The federal government recently released proposals to increase taxes on small businesses. These changes have been described by the government as closing loopholes. This is far from reality, however, as the proposals will involve a significant large-scale reform of the small-business taxation that has been in place since 1972. They will impact tax-planning strategies frequently used by incorporated businesses. Specifically, the changes will restrict a corporation’s ability to income sprinkle with family members, curtail the use of holding companies to defer tax on monies saved for future expansion and retirement planning, and increase the tax otherwise payable when a business is sold. Details of these changes, as they apply to incorporated businesses, are discussed in the “Specifics of the Proposed Changes” section of this article.
While many consider this to be an issue that only affects entrepreneurs, that is not the case. It will impact all of us. The changes are being promoted under the guise of ensuring fairness by taxing the “wealthy.” This is misguided as most small-business owners are middle-class – the very group the government claims to be helping. Indeed, there are numerous provisions (such as the stock option deduction) used mostly by Canada’s wealthiest that are not even being considered by the federal government in this current tax grab. It seems clear that the proposed changes will hurt – not help – the business component of the middle class.
Let me begin by discussing taxation in Canada. There are many layers of taxation: taxes on purchased goods and services (sales tax), property taxes, gasoline taxes, and, of course, income tax. The tax act deals specifically with the taxation of both individuals and businesses. The latter normally includes sole proprietors as well as corporations. The rule changes are specifically targeting small businesses operated through a corporation. The government is not looking to modify the taxation of large corporations, which many of us would recognize as public corporations.
Most of us would expect that the tax act was designed to be fair and that the government is proposing changes to small-business taxes simply to make sure that the act remains fair. However, the tax act was never intended to be fair. Rather, it is loaded with incentives to encourage various aspects of economic life in Canada. For example, the government wants to encourage investment in the scientific research and experimental development (SRED) field, so there are generous credits available to businesses that incur costs in the approved areas. For example, individuals who invest in higher-risk start-up companies in, say, wind farms, can receive a tax credit for up to 80% of their investment. Another example, on a smaller scale, is the transit credit available to individuals, which is designed to encourage the use of public transit.
The taxation of incorporated entities was designed to provide tax benefits. Why was this the case? Successive governments recognized that small businesses are the major driver of the Canadian economy. They provide employment for many Canadians. More specifically, there needed to be an incentive for individuals to take on the risks associated with starting up a business. Business owners do not benefit from employer-paid CPP, EI, medical plans, sick time, vacation time, and pensions. Rather, they risk their life savings to start a business. Most require loans to get their business started, and banks will almost always require personal guarantees. If a business fails, the banks will go after the business owner’s personal assets. Business ownership may seem glamorous, but it is a risky endeavour. It is also important to consider that small businesses act as collection agencies for the Canada Revenue Agency by collecting payroll and sales tax on the government’s behalf. With all the added risk – both personal and financial – there had to be some benefit to running a business, and this was addressed in business taxation.
The government argues that an individual who is incorporated and running a business should pay the same amount of tax as an employee earning the same amount of income. Why? Why would someone make the decision to run a business if they could make the same take-home pay as an employee but have none of the benefits available to employees? Equal taxation only serves to discourage anyone from taking the risk of running a business. I really can’t understand the government’s thinking. I am not opposed to tax increases for small businesses, but a benefit must still be available.
While I disagree with the sweeping changes being proposed, what will happen if they get implemented? No one knows for sure, but I have listened to the views of many economists and financial advisors. What seems to be unanimous is the belief that the proposed changes will hurt small businesses and the clients they serve. An increase in tax means a decrease in available cash for small businesses. How can they compensate? One option would be to increase rates, be it at your local pizzeria, your chiropractor, the corner store, your lawyer, etc. This will only mean that every individual’s cost of living will go up. And increasing rates is not an option in some professions. Take, for example, doctors, who are paid based on government-fixed rates. Their only real options are to close their practice, retire, or move to another jurisdiction where the pay is higher and/or the taxes are lower. Our country has a shortage of doctors. This will only serve to worsen the problem. Another option for small businesses is to reduce their costs. The easiest target is cutting back on salary spending, which would lead to higher unemployment. Ultimately, the economy will be hurt by these proposed tax changes because small businesses are the backbone of the Canadian economy.
Many of the tax-planning strategies being curtailed in these measures for small businesses are still readily available to large family-run businesses you would be familiar with in the Atlantic provinces. Much of the money these companies make is often quickly moved offshore. Why not focus on this movement of capital out of Canada and go after the offshore tax schemes promoted by large accounting firms? The government’s proposal has provided a 75-day consultation period for the draft legislation, but it appears that there is no intention to consult. The last major change to the tax act took seven years to formulate. I believe the government has hit on some important matters, but such dramatic changes to the taxation of small businesses in Canada should be carefully thought out before being implemented. Most important to consider is the impact they will have on every Canadian.
Suggestions for the remainder of 2017:
- The consultation period ends on October 2, 2017. Please consider writing to your MP to request that the consultation period be extended and more thought given to the magnitude of these changes. Let’s help – not curtail – small businesses in Canada.
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