The proposed tax legislation affecting small business has, it has to be admitted, created quite a stir. The proposals, tabled in July by Finance Minister Bill Morneau, offered a 75-day consultation period, ending October 2, designed to allow those affected by the legislation to provide commentary and feedback.
In the interest of clarity, I want to offer a non-judgmental summary of these proposals, which are designed to:
- Prevent business owners from lowering their tax rate by ‘sprinkling’ money to family members through dividends or by paying them salaries – whether they are actively involved in the business or not.
- Restrict the ability for private corporations to recover taxes through passive investments.
- Limit a corporation’s ability to convert income into capital gains and dividends.
1. Income sprinkling
Some business owners ‘sprinkle’ income to family members through salaries or dividends, as a way to reduce their family tax liability. The legislation would restrict the ability to pay salary or wages, or dividends, to adult children between the ages of 18 and 24, by extending the “kiddie tax” rules – formally called the “tax on split income” (TOSI) – to them.
In the past, families have also taken advantage of the lifetime capital gains exemption (LCGE), which shelters from tax up to $835,716, in 2017, of capital gains on qualifying small-business corporation shares. After 2017, it is proposed that capital gains realized by a family member can no longer be sheltered with the LCGE to the extent those gains built up while the individual was a minor.
2. Passive income
When a corporation generates revenue, it’s eligible for a competitive tax rate (about 15%, which varies by province) on the first $500,000 (federally) of active business income. If you’re the owner of a business and you don’t need all of this money to pay your bills and support your family, you can leave the unused portion in the corporation to invest – perhaps in a portfolio earning passive income.
3. Converting income to capital gains
Some small business owners convert what would otherwise be taxed as salary or dividends into capital gains. The new proposals would eliminate this option through an adjustment to section 84.1 of Canadian tax law.
Small business reaction
Reaction to these proposals was immediate. Krista Ross, CEO of the Fredericton Chamber of Commerce (Source: Elizabeth Fraser, CBC News, September 11, 2017) observed: ‘The federal government’s recent small business tax proposal is punitive and will have damaging effects on business communities in New Brunswick and across the country.’
This pretty much sums up the view of Canadian small business owners as a whole. Many categories of small business – including doctors, farmers, lawyers, small-business lobby groups and the Canadian Chamber of Commerce – have expressed concern about the changes.
From farmers to high-tech
Farmers in particular have protested that the changes would have financial impacts on their businesses, including putting incorporated family farms at a disadvantage to factory farms. Canada’s high-tech community is saying that these proposed small-business tax changes will undercut their efforts to boost innovation and expand the high-tech sector.
Some groups – including the Canadian Venture Capital and Private Equity Association (CVCA) and the National Angel Capital Organization – contend that the proposals will undermine Canadian entrepreneurialism. They are preparing submissions to the government expressing their concerns.
At the time of his initial announcement, Mr. Morneau conceded that some push back was likely and that he stood prepared to listen to, and take into consideration, small business reaction to his proposals. I’ll keep you up to date with events as they unfold.
Geoff Funke, Senior Wealth Advisor, Scotia Wealth Management, 604.535.4721.