For small f irms, biggest tax fight in decades persists
Threshold is prohibitive under new rules
Last year, the federal tax proposals were on everyone’s mind. Announced in the middle of the summer, the changes hit the small business community like a ton of bricks. They were the most drastic reforms to small business taxation in decades, leading to months of sustained outrage.
As a result of the intense pushback from entrepreneurs from coast to coast, the landscape shifted. In a package of government concessions during Small Business Week in October, some of the proposals were watered down and one of them — changes to capital gains — shelved indefinitely. Business owners were particularly pleased to see the government reinstate its promise to lower the small business tax rate.
Unfortunately, the signs government was listening took an about-face in December, when it announced that it would move forward with its plan to restrict the way owners share business income with family members. What was particularly galling was that this announcement was made only a few weeks before these significant changes took effect on Jan. 1, 2018. I doubt there is a single business owner in the country that understands what they are to do, and many will discover they are offside under the new rules if they are unlucky enough to be audited a year or two down the road.
All eyes were on the 2018 budget for details on the last chunk of the proposed reforms: changes to the tax treatment of passive investment income. These investments, as business owners and groups like CFIB have told the government for months, are important for firms as they serve as an insurance policy against hard times. Many use passive investments — such as investments in another firm or a rental property — as ways to save for a future big technology purchase or expansion.
The new rules will see business owners lose access to the small business tax rate once they cross a certain threshold in passive investments. If a business earns more than $50,000 per year from passive investments, they will begin to lose access to the lower small business tax rate on their regular, active business income. And if they have more than $150,000 in passive investment income, they will be considered to be a large corporation from a tax perspective.
While this is admittedly a better approach than the mess that was first contemplated, it remains a giant tax hike for small firms and has created an entirely new group of those who will lose. Effectively lost in the new approach is the commitment the government made to grandfather those who had already built up passive investment income. While it is true that the passive investment income itself will not be taxed at a higher amount under the new approach, requiring business owners to pay tens of thousands in higher taxes on active business income is by no means keeping the promise of ensuring those who made previous legal decisions are unaffected.
As tax professionals begin to sort out the net effect of the changes and share it with their clients, we at CFIB are beginning to hear from business owners who will be hit with the higher tax bills. A small-business owner in Newfoundland and Labrador reports he will pay $80,000 a year in higher corporate income taxes under the new approach. Another in Quebec reports she will pay $45,000 more per year.
Combined with new rules on income-splitting, these changes will mean $1 billion going into government coffers from small, independent business owners. Or at least that’s what the government says.
In reality, we don’t know exactly how much money the government will take in in new taxes. It looks increasingly like the government is lowballing how much money it’s going to get thanks to these new rules. The Parliamentary Budget Officer reports that the new revenue from income-splitting may be two or three times what is suggested in the 2018 budget.
The PBO would probably like to give a more definitive answer, but in their words, they “cannot clearly identify the individuals who will be subject to the (income-splitting) rules.” If the best minds at the PBO and the Department of Finance can’t agree on whom these rules will affect and how much they will owe, God help us when this falls to the Canada Revenue Agency.
The muddied tax changes come at a particularly bad time for Canadian businesses. Their energy bills have gone up thanks to carbon taxes, and firms in many provinces are facing massive hikes in minimum wages and costly new labour laws. And we can’t forget that business owners (and all employees) will see higher CPP premiums starting in 2019 and the following four to six years.
So while progress has been made, it is too soon to declare victory — but not too late for government to provide further relief to the nation’s entrepreneurs. As the changes wind their way through Parliament as part of the budget implementation legislation, we need them to keep listening.
Specifically, government needs to listen to owners whose spouses have put so much into the family business and who deserve some recognition. They should be exempted from the incomesplitting restrictions. Government needs to allow business owners more time to implement the new income sprinkling rules, too. Pushing effective implementation of the new approach to Jan. 1, 2019 would give business owners and the CRA time to ensure everyone gets this right.
And on passive investment income, a solution needs to be found to allow those who have built investments already to be exempted from the new approach. CFIB and the Coalition for Small Business Tax Fairness remain ready to work with the Department of Finance to find ways to do this without choking the system with new complexities and paperwork.
So the battle for tax fairness for small business owners continues. There are solutions to these problems that can address the government’s objectives without killing the geese that lay the golden eggs. Government, are you listening?