Ross + Sylvestre: The Advisor Special Feature
Small Business Tax Changes Unfairly Target Small Business–Have Your Say!
On July 18, Federal Finance Minister Morneau issued draft legislation poised to drastically affect the taxation of private corporations, along with a white paper summarizing the proposed legislative changes. In these documents, the Ministry of Finance proposes to address a number of perceived tax “loopholes” available to business own- ers, implying that business owners in Canada do not pay their fair share of taxes.
The legislation tabled introduces three tax measures designed to increase the share of the tax burden held by owners of private corporations:
1) Reduce or eliminate the opportunity for private corporations to pay dividends to family members of active shareholders whose shares were issued principally for the purpose of distributing cor- porate profits to persons eligible for a lower rate of personal tax, or to multiply access to the lifetime capital-gains exemption avail- able on qualifying share sales. (Shares held by family trusts are contemplated within the rules).
2) Reduce or eliminate the opportunity for private corporation shareholders to use corporate profits that have been taxed at advantageous tax rates (13.5% on up to $500,000 of small busi- ness profits and 27% on corporate business profits generally) to accumulate passive investment assets, such as stocks, bonds or rental properties.
3) Lastly, the draft legislation seeks to close tax planning oppor- tunities, which allow shareholders to withdraw value from a corporation so as to receive favourable capital gains treatment, rather than being treated as dividends. The change appears to be in response to concerns that taxpayers are more motivated to access capital-gains treatment following the dramatic changes to dividend and salary tax rates introduced in the past two budgets. The changes target several legitimate planning opportunities, including some estate tax planning measures and intergenerational transfers of businesses or farms.
The proposed legislation stands to add a significant degree of com- plexity and administrative cost to the tax system. Furthermore, the proposed changes have raised the ire of many tax practitioners and business advisors given they appear to be based on the premise that business owners should be taxed on earnings at the same level as an employee would be taxed on wages, with no regard given to the financing, economic, human capital and regulatory risks faced by business owners. Secondly, while the changes are being pitched as a means of “leveling the field” between business owners and the “middle class”, some of the changes will result in the double taxation of income – in some cases, income may be taxed upwards of 87%. Finally, as put forth by tax lawyer Michael Goldberg, “The measures in the Fair Tax Plan do not just impact the “1%”. In fact, the Fair Tax Plan undermines all Canadian small business owners, which, according to the Federal Government’s own statistics, comprised over 97% of Canadian businesses in 2015 and include restaurant owners, franchisees, real estate agents, plumbing contractors and a broad range of other small businesses.”
Chances are, that means you will be affected by these proposed measures too. While Finance has pitched the proposed changes as a move towards tax equity, we would argue that the changes ignore some of the obvious and significant differences between income earned by employees and income earned by business owners. For instance, business owners incur significant risk—businesses require investment capital; they are subject to regulatory changes and economic fluctuations, competition, changing technology and countless other factors. Family members tend to play an important role in helping sustain a business, either with direct involvement in the operations or indi- rectly supporting the active shareholders so that they can invest additional time or resources towards the business. Business success is rarely a short-term endeavour and our graduated tax rate system does not offer a mechanism to compensate for the years needed to achieve high rates of income, and so success comes with both tremendous sustained effort on the part of the family and ultimately at a significant tax cost. Furthermore, business owners must provide for their own retirements and often utilize the deferral advantages to accumulate the necessary wealth to sustain themselves after passing on their businesses. Few of them will benefit from large government-style pension funds.
Closing so-called “loopholes” available to business owners to ensure they pay their “fair share” is a misnomer; for example, our nation’s fiscal policies have until now included laws designed to incent busi- ness owners to retain wealth within their enterprises, and to reinvest it. Previously established policy reflected the value that small business brings to the economy. With this proposal, the Liberal government appears to be working against the financial interests of private busi- ness owners. ■