Corporate Tax Changes, Competitiveness and Fairness:
Can Canada Find a Balance?
It’s no surprise that, among the interventions from stakeholders in the Trudeau government’s consultation process on its corporate tax reform proposals, the Canadian Chamber of Commerce weighed in against them. As Perrin Beatty, the group’s president, writes, the roll-out seemed destined to confound its members.
Major tax reforms are taking place across the globe and Canada must decide if it is going to lead or get left behind.
France has embarked on the path of tax overhaul, with a 2017 budget that reduces or eliminates several business taxes, while reforming unemployment insurance. The UK undertook an important tax modification effort last year and the U. S. Congressional Republicans are determined to press ahead with a biggest tax reform in 30 years, which would see the general corporate rate slashed from 35 per cent to 20 per cent while eliminating certain tax credits.
What is Canada doing in the midst of our trading partners’ laser-like focus on competitiveness?
For several weeks in the summer and fall, the Chamber advocated with the business community against the government’s tax proposals. Much of the government’s messaging mentioned “high-income earners” were using “loopholes” to gain unfair advantages. The policies were overkill and seemed designed to affect the maximum number of businesses, in the most complicated manner, without collecting much revenue.
In response, the Canadian Chamber of Commerce launched a campaign asking chambers and businesses to email their members of parliament. A coalition was formed with 70 other business associations calling on the government to put the tax proposals on hold so we could have a more thorough review of the tax policy. We urged the government to:
• Take these proposals off the table.
• Launch meaningful consultations with the business community to address any shortcomings in tax policy without unfairly targeting businesses.
• Establish a royal commission to undertake a comprehensive review of taxing statutes, guided by the principles of simplification and modernization and having the goal of reducing compliance costs to make Canada a competitive tax regime once again.
Instead of relaunching consultations or going back to the drawing board, the government announced a series of quick fixes throughout the week of October 16 to improve the palatability of the proposed tax changes.
The big sweetener was a reduction in the small business tax rate from the current 10.5 per cent to 9 per cent, ef- fective in January 2019. The minister also promised that the proposed income sprinkling rules will be streamlined and clarified to significantly reduce red tape and that the tax on passive income will now include a threshold of $50,000 to exclude most businesses. Measures on converting income into capital gains were shelved indefinitely.
However, details about how these changes might actually work are still scarce in the Finance backgrounders, and there still could be huge unintended consequences for business and investment in Canada. We’re saddened that all this energy has been spent on measures that will have little impact beyond reducing Canada’s attractiveness as a place to invest. It’s a missed opportunity.
On income splitting, we certainly understand the government’s concerns about business paying unjustified salaries to family members in order to reduce taxes. However, we were concerned about the practicality of imposing “reasonableness tests” on family income, that the Canada Revenue Agency might interpret these rules too aggressively.
The government has now promised to streamline and clarify their proposed rules. The reasonableness tests have now been replaced with a “meaningful contribution test.” But with so few details, we remain convinced that the rules will add to the administrative burden facing Canadian business.
The proposal to tax passive investment income is the one that could have the most harmful economic im-
pact. Investment income is already taxed at a rate of 50.3 per cent, which is refundable when a shareholder receives the income because she will be paying personal tax rates. If the tax becomes non-refundable and then personal taxes are applied on top, the government would be hitting investment income with an effective tax rate between 65 per cent to 73 per cent. Business owners won’t have any incentive to keep surplus assets in the business, which means less of an economic safety net for those owners.
On October 18, the government announced that it would introduce a tax-free threshold of $50,000 for passive income to allow small business owners to save. This is an improvement, but why would it be legitimate for a small business to save, but a business with 100 employees that wanted to set aside $10 million be deserving of a 73 per cent tax?
A Bank of Canada study called “Productivity in Canada: Does firm size matter?” found that half the productivity gap between companies in the United States and Canada was the result of Canadian businesses being smaller, and smaller companies invest less in capital and skills. Businesses of all sizes need to accumulate assets and invest, and yet the government is proposing to create the world’s largest incentive for large and medium-sized firms to pull money out of the business.
Recently, one of our members, the Canadian subsidiary of a multinational, asked us if they should pull their holding company out of Canada be- cause income from the incorporated subsidiary operations would count as passive income. There could be widespread impact on venture capitalists and foreign investors that will reduce the availability of financing for Canadian firms. Overall, the tax on passive income would mean fewer jobs, less of the cushion to get us through an economic downturn, less venture-capital, and less foreign investment.
We certainly endorse the government’s objective of improving tax fairness. The Prime Minister said on October 16 that the problem is not individuals, but the system. We agree, but fairness is just one of several objectives in tax policy.
There are other priorities. With a combined federal and provincial corporate tax rate in the 27 per cent range, Canada is right around the OECD average. That is adequate for now, but if the US— our neighbour and main trading partner—goes ahead with a major tax reform, our competitiveness challenges could become acute. Rather than reactively waiting for the Americans to move before we figure out how to respond, let’s proactively get our own house in order and bring down rates to boost Canadian competitiveness.
Canada’s tax system could also be redesigned to support investments in productive assets and business growth. Instead of penalizing passive savings, Canada could offer incentives to invest in the business. A 100 per cent write- off of capital investment in the year it is made would provide a big inducement. More importantly, we need to shift these support measures from asset based capital cost allowance to figuring out how to make an immediate, positive impact on cash flow—which is the real driver of investment and growth.
On the human capital side, Canada needs to attract and retain worldclass talent, both for skilled workers and entrepreneurs. This means that we also need to look at personal income tax to determine if top marginal rates in the 53.5 per cent (in Ontario) are providing a disincentive. Many of the people affected are not just the maligned “high income earners”, but also the innovators and creative visionaries who can lead businesses in the 21st century.
Finally, we need to confront the total overall cost of doing business in Canada—the serious cumulative impact of the growing burden imposed by fees, taxes and regulations the private sector is being asked to bear. Between Canada being a high labour cost jurisdiction to the rising electricity costs and the Canada Pension Plan contribution rates increasing by 2 per cent beginning in 2019, our members are worried about their ability to both grow their businesses within Canada and compete for investment and customers from abroad.
The overall burden of governmentimposed costs is hampering the ability of Canadian business to create jobs and provide tax revenues that support government services.
Canada has a real shot at creating an internationally competitive tax system that rewards entrepreneurship and encourages businesses to invest in the technologies, skills, and the capacity needed to grow. In order to accomplish that though, we need a real willingness from government to work with the business community, and to put our archaic, complex and frustrating tax system on the table to make way for a new, competitive and modern model.
Finance Minister Bill Morneau delivering Budget 2017 on March 22. The fall fiscal update came seven months later on October 24.