The Private Capital Markets Association of Canada (PCMA) and the Coalition for Small Business Tax Fairness have written a joint letter to the Minister of Finance Bill Morneau to demand a comprehensive review of Canadian tax policy.
The letter outlines the impacts of tax proposals to investors, particularly small businesses. It also lays out recommendations on how to go about the demands of such business for a review of the planned reforms.
Below is the copy of the letter:
Subject: Coalition for Small Business Tax Fairness letter on proposed tax proposals
Dear Minister Morneau,
Since we last wrote, the Coalition for Small Business Tax Fairness has doubled in size and now represents more than 70 business associations. Together, our organizations represent hundreds of thousands of independent businesses, professionals and taxpayers across all sectors of the economy and all regions of the country that employ millions of Canadians. Minister, we are renewing our call for your government to set aside these changes in favour of a comprehensive review of Canadian tax policy.
We have been following your government’s public comments on the proposed changes closely. We are alarmed by the significant gap between the government’s statements on the expected effects of the proposals and the analyses by Canadian tax practitioners. This requires immediate clarification.
Your government has stated that it is concerned with the growing number of Canadian Controlled Private Corporations (CCPCs) and the goal of the tax changes is to ensure business owners pay the same rates as otherCanadians in pursuit of tax fairness. You have also suggested that your proposals would not affect business owners with incomes under $150,000.
These statements are at odds with all the analyses conducted by tax professionals in several important ways.
- Business owners at all levels of income will be potentially affected by at least one of the three measures in this package of changes, including those earning well below $150,000.
- Many – if not most – business owners will face a higher overall tax burden in the future if these proposals proceed.
- Business owners will pay higher rates of taxation than other Canadians at the same income level as a result of some of the proposed changes.
Impacts of changes on income sprinkling
Changes to income sprinkling have the potential to affect all incorporated taxpayers that have family members as shareholders who contribute to the business, regardless of income. In fact, this could remove the benefit of sharing business income from taxpayers earning $50,000, not just those above $150,000.
The additional paperwork associated with the “reasonableness test” will also bring added costs and complexity for many business owners who will struggle to cope with compliance requirements due to the ambiguity created by the new rules and fear of being unfairly penalized by CRA. We worry that your government is not fully aware of many formal and informal ways family members in businesses play critical roles in contributing to the success of the business and believe there will be many unintended consequences of your proposed changes on all business owners, including those in the middle class.
Impacts of changes to passive investment rules
First, we wish to challenge the assumption that the deferral of the personal level of tax on corporate business earning is bad tax policy. There are a number of reasons why a business owner would choose to, or be required to, retain business earnings in the corporation. We offer the following observations:
- Under the current corporate tax regime in almost all provinces, business earnings inside a corporation are actually under-integrated. This means the business owner will pay more tax on business income earned inside a corporation (and distributed as a dividend to the owner)as compared to the same earnings in an individual’s hands.
- Many business that are financed have debt arrangements that require a fixed amount of retained earnings to be left in the corporation, or limit the amount that can be distributed to the shareholders.
- Many businesses incur losses in their start up years that the shareholder cannot use to offset personal income.
- Successful businesses (particularly in the high-tech sector) use retained profits in the corporation to invest in other start-ups(angel funding). Such investments carry a high level of risk and punitive levels of taxation will reduce an important source of financing for new firms.
While we recognize you have not put forward draft legislation on passive income rules, tax practitioners agree that the current proposals could result in a combined corporate and personal tax burden for an Ontario business owner of as much as 73% on corporately-earned investment income and 59% on corporately-realized capital gains (assuming a business owner is paying the highest marginal rate of taxation) (see figure on next page). This is far more than what an employee with a similar level of investment income would pay. Regardless of the level of income however, the consensus is that the proposed tax changes would result in higher combined corporate and personal taxes for business owners across the board, and would therefore no longer be aligned with the key tax principle of integration.
Furthermore, your government seems to be asserting that middle-class business owners could use other retirement vehicles such as RRSPs and TFSAs if they want to save for retirement. While many do use these vehicles, a large number of business owners require the flexibility of retaining passive investments in the business to ensure they can quickly access money for the business itself since current RRSP rules do not allow for business reinvestment. While government may reap a short-term benefit by encouraging business owners to withdraw any money available for investments from the business, this will have long-term negative consequences as businesses are left cash strapped in challenging times or when an opportunity for growth or expansion occurs.
Impacts of changes to capital gains rules and intergenerational transfers
It is our understanding based on analysis done by many tax professionals in Canada, that the tax changes on capital gains will have a material impact on intergenerational transfers of business, again regardless of income level. There is fear that long-standing family businesses may be forced to sell the business to non-family members in order to decrease the ultimate tax bill on transition, whether on the retirement of the current business owner or on death.
For example, the tax bill for an intergenerational transfer that results from the death of the owner will effectively increase by as much as 70% from what it was before July 18, 2017. Depending on province or territory, the former capital gains rate on death of about 24-27% will increase to an effective dividend rate between 40-46%. And this increased tax cost can apply as a result of a death that occurred before July 18, 2017 contradicting the statement that none of the proposals are retroactive.
Disproportionate Impacts on Women Entrepreneurs
The proposed tax changes may limit women from benefitting from entrepreneurship. As two-thirds of Canadian incorporated businesses are majority owned by men, the restrictions on sharing income with a spouse are likely to remove a disproportionately higher number of women from benefiting from business ownership. In addition, while entrepreneurs do have optional access to limited Employment Insurance benefits during maternity or parental leaves, female led businesses can currently use passive income investments to ensure their business remains open during a maternity leave, protecting the income of both the business owner and the employees. We believe strongly that the proposed changes on income sprinkling and passive income would fail a gender-based analysis.
Minister, the Coalition urges you to review carefully the dozens of analyses of your proposed changes by tax professionals across the country. While we are aware of a few academic papers supporting your changes, tax practitioners are united in the view that these changes have the potential to affect business taxpayers at all levels of income and increase their rates of taxation to levels higher than that of other taxpayers. To assist your efforts, we have listed five reports supporting our concerns and would be pleased to provide others to your staff.
Report 1: STEP Examples (available in PDF only and attached to this letter)
Report 2: Moodys Gartner Tax Law – Proposed Tax Changes: What Do They Mean To You?
Report 3: Deloitte – Tax Alert – Capital gains implications
Report 4: Yale & Partners submission to Finance Canada
Report 5: Goldberg, Killoran and Good is – Is a 93% tax rate fair to Canadian small business owners?
Conclusion and Recommendations
We would like to reiterate our offer that should there be worrisome abuses of the current tax system, we stand ready to work with the federal government to pursue ways to tighten the rules. The current proposals are not the solution and are creating unnecessary uncertainty for business owners.
While we appreciate your public statements indicating an openness to”tweaking” the proposals, we feel the significance of these proposals requires far more than a few tweaks. We make the following recommendations:
- Take these proposals off the table.
- Launch meaningful consultations with the business community to address any shortcomings in tax policy without unfairly targeting independent businesses.
- Consider a comprehensive review of the Canadian tax system with a view toward fairness and simplification for all taxpayers, which was recommended by the Standing Committee on Finance in their report dated December 2016.
Please do not hesitate to reach out to any of the undersigned groups and sectoral associations should you have any questions or comments about the contents of this letter. We remain committed to working with you.
Sincerely, PCMA and the Coalition for Small Business Tax Fairness