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Tax Increase Proposed for Small Businesses and Their Owners

Posted By: candiceT

By Nizam Shajani, CPA. CA, MBA, Partner

Yesterday Finance Minister Bill Morneau and the Department of Finance Canada released a summary overview titled Consultations on Tax Planning Using Private Corporations.  With a pretense of creating a growing healthy economy that works for the middle class – the paper sheds a disparaging light on small business owners as unfairly obtaining tax advantages that are not available to other Canadians and therefore pay less than their fair share of tax.  Properly understood, their focus on income splitting, passive investment income and capital gains is a tax grab that will affect only small business owners. 

Income Splitting

Using the term income sprinkling, the summary defines this as diverting income from an individual with high income to a family member with low income.  Using the example of a family business, the government notes the splitting of income between a spouse and adult child would result in significantly lower taxes paid than compared to one individual earning the full amount as employment income. 

There are already rules in place to address salaries and wages to family members – requiring work to be done and the compensation to be reasonable.  The income sprinkling would therefore be addressing dividends to family members as investors in the small business.  While dividends are paid to shareholders who have invested in the company – the result of the proposed rules would provide an incentive to invest in large corporations (that would not have the same limitations) over a small business.  There also seems to be no concern over the legal rights to a return via dividends of shareholders who have made those initial investments in family run businesses. 

The affect of placing limitations on dividends from small businesses would also impact individuals who earn their income from their family business.  This often relates to adult children who attend post secondary institutions and spouses who administer the home front to allow their significant other the means to earn that income.  On an individual basis – the government proposal limits the ability for individual who earn little income.  The absurdity may be to tax one shareholder at a higher rate, the funds which are collect by the government are then to be distributed to individuals with little income, including the shareholders’ spouse and adult children – or to leave those family members without income.   

Passive Investment Income

While touting Canada’s system of promoting business income and economic growth – the proposed changes ironically work to diminish investment and growth.  The government summary finds issue with small businesses holding passive income.  While passive income in those small businesses are already taxed at higher rates or subject to a part IV tax – limiting the current structure would oblige small business owners to withdraw funds from their corporation, pay tax and then invest the remainder of funds.  This would inevitably result in less funds available for investment in businesses and economic growth. The proposal underlines that corporate taxes are lower for corporations than individuals – but fails to consider that when investments are withdrawn from the corporation – personal taxes are paid.  This integration within our taxes has worked well.  Changes to the system would not result in fairness, but rather penalize small business owners for making investments.  

Capital Gains

The capital gains distributed from a corporation work with the integration rules, meaning the same amount of tax would be due regardless of the gain being incurred within a corporation or by an individual.  While past proposals to increase the capital gains tax on individual have been abandoned due to its unpopularity – there now seems to be a push to move this burden onto small business owners. 

The proposal would also farther diminish investment in and growth of our economy while increasing the tax burden on small business owners. 

Voice Your Concerns

The condemnation of small business owners as being deceitful and not paying their fair share of taxes through the government summary is disheartening.  It may be time to call your federal government representative to voice your concerns.         

This information is for discussion purposes only and should not be considered professional advice. There is no guarantee or warrant of information on this site and it should be noted that rules and laws change regularly. You should consult a professional before considering implementing or taking any action based on information on this site. Call our team for a consultation before taking any action.

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