Private corporation tax proposals could make financing conditions worse for small business

Last summer, the federal government announced a series of tax proposals aimed at making private corporations “pay their fair share of tax." After a contentious consultation process, a revised version of the new rules came forward in the February 2018 budget. The reaction to the budget proposals has been relatively muted, and, on balance, positive, largely because the proposals shelter small businesses qualifying for the small businesses deduction from the proposed increase in the effective tax rate on passive income, and because the government announced plans to lower the small business tax rate to nine per cent by 2019. The new rules for taxing passive income are much simpler and will impact fewer businesses (approximately 50,000 private corporations) compared to the original proposals. However, these businesses will have less cash resources to meet legitimate, strategic business objectives. Moreover, the new rules impose a greater administrative and compliance burden on businesses. First, the $500,000 small business deduction will be reduced by $5 for every $1 of passive income earned in excess of $50,000 in the taxation year. The availability of the small business deduction, and hence the preferred small business tax rate, would be completely eliminated once passive income reaches $150,000 in a year. Small businesses with more than $150,000 in passive investment income will pay the higher general corporate income tax rate (15 per cent) on their active business income. Further, while the government pledged last fall that all past investments and the income earned from these investments would be grandfathered, this has turned out not to be the case. Businesses that had built a significant pool of passive investments will be negatively affected by losing access to the small business tax rate. Moreover, the $50,000 and $150,000 exemption limits are not indexed to inflation, meaning that over time, more and more small businesses will be subject to bracket creep on the taxation of their passive investment income. Second, large Canadian-controlled private corporations (CCPCs) will have access to refundable taxes only when a they pay non-eligible dividends. Before the budget measures were introduced, this refund applied to all private corporations, whether the corporation paid out an “eligible” or “non-eligible” dividend. Third, the so-called “income sprinkling” proposals will have significant implications for businesses that distribute income to multiple individuals, including co-owners and family members. A business must now meet a “reasonableness test” to prove a family member has made a meaningful contribution to the business, in terms of work performed, property contributed, and risks assumed. This is highly subjective and places a costly administrative burden on businesses. Without clarification, what is “reasonable” will be decided over time by the CRA and the courts. The federal government expects to raise from these measures $925-million per year by 2022–23, or $3.4-billion over five years. This means private corporations will have $3.4-billion less to weather economic downturns, purchase equipment, invest in property or land, expand their operations, or invest in new and emerging businesses. Research conducted by the Parliamentary Budget Office (PBO) indicates that CCPCs with large amounts of passive investment income are disproportionately large in size. Roughly one-third of passive investment income is earned by firms with more than $15 million in taxable capital. Three sectors combined—finance and insurance, real estate, and management of companies and enterprises—earned close to 50 per cent of all taxable passive income. Evidence suggests these CCPCs, impacted by the tax measures, are deeply integrated into the small and mid-sized business sector, engaged in debt and equity financing, strategic corporate advisory services, and merchant banking. As independent corporations and holdco structures, they take ownership positions in active businesses for long-term investment and to restructure businesses for eventual resale. The estimated large holdings of passive assets (some $250 billion in total) and annual passive investment income earnings (estimated at $27-billion), suggests these CCPCs have a sweeping impact on the small business sector. These specialized private corporations play a key role promoting growth and expansion of small and mid-sized businesses in Canada, particularly as an alternative to public venture capital markets and private equity markets. The government’s proposed measures will discourage the specialized large private corporations from undertaking advisory and financing activities in the small business sector. It is likely that affiliates of these firms will shift operations to the United States to take advantage of more favourable tax treatment. This shift of advice and capital south of the border will be a significant loss for the Canadian small business sector and the Canadian economy. Ian C.W. Russell is president and CEO of the Investment Industry Association of Canada and past-chair of the International Council of Securities Associations. The Hill Times

Private corporation tax proposals could make financing conditions worse for small business

The government’s proposed measures will discourage the specialized large private corporations from undertaking advisory and financing activities in the small business sector.

In a minority Parliament, Liberals should get serious about tax fairness

PBO campaign proposal costing ‘above expectations’ so far, hundreds more estimates expected

Liberals set their pre-election machine in motion with generous, progressive-themed budget

In a minority Parliament, Liberals should get serious about tax fairness

Canada needs a modern, national health data architecture

To address online harms, Canada must commit to digital media literacy

A cure for multiple sclerosis could be just around the corner

Renewable energy is the way to go, says letter writer

Supporting local broadcasters is critical for our democracy

Budget 2018 comes with $6-billion in new spending and projected $18 billion deficit

Federal fiscal policies ‘sustainable’ over long term, says new PBO report

At least Bill Morneau attempted tax reform

Women doctors, entrepreneurs say proposed tax changes could make it hard for young professionals to go on maternity leave

Vox populi on tax reforms

News

Get free news updates

Opinion

Submit a guest opinion article

resources

Advertise

subscribe

get help

Private corporation tax proposals could make financing conditions worse for small business

The government’s proposed measures will discourage the specialized large private corporations from undertaking advisory and financing activities in the small business sector.

Get The Policy Briefings Newsletter