Tax changes risk unintended consequences

BOn the Contrary eing an Albertan, I remember it wasn’t that long ago we encountered a change in taxation based under the guise of oil companies paying their “fair share.” In the end, then-premier Ed Stelmach’s New Royalty Framework (NRF) proved to be a disaster due to the number of so-called “unintended consequences.” His NRF was eventually scrapped a few years later with a much-improved iteration recently introduced by the NDP government.

Our current federal government is now proposing a material change in private-corporation tax policy on the same premise of ensuring all Canadians pay their “fair share” which could have a number of unintended consequences of its own.

What concerns us the most as an investor in Canadian markets, is the potential impact on the Canadian economy at a time when we appear to be heading in the right direction. The problem, according to Kim G. C. Moody, a director of Canadian tax advisory at Moodys Gartner Tax Law, is that the federal government may be missing a key point.

“The federal government is billing their proposed changes as ‘tax fairness for the middle class,’ but many of us in the middle class either own or work for a small business,” Moody says, noting that Statistics Canada figures show that in 2015 small businesses employed more than 70 per cent of the 11.6 Canadians who work in the private sector.

“As a result, small business has become a core component of our economic innovation and growth accounting for 27 per cent of total research and development expenditures by spending $13 billion between 2011 and 2013,” Moody says. “In 2014, small business contributed 30 per cent of total GDP in their respective province.”

In regards to the potential magnitude of impact, Moody points out that if enacted, it would result in “some of the most dramatic tax policy changes for private corporations and their shareholders in almost 50 years.”

“Unfortunately, these are tax rules that will affect virtually every small business, most of whom do not have the ability to engage in complex tax planning nor can afford to have dedicated tax people on staff or to engage external professional help.”

Then there is the risk question. While many are calling the current system a ‘loophole’, in actuality many entrepreneurs have taken on a high degree of risk with the understanding that the existing tax structure will provide a partial offset.

Moody says his firm has seen “an uptick in Canadian business owners leaving Canada and changing their plans so that the growth of their business will occur outside of Canada” due to increased personal tax rates and other changes. The new changes could further exacerbate the problem, he says.

This isn’t surprising as simply take a look at the near 30-per-cent vacancy rates in downtown Calgary thanks to the mass exodus of capital from the energy industry as local companies cut back spending and international companies altogether pack up and sell their Canadian operations.

While there have been all kinds of excuses pertaining to the low oil price, we wouldn’t discount our lack of government support for infrastructure such as pipelines and access to non-U.S. export markets, increased taxation from the recent carbon-tax legislation, and an overall more-challenging operating environment than other jurisdictions.

Therefore, we agree with Moody when he stresses the importance of government to provide fertile gardens for entrepreneurs to thrive and create more taxpaying jobs. This is why the government should take its time and gather as much information as possible.

As Moody puts it: “Poorly thought out tax policy that is implemented in a hurry can have dramatic unintended consequences.”

As an investor this is definitely worth keeping a very close eye on, especially as our central bank is on a course to de-stimulate the economy with higher interest rates and a rocketing Canadian dollar. Higher taxes on small business certainly isn’t going to help foster not only economic growth but innovation and diversity, all of which are key components when making portfolio allocation decisions.