In July the prime minister of Canada and the federal finance minister introduced proposals that, if enacted, will fundamentally change how small business in Canada operates.
Since that unveiling of proposals, debate on the merits of each point has been impassioned. Debate has since polarized along ideological dogma. Canadian society must decide where they wish small business to be and what role it is to play in our future.
Canada was built by entrepreneurs investing their ingenuity and physical effort to get ahead in a new nation. As a nation, we have done a complete “180” from that time. Today small businesses (many are incorporated) that make up 98 per cent of firms in Canada and 88 per cent of private employment growth nationwide have been called tax cheats and utilizing “loopholes” to circumvent taxes. This is a stark change over the past century.
We need to understand and appreciate that small business creates wealth for all Canadians while government recycles and redistributes it. Without small business we would have a shortage of wealth for government to redistribute. We should encourage wealth creation by small business for our collective well-being.
Proposals put forth would curb income splitting with family members of Canadian controlled private corporations (CCPC) and curb passive investments in CCPCs. There appear to be more CCPCs being formed in recent years due to an expanding economy and a widening tax rate between personal and the small-business rate.
The proposal to curb income splitting would require a family member to prove their worth to the CCPC before a dividend could be paid. A spouse who has an off-farm job may not qualify despite being a shareholder in the farm business. The decision will be left to CRA to determine if the dividend paid is “reasonable.” I cannot imagine who among us wishes to prove to CRA our family member actually did contribute to the business. If there are abuses let’s stop them while leaving legitimate businesses alone by limiting dividends by age of shareholder.
Completely absent in this debate is the recognition of risk in the management of a CCPC. Risk is priced into every market. It exists whether we recognize it or not. If a person is a higher risk to lend money to, the lender demands a higher interest rate. There must be a premium available for someone to take the risk of beginning a business; a chance to do well and earn more than would normally be available by working for a wage. If that premium is taxed away, (curbing passive investing) then the elevated risk is no longer worth the effort. Who then do we work for? This proposal is valuing risk at zero, an illogical situation.
To clarify the concept of passive investments in a CCPC, we need to understand that, if small business earns a profit there are choices a manager has for that profit. Either a wage could be paid to the manager/owner (they always get paid last and only if there is a profit), new equipment could be invested in or the profit could be retained in the company. Profit retained by the company would attract taxation at the small-business tax rate.
The after tax money is either paid out to shareholders as a dividend or invested passively for use in future to cover operating costs or any number of expenses that occur even if there is no profit (including maternity leave, medical insurance, vacation time, statutory holiday pay, sick time) none of which are part of the self-employed pay package.
Let us be clear: any wage or dividend paid out to an employee or shareholder faces that person’s marginal tax rate. Any passive investment income inside the CCPC faces the highest marginal tax rate which in Manitoba is 50.4 per cent.
Anyone with a personal taxable income below $202,800 would have every incentive to pay out dividends from a CCPC to avoid the high tax rate (50.4 per cent) inside the CCPC. Tax integration ensures passive income received within a CCPC and paid out to a shareholder will be taxed at the same rate as if received by that shareholder on investments held outside a CCPC.
Curbing passive investing in a CCPC is problematic as without surplus cash available, what happens in a poor year?
After a number of years and a profitable business, retained earnings may accumulate providing a source of funding for expansion or for the owner’s retirement. Changing the rules to affect retained earnings and the return on them after decades of planning is unfair to those retiring or nearing retirement and will cause many CCPCs to be collapsed.
The proposal to affect passive investing in a CCPC should be scrapped, or simply eliminate the small-business tax rate entirely.
There is a problem with income splitting by too many Canadians within the CCPC structure and that should be dealt with to ensure fairness in the tax system. Triple taxation of dividend capital passively invested (eliminating refundable dividend tax) is outrageous, punitive and entirely unnecessary. Tax law already provides strong incentive to pay out passive income from a CCPC.
The proposals as they stand make establishing a new corporation questionable from the outset, although new businesses would benefit from the corporate structure by limiting personal liability.
If a wage earner feels the self-employed incorporated business owner is the panacea they search for, then establish your own business. Go for it, and find out for yourself.
Terry Fehr is president of Meadowlark Honey. He lives near Gladstone, Manitoba.