When Finance Minister Bill Morneau announced proposed changes to federal income tax legislation in 2017, he infuriated owners of small and medium-sized businesses, the backbone of the Canadian economy.
What Morneau framed as a tax on the rich was nothing of the sort, said business owners. It was, they said, an attack on those who risk everything to start a business, and for whom long-standing supportive tax legislation can be an economic lifeline.
As the furore built, the Senate National Finance Committee launched its own cross-Canada tour to seek input from stakeholders and, among other recommendations, urged the government to put the changes on ice for a year to better assess the ramifications.
Morneau also invited input from the business community during his own in-person “listening tour” across the country.
At issue were tax on split income (TOSI) rules and income from passive investments (i.e., investments not directly related to the business enterprise).
Faced with a sustained backlash, Morneau softened the proposed measures – a little – and went ahead with cuts to the small business tax rate. In 2019, the combined federal/Ontario small business tax rate will be 12.5 per cent compared to its pre-cut high of 15 per cent.
Chad Saikaley, a GGFL partner and the firm’s head of tax, was an early critic of Morneau’s proposed changes and wrote this shortly after the measures were announced:
“The accounting community accepts that the current legislation is not perfect and many of us support some of the changes. But we also know that this proposed targeting of small business corporations is less a crackdown on the wealthy, more an attack on middle-class Canadians . . . Canadians who have taken on the risks and responsibilities that come with competing in the market place while providing livelihoods for their families and their employees.”
So, what do those owners of small and medium-sized businesses need to know now that the dust has settled?
“The measures are not as punitive as they were initially,” says Saikaley. “But, if the government had waited for that year recommended by the Senate, they could have arrived at better solutions – especially given the tax changes that we knew were going to happen in the United States.”
TOSI, as anyone in business understands, is the tax imposed when a firm’s owner improperly splits income among family non-employee members to reduce the owner’s income tax.
“When people go into business, they put everything on the line,” says Saikaley. “They have no pension plan and initially, at least, are often not drawing a full salary. Income splitting with a family member offers some financial support to the entrepreneur.”
Saikaley concedes that some tightening of the TOSI rules was justified.
“Some wealthier people were abusing income splitting so to a degree, you could understand the need for changes,” he says. “But the government measures went way beyond what was necessary.”
The bad news today is that the tax picture is bleaker for small and medium-sized business owners.
The good news is that tax reduction and deferral opportunities are still available.
“Even with the passive income rules, you can still defer tax for an operating business that uses earnings to reinvest in the business."
“Even with the passive income rules, you can still defer tax for an operating business that uses earnings to reinvest in the business,” adds Saikaley.
And don’t abandon the idea of a family trust, he advises. They still have value.
“At the outset, many incorrectly assumed that there was no longer a benefit to having a family trust. We never believed that at GGFL, because there was always more to a trust than income splitting. There are financial and non-financial benefits that are still available, depending on individual circumstances.”
Among other benefits, a trust can offer creditor protection of assets, opportunities to move wealth from one generation to the next, and can minimize the tax implications on death.
The dust that cleared has since been replaced by mists of uncertainty – partly because of that massive U.S. tax reduction and the assumption that provinces would fall into line behind the federal proposals.
Post-election changes in provincial governments – notably in Ontario – have proven that assumption wrong.
“Our finance minister is now scrambling to remain competitive with the States because the Americans went in exactly the opposite direction, making it less attractive to invest in Canada,” says Saikaley. “To compensate, Morneau is offering accelerated deductions on certain capital investments within Canada, but will it be enough?”
The bottom line is that the federal changes have left small and medium-sized Canadian businesses worse off, but not without the opportunity to alleviate their tax burdens, says Saikaley.
“The changes do make it less attractive to be an entrepreneur in Canada,” he adds. “You have to be more sure of your financial prospects, and that means less risk taking. The passive income changes further widen the gap between employees with guaranteed pension plans and job security versus the self-employed who must take care of their own financial futures.”