Government out of touch on small business tax changes

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Mistaken perceptions of business owners fueling outrage in business community

In the middle of summer, when much of the country was in vacation mode, Federal Finance Minister Bill Morneau dropped a set of corporate and small business tax proposals that has since sent Canada’s business community into a level of activity and outrage few have seen before.

High-profile small business advocates in Ottawa have observed that they have never seen the likes of the negative reaction that has accompanied these proposals, and the rhetoric employed by the Minister in their defense has many small business owners claiming the government is disconnected from the realities faced by Canada’s job creators.

The changes are highly technical in nature but amount to crackdowns in three areas the government sees as ripe with tax avoidance “loopholes” used mainly, the government claims, by wealthy Canadians.

Proposed changes include a crackdown on income sprinkling, tax hikes on passive investments in a private corporation and changes to rules when converting corporate income into capital gains.

These proposed tax changes could make it difficult for companies to invest in future growth, plan for expansion or retirement if implemented as initially proposed.

While few will take issue with the notion that small business owners should not be able to pay family members for doing nothing productive for the firm (the ostensible motivation for the income sprinkling move), changes to the tax treatment of passive income earned inside a corporation will be met with further vociferous opposition by business owners unless the government backs down on that particular provision.

Furthermore, rhetoric that paints small business owners as a group of tax-avoiding one-percenters is adding fuel to the fire of opposition to these proposals. The backgrounds of the Prime Minister and his Finance Minister may explain this problem. The Prime Minister himself has claimed multiple times that many small businesses are set up not to pursue a productive economic idea, but to shelter income from high personal tax rates. His Finance Minister has echoed this sentiment.

While there are undoubtedly some questionable incorporations that take place under Canadian tax law, the overwhelming majority of small businesses are just that: small firms whose principals put in thousands of hours of sweat equity and often risk everything to build a profitable enterprise and to create livelihoods for their employees.

Incorporations that take place merely for “tax planning” do so due to the huge spread between top personal tax rates and corporate tax rates, a spread that is only growing as governments continually ask high earners to “pay a little more.”

Proposed changes include a crackdown on income sprinkling, tax hikes on passive investments in a private corporation and changes to rules when converting corporate income into capital gains.

Finance Minister Morneau comes from what can charitably be referred to as the economic elite of Canada’s largest city.

The circles in which he spends his time include some very high-income people indeed, many of whom have undoubtedly personally incorporated to monetize the spread between personal and corporate tax rates.

But the Finance Minister’s personal experience is not in any way representative of Canada’s small business community. These mistaken perceptions are, however, driving policy decisions out of the Finance and Prime Ministers’ offices.

Dealerships and other small firms need to be able to allocate a portion of profits for future capital expenditure, to finance leaner years, to plan and invest for the future, and to save for retirement.

Dealers, for example, operate large physical infrastructure in constant need of maintenance and updates.

A new roof will cost the average store hundreds of thousands of dollars. If tax hikes discourage the saving required to finance these regular business expenses and capital investments, firms will be less inclined to make the investments or will go into debt in order to finance them.

If within-corporation savings are taxed at the top personal rate of income tax instead of the current small business rate, business owners will be incentivized to withdraw the funds instead of saving them inside the corporation to finance future growth and investment.

These tax measures treat the symptoms and not the cause of “tax planning” within corporations.

The cause is the wide spread between top personal rates and small business rates, a spread widened by this Finance Minister in his first budget.

Furthermore, they are damaging to the business investment and long-term planning that is urgently needed to grow the economy.

Dealers and all small businesses will hope that the Minister hears their feedback, and changes the most damaging of these proposals accordingly.

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