Nobody cares about the high cost of compliance for those who conspire to use a loophole, but we should all care about the high cost of compliance for honest businesses who must navigate the same laws at great risk. Our priority should be high wages, not high compliance costs.
A flat tax that applies to all entities and to all types of income is more efficient, equitable, and transparent. Personal refundable credits would create a truly progressive system with a basic minimum income that could reduce some income assistance plans.
A flat tax is often suspiciously viewed as a method to reduce the top marginal rate of the wealthy. But the wealthy are not paying the top marginal rate and they never will as long as we continue to tax some dollars at lower rates than others. When income is very large the cost of reorganizing your income to lower tax rates becomes relatively small. An honest business could have exactly the same organization for entirely valid reasons. There is no spirit of the Income Tax Act that can be summoned to decide which organization is authentic and which is a sham. The Income Tax Act was written by many people, each of whom, would elaborate differently.
Subsection 125(7) limits certain income eligible for the small business deduction to "an amount that the minister determines". You have to expect a culture of corruption when the law creates uncertain tax positions.
In 1969, the Carter Commission boldly stated that "a buck is a buck" and proposed to tax all gains as income. The government retreated from implementing this simplification in the face of overwhelming opposition and we have being going in the wrong direction ever since. A flat tax is politically viable when you choose the correct rate and refundable credits, because "a government which [taxes] Peter to pay Paul can always depend on the support of Paul" - George Bernard Shaw.
We cannot implement government policies through the Income Tax Act because big income will always find a way to the lower tax. There would be no reason to move income from one entity to another entity, re-characterize that income, or determine intentions, if every dollar of income paid the same amount of tax. A loophole works because it copies an otherwise valid structure approved by law. You can only get rid of the loophole by removing the incentive as well, and that is done with a simple flat tax.
Joe Milla, CPA, CA