analysis shows that Cheryl’s current savings plan (RRSP and corporate investment plan) will result in a substantially smaller retirement nest egg/income than Bob. This is in addition to bearing the burden of investment risk and the anxiety of market volatility while providing jobs and staff benefits.

We have no issue with the total compensation enjoyed by civil servants. However, we should return to the original narrative Minister Morneau used to describe the unfair advantage incorporated professionals and business owners have over other Canadians. The real issue here is that Minister Morneau is only looking at half of the picture and, with all due respect, his analysis is incomplete.

One needs to consider not only the benefits during the working years, but also how each individual (a civil servant and an incorporated professional) is able to provide and plan for retirement; guaranteed pension for civil servants vs. RRSPs and corporate savings for an incorporated professional.

There is a strong argument that the system is not only fair but plays out far better for the 3.6 million government employees vs. the 1.1 million small business owners.

For up to date information on the federal government’s proposed tax changes 
visit our Tax Resouce Dashboard.

This material contains the current opinions of the author and such opinions are subject to change without notice. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. NWM is registered as a Portfolio Manager, Exempt Market Dealer and Investment Fund Manager with the required provincial securities’ commissions.