Per­rin Beatty

Policy - - In This Issue - Per­rin Beatty

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.

Adam Scotti photo

Fi­nance Min­is­ter Bill Morneau de­liv­er­ing Bud­get 2017 on March 22. The fall fis­cal up­date came seven months later on Oc­to­ber 24.

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