Frequently Asked Questions Regarding the Proposed Federal Tax Changes
This summer, the Government of Canada announced a number of changes to tax legislation and regulations that will have a lasting impact on our families and small business. We’ve compiled
some answers below to help you understand how these changes can and will affect you, your family, and your business.
What aspects of taxation are the changes targeting?
The proposed changes to the corporate income tax system aim to limit the usage of three key areas of tax planning:
- Income Sprinkling: Income sprinkling is an arrangement where corporate income is diverted to persons other than the business owner, most often family members. The person other than the business owner is often in a lower tax bracket than the owner themselves. The concern for businesses is that business owners will be unable to support their families through dividends and will need to pay larger salaries to themselves or family members to account for the increased taxes (which has knock-on effects in other aspects of the business).
- Passive Investment Income In a Private Corporation: Passive investment income is money (savings) that is held in the business and is not used for day-to-day expenses. This money is usually earmarked for re-investment in the business itself to fund growth, expansion, or capital expenditures. The concern for business is that money that is made by the business and that is being held in reserve for strategic business purposes will be taxed as personal income at a higher tax rate, thus impeding the business’ ability to grow and hire staff.
- Converting Regular Income into Capital Gains: When a business is sold, the profits are considered to be capital gains, which are taxed at a lower rate than regular income such as dividends and salaries. Businesses will often utilize this methodology as part of their succession planning. The concern for business is that a sale of a business to a relative (e.g. family farm) will be effectively taxed at a higher rate than if the business were sold for the same price to a third-party, thus limiting the ability of families to transfer their business from one generation of the family to another.
Why is this such a big deal? Can’t rich business owners afford these taxes?
Yes, some business owners are rich. The majority though? The majority of business owners, particularly those with small or medium enterprises (150 employees or less), do not fall into this category and can more correctly be referred to as “middle class.” Business owners are often rich in assets, but poor in cash. What this means is that the money that business owners take home to their families at the end of the day is far less than what stays in the business to cover regular expenses (such as payroll) or pay for equipment or machinery.
These business owners also take on an element of risk that employees don’t. Entrepreneurs have risked their house and sacrificed time with their family in order to start a business, and, in many cases, have worked for less than minimum wage while getting the business off the ground (in terms of dollars per hour). While employees often have benefits, savings, and retirement plans provided through their employment, business owners have none of these benefits themselves. Often, the only retirement or savings plan available to a business owner is the sale of their business.
These changes affect the ability of business owners to support their families and employees (see below). The family business is often the sole source of revenue for the owner’s family and this is where dividends and income sprinkling allow the business owner to support their spouse or provide an education to their kids.
Will these changes affect employees of a company, not just the owner? If so, how?
In short, yes. While the proposed changes appear to only affect business owners and shareholders, it is important to note that the effects will be felt by every member of a company. Here are a few key areas where these changes can have an effect on every employee in a company:
- Salary, benefits, and layoffs: The amount businesses can afford to pay employees is directly related to the income of the business and the savings held within the business. These changes will result in less money being available to employers after factoring in other essential costs for the purposes of paying employees. There are two obvious solutions to this problem: lower salaries and benefits or layoff employees. Neither of these scenarios are positive for either the employee or employer.
- Growth/job creation: The inability of a business to save money within the company affects a company’s ability to grow and hire new employees. As it stands, small businesses employ a large majority of private (non-government) workers in Canada and these changes would impact the ability of these companies to create new and better-paying jobs that can help and support Canadian families.
- Family employment: With the changes tightening the rules surrounding income/dividend sprinkling, how many businesses will look to create jobs for family members who previously did not actively work in the business? If businesses look to create these jobs it either means one less job being available to others or another salary to fit into the same amount of revenue.
How will these changes affect my ability to start my own business?
As is commonly known, 90% of start-ups are unsuccessful. The cumulative impact of the changes mean that that failure rate will go up as it becomes harder to make a living for one’s family and save money within the business through income sprinkling and passive income, respectively. The risks associated with entrepreneurship are great enough as it is without these changes.
However, should one successfully start a business and develop it to the point of being able to sell all or a part of that business to an interested party, these changes will still significantly increase the amount of tax paid on the transaction by all initial investors. A reduced ability to monetize an idea or business takes away a large part of the incentive to innovate and grow a business while leaving all the risk in the process.
Needless to say, innovation and entrepreneurship is a large factor in job creation and so the consequences with regards to employment and pay remain the same as those facing an established business. Society will also suffer from de-incentivizing innovation and entrepreneurship as fewer people take risks to develop solutions to society’s problems.
How will these changes affect my community?
Small business owners and entrepreneurs are extremely community-minded and use money generated by their businesses to contribute to various aspects of community life. On one end of the spectrum, many small businesses sponsor local sports teams and help cover the costs things such as jerseys, equipment, and the administration of organized leagues. On the other end, private businesses contribute to projects for the betterment of the community such as the Jim Pattison Children’s Hospital, lowering the amount of tax dollars required to fund these projects.
These aspects of community participation by businesses is threatened by this legislation as a higher tax rate or the inability to hold savings within the company cuts into the budget available for community projects and sponsorships that are vital to maintaining the communities we love.
How else could these changes affect me and my family?
Apart from the aforementioned effects, there are a couple other ways that families could be indirectly affected by the proposed changes:
- Health Care: While doctors who have incorporated will face all of the staffing and savings concerns expressed above (which have effects on patient care in their own right), there is also a very real risk that the proposed changes will lead to an exodus of doctors and specialists to other jurisdictions. Not only will other jurisdictions, such as California, be able to offer better tax rates, but they also offer signing bonuses to doctors that cover the extensive student loans doctors must take out to make it through the 10+ years of school it takes to become certified in their field. In the United States alone, there is an expected shortage of thousands of doctors in the next 10 years and one can expect the incentives for Canadian doctors to move south to only increase in the future while the incentives to stay in Canada dry up due to this legislation. All in all, this amounts to a potentially catastrophic change to patient care in Canada.
- Farming: In the short term, farmers will face an extra pinch just like all businesses affected by these changes and this could have affects on food prices and availability (particularly in stock – i.e. beef or poultry – farming operations) which will hit each and every family across Canada. In the long term, the affects of these changes on succession planning will hit family farms particularly hard. The changes will create uncertainty in farming and potentially disrupt the business operations of farms that are sold to disinterested third-parties, sold to family members who must cut back operations to save the farm as a whole, or that sit dormant because there is no buyer willing to farm the land. In each case, there is great potential for food supply to be disrupted and prices to rise as a result.