Federal tax proposals miss their target
When the federal government announced plans to review the fairness of Canada’s taxation system, few small businesses pressed the panic button. After all, going after tax cheats is important work. However, in recent weeks, the proposed tax changes have caused significant anxiety for small business owners. There is worry, frustration, and in some cases anger.
But as it concerns the tax system, the devil will always be in the details.
There are three main proposals targeting high-income individuals: (1) Limit the spreading of income and capital gains (and in some cases the capital-gains exemption) among family members associated with a corporation; (2) prevent a corporation from investing in passive assets using corporate after-tax earnings; and (3) ensure that capital-gain tax treatment cannot be used in taking out corporate earnings in lieu of taxable dividends.
At face value, the proposals fit with an image of bringing fairness to the tax system. However, despite claims of surgical precision targeting only those who abuse “loopholes,” ordinary businesses owners are going to wake up to a few missing organs.
New rules on income splitting would significantly complicate tax compliance for family businesses — yet have relatively little impact on revenue for government. Even if owners convert to paying salaries instead of dividends to family workers, they would still be subject to yet-to-be-defined “reasonableness” rules from the Canada Revenue Agency. With the wide variation of business types across the country and the differing levels of contributions made by family members, tracking and recordkeeping will have to be heroic.
Draft rules on passive income are also highly problematic for small businesses — and not just the well-to-do. For many small businesses, after-tax profits act like a savings account. Because these businesses do not have access to public equity markets, government grants, or bank credit to any large degree, they rely heavily upon profits to pay for new equipment, replace an aging work truck, or create a cushion for downturns.
Since this is usually a multi-year process, money is often placed in passive investments, such as interest earning accounts. Government now wants to treat that passively earned income as if it is going to be immediately distributed to the owner(s) — and, potentially push up the total tax rate on those earnings to more than 70 per cent.
Finally, changes to capital-gains treatment will make succession planning much more difficult. Though aimed at distributions to minors, through trusts, or via split income, for some it could be a form of retroactive taxation. For others, double taxation of estates would become a problem. This creates especially adverse situations for family businesses being passed on to the next generation.
The basic principles of smallbusiness tax treatment have been the result of decades of experience, balancing, and compromise. The aim has been to recognize the uncertainty and variability of small-business earnings and the financial risk ordinary people take when opening their businesses. Yet, the Prime Minister and Finance Minister are insistent on moving forward with these changes, with maybe some tweaking.
Having been released during the summer and with barely 75 days for the public to react, more time is needed — both to understand government’s objectives and to work through the potential effects of any needed changes.
New rules on income splitting would significantly complicate tax compliance for family businesses — yet have relatively little impact on revenue for government.
Vaughn Hammond is director of provincial affairs in Newfoundland and Labrador for the Canadian Federation of Independent Business.