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Changes to Canada’s Small Business Tax Rules: What You Need to Know

It’s already old news. Tax reforms are on the doorstep of every business in Canada. On July 18, 2017, Canadian Finance Minister Bill Morneau announced the launch of consultations aimed at identifying opportunities to “close loopholes and address tax planning strategies that give unfair tax advantages” to private corporations.  As this consultative period draws to an end — the deadline for feedback is October 2, 2017 — many small business owners and incorporated individuals are trying to make sense of the anticipated changes and determine what the implications will be for their bottom line. Here is a breakdown of the proposed small business tax changes.

Proposed Changes to Small Business Tax Rules

1.Income Sprinkling

Business owners divert their income to lower-earning family members to reduce their family’s overall tax burden by paying them salaries, wages, or dividends, even if they don’t actually work for the company. 

As part of the proposed measures to change the current rules regarding income sprinkling, the government is looking at applying a “reasonableness test” to determine whether or not a family member is actively engaged in the activities of the business and if the wages or salary they receive are considered “reasonable” based on the amount that “an arm’s length party” would have agreed to pay for that type of work.

2.Capital Gains

Business owners are currently able to convert income into capital gains — profits earned from the sale of securities, stocks, or property above the purchase price — so that they can take advantage of lower tax rates. This is done by taking out the retained earnings of a corporation and selling some shares to a holding company, where the earnings don’t get taxed. 

The proposed changes will see immediate taxation whenever those assets are accessed, which small business owners say will make it challenging to grow their company or plan for retirement.

 3.Passive Investment Income

Small business owners and those who own and control a private corporation have the opportunity to hold passive investments inside the corporation, which the government says are being used as a “vehicle for the purpose of gaining a tax advantage” since these amounts are taxed at the much-lower corporate rate.

The government is considering changes in the tax treatment of a private corporation’s passive investment income, so that “the benefits of the corporate income tax rates are directed towards investments focused on growing the business, rather than conferring a personal investment advantage to the corporate owner.” At the time this article was written, the government was considering several different approaches aimed at eliminating “the tax-assisted financial advantages of investing passively through a private corporation, and ensuring that no new avenues for avoidance are introduced” and was seeking stakeholder feedback on potential design considerations for each potential approach. 

A thorough description of the proposed changes is available in the Department of Finance’s online document: Tax Planning Using Private Corporations.

What are the main issues with the proposed changes?

The government argues that the biggest impact of these changes will be felt by incorporated individuals and small business owners who make $150,000 or more per year, or those who are in a position where they can continue to invest money after contributing the annual maximum to RRSPs and TFSAs.

Critics are quick to point out, however, that families with annual combined incomes of $150,000 are not exactly considered “Canada’s one-percenters.” While farmers, doctors, dentists, accountants, lawyers, and other professionals have been among the most vocally opposed to the changes, experts contend that middle-class small business owners will also feel negative effects of the changes. Many business owners say that the proposed changes don’t take into consideration the added risk involved in being an entrepreneur and how these legal tax-saving opportunities help business owners save money to withstand an economic downturn, plan for retirement, or cover a parental leave.

A recent poll by the Angus Reid Institute suggests small business owners are most concerned about the changes to passive investment income with 55 percent calling it unfair and 42 percent saying it will hurt their business, while the majority (63%) are saying that proposed changes to income sprinkling will have no impact on their business.

While most business owners and the privately incorporated agree that the proposed changes are unfair, what seems to have really raised the ire of entrepreneurs is the language the government is using to pitch its proposed changes.

In an open letter on his website, Liberal MP for Edmonton Centre, Randy Boissonnault, apologizes to business owners for how the government presented the reforms. “First, and foremost, I want to apologize to each and every entrepreneur and small business owner in Edmonton Centre for the tone and the language that has been used in rolling out these proposals,” says Boissonnault. Members of the Canadian Chamber of Commerce have also criticized the government for its casting of business people in a negative light.

"Characterizing the last 45 years of Canadian tax policy as loopholes is insulting to businesses that have worked within the rules in good faith to build their businesses, to save for retirement, and sometimes just to keep their doors open," explains Krista Ross, CEO of the Fredericton Chamber of Commerce.

It will be interesting to see what, if any, measures the Federal government will offer to help soften the blow once the consultation period is officially over on Oct 2. While it seems unlikely that the government will completely scrap any of the proposed reforms, there are hints that a “proverbial spoonful of sugar” is anticipated as part of the final proposals. Some speculate this could include a reduction in the small business tax rate to nine percent or a phased-in approach to the tax reforms.

Until more is known about exactly how the government plans to move ahead with the proposed changes to small business tax rules, incorporated professionals and small business owners are likely left with more questions than answers at this point.


That being said, how are you feeling about the proposed changes? Do you anticipate a negative impact or will it largely be business as usual?








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