On the front lines

The Globe and Mail (Atlantic Edition) - - FRONT PAGE - ALEXAN­DRA POSADZKI ERIC ATKINS DAVID PARKIN­SON

This de­bate is about more than money

En­trepreneurs say Ot­tawa’s pro­posed changes to small-busi­ness taxes are a costly ‘slap in the face’ to the peo­ple who take big risks to build the econ­omy and create jobs. The gov­ern­ment says it’s sim­ply lev­el­ling the play­ing field, clos­ing loop­holes that widen the gap be­tween the wealthy and the mid­dle class. Who’s right?

Ot­tawa’s call for changes to the way pri­vate com­pa­nies are taxed has sparked wide­spread out­rage and raised ques­tions about the per­ceived value of en­trepreneurs to the Cana­dian econ­omy. How did we get here, and where are we headed?

The tax-avoid­ance quag­mire that fed­eral Fi­nance Min­is­ter Bill Morneau wants to clean up via pro­posed small-busi­ness tax changes is one Ot­tawa helped create – more than four decades ago, when an­other Trudeau was prime min­is­ter.

Prime Min­is­ter Justin Trudeau was only a few days old when a broad pack­age of tax re­forms en­acted by the gov­ern­ment of his fa­ther, Pierre Trudeau, took ef­fect on Jan. 1, 1972. While small busi­nesses had re­ceived tax breaks be­fore, the 1972 tax re­forms in­sti­tuted the small­busi­ness de­duc­tion, which made the ef­fec­tive tax rate for small busi­nesses sub­stan­tially lower than that of larger com­pa­nies. This is the ba­sis of the tax struc­ture un­der which small busi­nesses still op­er­ate to­day.

The in­tent was sim­ply to let small busi­nesses hold onto more of their prof­its so they could fi­nance their growth. But the changes put in place the foun­da­tion for what has be­come a com­plex jumble of tax breaks and in­cen­tives for small busi­ness, cre­at­ing fer­tile ground for tax ex­perts to ex­ploit – some­times in ways that do not pro­mote the small-busi­ness growth and job cre­ation that govern­ments had in mind. Toss in the string of fed­eral and pro­vin­cial cor­po­rate tax cuts over the years, which have opened a wide chasm be­tween small-busi­ness and per­sonal tax rates, and in­cor­po­ra­tion has be­come an in­creas­ingly at­trac­tive op­tion – par­tic­u­larly for high earn­ers seek­ing to shel­ter in­come from the tax man.

“The rhetoric around ‘loop­holes’ and the rich tak­ing ad­van­tage – this stuff has been there for a long time, and govern­ments have con­trib­uted,” said tax-pol­icy ex­pert Jack Mintz, the pres­i­dent’s fel­low of the School of Public Pol­icy at the Univer­sity of Calgary.

Now, Ot­tawa is try­ing to put this tax-shel­ter­ing ge­nie back in the bot­tle with its con­tro­ver­sial pro­pos­als, which rest on three planks. The first would limit a busi­ness owner’s abil­ity to “sprin­kle in­come” among fam­ily mem­bers who do not work for the com­pany. The sec­ond af­fects a busi­ness owner’s abil­ity to con­vert in­come to cap­i­tal gains, which are taxed at a lower rate. And the third would re­strict the cor­po­ra­tion’s abil­ity to take cash out of the busi­ness to make so­called pas­sive in­vest­ments in out­side as­sets, such as eq­ui­ties.

The gov­ern­ment has faced an out­pour­ing of heated crit­i­cism about the pro­pos­als. Doc­tors, restau­rant own­ers, man­u­fac­tur­ers farm­ers and count­less other groups have gath­ered to dis­cuss them, com­plain to their MPs and voice their views on so­cial me­dia.

The pro­pos­als are com­plex and will af­fect com­pa­nies dif­fer­ently, but they could have se­ri­ous im­pli­ca­tions for how busi­nesses op­er­ate and for the care­fully con­structed fi­nan­cial plans of small-busi­ness own­ers and their fam­i­lies. While the changes will have a greater im­pact on wealthy busi­ness own­ers, they also limit the op­tions of the not-so-wealthy. For many, the fed­eral tax changes are yet an­other bur­den for busi­nesses fac­ing ris­ing costs and new pro­vin­cial gov­ern­ment poli­cies such as a higher min­i­mum wage.

And the de­bate sur­round­ing the tax changes is about more than just money. At its core it’s about the place of en­trepreneurs in our so­ci­ety. Does their role in cre­at­ing eco­nomic ac­tiv­ity and jobs jus­tify giv­ing them pref­er­en­tial tax breaks, or are busi­ness own­ers no more de­serv­ing than any other tax­payer?

Busi­ness own­ers take is­sue with the sug­ges­tion that the cur­rent rules are un­fair and feel the gov­ern­ment has cast them as un­car­ing elites who are happy to dodge taxes and beg­gar other Cana­di­ans.

Ken Seto, the CEO of Toron­to­based game stu­dio Mas­sive Dam­age Inc., says en­trepreneurs take risks that reg­u­lar salaried work­ers do not – and that it’s im­por­tant to en­cour­age them to keep do­ing so.

“I feel like it’s kind of a slap in the face to keep leg­is­lat­ing things so that we’re put on an even slate with peo­ple who are em­ployed full-time,” said Mr. Seto, adding that over the past decade he has had to steer his com­pany away from the brink of col­lapse more than once.

“If the com­pany had ac­tu­ally im­ploded and went out of busi­ness, there’s no safety net for me,” he said. “I’d have to go out there and try to find a job. There’s no cushy EI – there’s none of that stuff.”

About a decade ago, Mr. Seto sold his Mini Cooper for $16,000 to help fund his mo­bile-app com­pany, End­loop. He says en­trepreneurs work long hours and risk ev­ery­thing, in­clud­ing their homes, to get their busi­nesses off the ground. “Shouldn’t that be re­warded? Shouldn’t that be some­thing that you want peo­ple to strive for?”

Joe Camillo, who owns Niko Ap­parel Sys­tems in Hamil­ton and co-owns row­ing com­pany Re­gat­taS­port, echoes the sen­ti­ment.

“I don’t have a pen­sion plan,” Mr. Camillo said. “The fu­ture for me ver­sus a salaried em­ployee with a ben­e­fits pack­age is very dif­fer­ent. So why shouldn’t I have some of those ad­van­tages, like not be­ing that taxed on my pas­sive in­vest­ments or not hav­ing to worry about pass­ing on an ex­or­bi­tant tax bur­den to my kids if they want to carry on the busi­ness?”

In fact, that move to re­strict pas­sive in­vest­ments is a con­cern for many busi­ness own­ers. Un­der the pro­posed rules, com­pa­nies that make in­vest­ments in­side the com­pany will face a higher tax rate than if the busi­ness own­ers made those in­vest­ments in their per­sonal ac­counts.

Gavin Sem­ple, owner of Brandt Group of Com­pa­nies, a Regina-based maker of farm and mine ma­chin­ery, says the move will limit com­pa­nies’ abil­ity to amass cap­i­tal for ex­pan­sion. Mr. Sem­ple says he has used the tech­nique to save money for in­evitable eco­nomic down­turns and, re­cently, to help fund the pur­chase of a plant in Saska­toon.

Brandt Group is not a small busi­ness – it is Saskatchewan’s largest pri­vately held com­pany, em­ploy­ing 1,800 peo­ple in Canada and the United States. But Mr. Sem­ple says the pro­posed tax changes – he is un­happy with them all – will be felt at busi­nesses large and small.

“This is an at­tack on pri­vate busi­nesses across the coun­try. It doesn’t matter whether you’re a dry clean­ing out­fit with four em­ploy­ees or you’re a com­pany like Brandt with 1,800 em­ploy­ees,” he said. “The cu­mu­la­tive ef­fect is bru­tal. What it does to our de­ci­sion-mak­ing is we start to ques­tion our di­rec­tion and our strat­egy. Do we want to in­vest here?”

For some busi­ness own­ers, such as farmer Megz Reynolds, the is­sues lit­er­ally strike close to home.

A 640-acre sec­tion of farm­land just out­side of Kyle, Sask., has been in her hus­band’s fam­ily for over a cen­tury. But un­der the gov­ern­ment’s pro­posed tax changes, Ms. Reynolds is afraid she and her hus­band may not be able to af­ford to buy it from her in-laws when they re­tire.

“If we were to buy that land from my fa­ther-in-law, we would ac­tu­ally be taxed at a much higher bracket than if he was to sell it to a com­plete stranger,” she said – ef­fec­tively be­cause, un­der the new rules, it would be taxed as a div­i­dend rather than a cap­i­tal gain.

Pe­ter Weiss­man, a part­ner with the ac­count­ing firm Cadesky Tax in Toronto, says the tax rate if the busi­ness is trans­ferred to one’s kids would be about 45 per cent, against just 25 per cent if were sold to an out­sider.

Los­ing the fam­ily land would be a big hit to the cou­ple’s crop-farm­ing busi­ness, Ms. Reynolds said. The sec­tion of land in ques­tion, which the cou­ple cur­rently rents, con­sti­tutes just un­der half their farmable land. But there are emo­tional im­pli­ca­tions in ad­di­tion to fi­nan­cial ones, she says, not­ing that ev­ery gen­er­a­tion of farm­ers in her hus­band’s fam­ily has lived on that land.

“It’s a legacy thing,” she ex­plained. “Our girls are fifth­gen­er­a­tion farm­ers. That land could po­ten­tially be in the fam­ily for an­other hun­dred years. It would be ex­tremely emo­tional

The rhetoric around ‘loop­holes’ and the rich tak­ing ad­van­tage – this stuff has been there for a long time, and govern­ments have con­trib­uted. Jack Mintz Tax pol­icy ex­pert, Univer­sity of Calgary

I think there’s been an enor­mous amount of fear and mis­in­for­ma­tion pumped into the de­bates. You’ve got very small frac­tions of the pop­u­la­tion who are go­ing to be af­fected, but you’ve got a whole lot who are now wor­ried. Lars Os­berg Eco­nomics pro­fes­sor, Dal­housie Univer­sity

to lose land that’s been in the fam­ily for 107 years.

“The Trudeau gov­ern­ment’s re­sponse is that we don’t need to worry un­less it’s over a mil­lion dol­lars,” Ms. Reynolds said. “But the re­al­ity is that a mil­lion dol­lars re­ally doesn’t get you much in the way of farm­land any more.” Ob­vi­ously, the gov­ern­ment’s ef­forts to sell the pro­pos­als to Cana­di­ans has not gone well and has spurred at least two Lib­eral MPs to de­nounce the process. Mr. Trudeau has sig­nalled he is will­ing to lis­ten to crit­i­cism and make changes to some of the pro­pos­als, but he is not back­ing down from his po­si­tion that the rich need to pay their fair share.

“A lot of those wealthy folks are re­ally fight­ing to keep those ben­e­fits that they have – and they’re mak­ing a lot of noise,” he said in a CBC in­ter­view aired on Sept. 12. “We just want to make sure that peo­ple us­ing pri­vate cor­po­ra­tions don’t have ben­e­fits that aren’t avail­able to av­er­age Cana­di­ans, and that’s where we’re mak­ing a lit­tle tweak.”

Lars Os­berg, an eco­nomics pro­fes­sor at Dal­housie Univer­sity in Hal­i­fax whose spe­cial­ties include in­come and wealth dis­tri­bu­tion, says Mr. Trudeau’s po­lit­i­cal foes and the busi­ness com­mu­nity are is­su­ing “crazy ex­ag­ger­a­tions” in or­der to “muddy up” the gov­ern­ment. Dr. Os­berg says the changes would help bring eq­uity to a tax sys­tem that favours the well off.

“I think there’s been an enor­mous amount of fear and mis­in­for­ma­tion pumped into the de­bates,” he said. “You’ve got very small frac­tions of the pop­u­la­tion who are go­ing to be af­fected, but you’ve got a whole lot who are now wor­ried.” In fact, mis­in­for­ma­tion – or a lack of in­for­ma­tion – is at the heart of the de­bate. De­spite Ot­tawa’s zeal to close loop­holes in the small-busi­ness tax sys­tem that can be ex­ploited to re­duce per­sonal-tax bills, no one re­ally knows how big this prob­lem is. There is no de­tailed re­search re­veal­ing how many peo­ple are in­cor­po­rat­ing as small busi­nesses pri­mar­ily as a tax-avoid­ance strat­egy.

Univer­sity of Ot­tawa re­searcher Michael Wolf­son has been do­ing his best to shine a light on what he calls the “dark cor­ner” of Canada’s in­come tax sys­tem. In 2015 and 2016, he co-au­thored two in­flu­en­tial re­ports on the topic of small­busi­ness in­cor­po­ra­tion and its use by high-in­come Cana­di­ans. (In­deed, it was Mr. Wolf­son’s work that in­spired the gov­ern­ment to look into tight­en­ing the rules sur­round­ing small-busi­ness tax breaks.)

His re­search came to a cou­ple of key con­clu­sions. First, in­cor­po­ra­tion is heav­ily skewed to­ward the coun­try’s high­est earn­ers. And sec­ond, one of the most lu­cra­tive tax ad­van­tages of earn­ing in­come in a cor­po­rate struc­ture is in­come split­ting, the abil­ity to spread in­come among fam­ily mem­bers – typ­i­cally through cor­po­rate div­i­dend pay­ments – to sub­stan­tially re­duce the fam­ily’s over­all per­sonal in­come tax bill. In fact, he cal­cu­lated that in­come split­ting within the cor­po­rate small-busi­ness struc­ture is cost­ing the fed­eral gov­ern­ment about $500-mil­lion a year in lost rev­enue – an es­ti­mate he char­ac­ter­ized as “con­ser­va­tive.”

“Sub­stan­tial tax ben­e­fits are likely flow­ing to a se­lect group of mostly higher-in­come fam­i­lies, where the ob­jec­tives of sup­port­ing wor­thy ob­jec­tives such as en­trepreneur­ship and job cre­ation are un­likely to be re­al­ized,” he con­cluded.

We also know that since the turn of the cen­tury, the use of small-busi­ness in­cor­po­ra­tion has soared. Depart­ment of Fi­nance fig­ures show that the num­ber of Cana­dian-con­trolled pri­vate cor­po­ra­tions, or CCPCs, (which qual­ify for the small-busi­ness tax rate on their first $500,000 of an­nual in­come) in­creased by 50 per cent from 2001 to 2014, to about 1.8 mil­lion. (The num­ber of self-em­ployed Cana­di­ans, in­clud­ing those whose busi­nesses have em­ploy­ees, rose just 20 per cent over the same pe­riod.)

This growth has come dur­ing an era of gen­er­ally de­clin­ing small-busi­ness tax rates in Canada, both at the fed­eral and pro­vin­cial lev­els.

“By far the most im­por­tant [fac­tor] is that the in­cen­tive has got­ten big­ger as the small-busi­ness tax rate has de­clined over the past 10 or 20 years,” Mr. Wolf­son said in an in­ter­view this week.

The fed­eral tax rate on small­busi­ness in­come has fallen from 13.12 per cent a decade ago to 10.5 per cent to­day. When com­bined with dif­fer­ing pro­vin­cial rates, the Fi­nance Depart­ment cal­cu­lates that the av­er­age com­bined fed­eral-pro­vin­cial tax rate for small busi­ness has fallen from about 20 per cent in 2000 to just 14.4 per cent to­day.

At the same time, the com­bined fed­eral-pro­vin­cial top mar­ginal per­sonal in­come tax rate has risen, from about 41 per cent to 51.2 per cent. That widen­ing gap be­tween the tax hit on per­sonal in­come and small­busi­ness in­come has made in­cor­po­rat­ing a com­pelling tax strat­egy, es­pe­cially for high-in­come Cana­di­ans.

“We kept low­er­ing the small­busi­ness tax rate on ac­tive busi­ness in­come, be­cause it was very pop­u­lar with small busi­nesses, and kept open­ing up the dif­fer­en­tial be­tween the cor­po­rate rate and the per­sonal rates as a re­sult,” Mr. Mintz said. “That helps push more peo­ple to in­cor­po­rate.”

Among pro­fes­sion­als such as doc­tors and lawyers, the num­ber of in­cor­po­ra­tions has tripled since the turn of the 21st cen­tury, as reg­u­la­tory changes first made it an avail­able op­tion for them.

Mr. Wolf­son points to a change in On­tario’s reg­u­la­tions for doc­tors in 2005 as a case in point. As part of the prov­ince’s fee ne­go­ti­a­tions with the On­tario Med­i­cal As­so­ci­a­tion, the gov­ern­ment agreed to al­low fam­ily mem­bers to own shares in physi­cians’ cor­po­ra­tions. It was, in ef­fect, a way for the gov­ern­ment to de­liver more in­come to doc­tors without rais­ing their fees, by en­abling in­come split­ting. The re­sult: CCPCs among On­tario physi­cians soared ten­fold from 2005 to 2011. (At the same time, Mr. Wolf­son found, CCPCs among restau­rant own­ers were es­sen­tially flat.)

Taken to­gether, the ev­i­dence points to an in­creased use of small-busi­ness in­cor­po­ra­tion as a tax shel­ter. But there is a con­cern that the gov­ern­ment has not only over­reached with its pro­pos­als but has jumped the gun – pen­ning pol­icy be­fore it has in­vested in this ad­di­tional level of re­search. This is, af­ter all, a gov­ern­ment that came into of­fice pledg­ing ev­i­dence­based pol­icy-mak­ing.

“I think it’s re­ally a shame that they don’t seem to have the num­bers read­ily at hand,” Mr. Wolf­son said. “If public pol­icy is to be done on an ev­i­dence­based man­ner, then a sub­stan­tial in­vest­ment needs to be made … on mak­ing sure you have the in­for­ma­tion in or­der to un­der­stand and mon­i­tor what’s go­ing on with these pro­grams.”

Dr. Os­berg of Dal­housie says the in­creased use of tax shel­ters by pro­fes­sion­als isn’t an eco­nomic trend but rather a re­la­belling of in­come for tax pur­poses. “Once a trend like that gets go­ing, you’re suck­ing an aw­ful lot of tax rev­enue out of the sys­tem. … Once you start, it just keeps on go­ing. Every­body says: Well, if he gets it, why don’t I? The rest of us, who are ac­tu­ally paid on salary, we end up pay­ing for it be­cause the tax rev­enue has to be made up some­where.” But when Mr. Trudeau says the pro­pos­als will close loop­holes en­joyed by the “wealthy,” many busi­ness own­ers take it per­son­ally. They see them­selves as the very mid­dle class the gov­ern­ment is al­ways talk­ing about help­ing. They work hard, em­ploy others, pay taxes.

“The mes­sage has been very in­sult­ing to us. That’s why we’re so mad. It re­ally is up­set­ting,” said Chris Struthers, owner of Struthers Tech­ni­cal So­lu­tions Ltd., an elec­tri­cal en­gi­neer­ing com­pany in Pen­tic­ton, B.C., that works in Canada and around the world.

“I think busi­ness own­ers in gen­eral, we’re happy to pay taxes. We’re happy to pay our share un­der the ex­ist­ing rules,” Mr. Struthers said. “I do a lot of work in coun­tries where peo­ple don’t pay taxes … and they’re not good places to work. So we rec­og­nize that taxes need to be paid and we con­trib­ute a lot. So to be la­belled as guys rip­ping off the rest of the tax­pay­ers with these loop­holes … it’s up­set­ting.”

Mr. Struthers started his elec­tri­cal en­gi­neer­ing com­pany al­most seven years ago. He says that if he could do it all over again, he likely wouldn’t – not if the pro­posed tax changes were in place.

“I sat on the fence for a very long time,” he said. “I had a draft busi­ness plan that I sat on for about a year, and fi­nally my wife prod­ded me to go meet with an ac­coun­tant to have the busi­ness plan re­viewed. He said: You’ve got some great ideas and here’s some tax in­cen­tives you might be able to uti­lize to re­duce your risk. And those made a huge dif­fer­ence in tak­ing the leap. … The biggest one was the in­come split­ting.”

Be­ing able to share in­come with his wife al­lowed him to re­duce the tax bill and spend the money on equip­ment and new em­ploy­ees.

“We took min­i­mal in­come in those years so we could in­vest in the busi­ness and grow. In those years, my wife and I were the low­est-paid peo­ple in the busi­ness for the first three years,” he said. “It was not un­til the fourth year that I started pulling ahead and en­joy­ing some of the fruits of our labours. Retroac­tively speak­ing, if those rules were in place then, I’m sure they would have stunted our growth.”

TOP: SEAN KIL­PATRICK/THE CANA­DIAN PRESS; BOT­TOM: FRED LUM/THE GLOBE AND MAIL

Fi­nance Min­is­ter Bill Morneau, top, wants to level the tax­a­tion play­ing field. But Hamil­ton small-busi­ness owner Joe Camillo, above, be­lieves the fed­eral gov­ern­ment’s pro­pos­als will put en­trepreneurs such as him at a dis­ad­van­tage.

FRED LUM/THE GLOBE AND MAIL

Hamil­ton busi­ness owner Joe Camillo points out that en­trepreneurs take risks. ‘The fu­ture for me ver­sus a salaried em­ployee with a ben­e­fits pack­age is very dif­fer­ent.’

CHELSEY KRAUSE/THE GLOBE AND MAIL

Farmer Megz Reynolds fears the pro­posed tax rules will hit suc­ces­sion plans. ‘It would be ex­tremely emo­tional to lose land that’s been in the fam­ily for 107 years.’

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