Proposed tax changes for small business

The Ritcey Report

September 14, 2017

An educational overview

In July of this year, Finance Minister Bill Morneau introduced a number of tax proposals affecting small business owners. In the interest of clarity, I want to offer a non-judgmental overview of these proposals, including some commentary expressed – as might be expected – by small business groups uncomfortable with the legislation.

An overview

In a nutshell, the government’s small business tax proposals include limiting a corporation’s ability to convert income into capital gains and dividends, halting business owners from lowering their tax rate by sprinkling money to family members regardless of their involvement in the business through dividends or by paying them salaries, and restricting the ability for private corporations to recover taxes through passive investments.

Income sprinkling

Some business owners ‘sprinkle’ income to family members through salaries or dividends, as a way to reduce their family tax liability. Mr Morneau now wishes to 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.

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. Most small business owners see this tax opportunity as a kind of ‘reward’ for their entrepreneurialism.

Converting income to capital gains

Some small business owners convert what would otherwise be taxed as salary or dividends into capital gains. Mr. Morneau’s proposals will eliminate this option through an adjustment to section 84.1 of Canadian tax law.

Small business reaction

As has been widely reported, 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. Farmers in particular have raised concerns that the changes would have financial impacts on their businesses, including putting incorporated family farms at a disadvantage to factory farms.

More recently, 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. As I understand it, many large organizations are preparing submissions to the government expressing their concerns about Mr. Morneau’s proposals.

According to Krista Ross, CEO of the Fredericton Chamber of Commerce ‘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.’

Consultation period

The mid-July announcement launched a 75-day consultation period, ending October 2, designed to allow those affected by the proposed legislation to digest the proposals and provide feedback that could lead to adjustments. At the time, Mr. Morneau admitted he anticipated some push back. His prediction appears to be coming true.