– Doug Johnston is a Certified Professional Accountant and founder of Johnston Johnston & Associates Ltd. in Nanaimo.
CANADA – On July 18th federal Minister of Finance Bill Morneau released proposed changes to the taxation of private corporations.
Although these changes have received remarkably little coverage, they have created shockwaves with CPA’s and tax lawyers that deal with the taxation of small businesses and their owners.
Justin Trudeau stated in 2015 “that a large percentage of small businesses are used by wealthy people to shield income from taxation.” In this writer’s opinion, and I have largely practiced in this area of taxation for 45 years, since 1972, these comments and tax proposals indicate a fundamental ignorance by Trudeau of how the economy of Canada works and what comprises the vast majority of small businesses.
In 1972, the Carter Commission made substantial changes to Canadian tax law. For Small Business, it recognized that it was necessary to defer a portion of tax on income, based on the fact that income was rarely in the form of cash: It was represented by financing receivables, inventory, property, plants and equipment.
The Carter Commission however was clear that “a buck was a buck” which resulted in the concept of “integration”. That concept essentially says that the total tax the small businessperson pays first at the corporate level and then later on the dividends they withdraw from the small business should be approximately the same as the tax paid by an individual.
This has been the basic philosophy of the Canadian tax system since 1972. I have rarely seen anyone starting a small business that I would describe as “rich” or “wealthy”.
Indeed, if these entrepreneurs have a common character trait , it is the willingness to work incredibly hard and risk everything for not just themselves but also their families. As these small businesses mature, the ones that have been able to survive are able to pay off liabilities of their active business and start to invest in what is called “passive” income such as commercial or residential rental properties and investments in the stock market.
In the proposals, the Liberals indicate that they think that it is “unfair” that this active income can be invested in these passive investments without further immediate tax being paid – despite the fact that the integration concept still results in overall income tax being the same.
In the example that the Minister gave, he suggested that an individual earning over $200,000 per year would pay approximate 50% of immediate tax while the small business corporation would only pay 15% .
To “fix this” and make it “fair”, the thrust of his proposal would be to increase the immediate tax from 15% to 50% which would TRIPLE the amount of tax paid. According to the government, they hope to raise an additional $250 million per year from Small Business.
The concept of “fairness”, in my experience, “is in the eye of the beholder”. Let’s compare a government employee, for example, and a small business person who are now both earning $200,000 per year.
The government employee has had his employer, the government, i.e.: us, paying into his pension plan from day one. The small business person in most cases is unable to contribute to an RRSP until later in life, as he has been putting all of his income into paying off the business.
The government employee receives vacation pay, pay for statutory holidays, pay for when he is sick or needs a “mental health day”. They are entitled to a “basket” of benefits such as medical, extended medical and insurance premiums. The small businessperson has received none of these benefits and their only ability to avoid retirement risk is simply to work harder and smarter now.
The reality is, for small business people, their corporation is their retirement vehicle and the Liberals propose to take it away.
The Liberals’ other proposal is to essentially eliminate family trusts through punitive taxation at the highest rates of tax for trust beneficiaries. This is based on the premise that “the reason for the existence of family trusts is to save tax”.
The true principal purpose of a trust is to facilitate the orderly transfer of an individual’s estate. Trudeau, as a “trust fund baby”, should recognize this more than anyone.
Fundamentally, the Liberals are running $30 billion annual deficits and must have determined that since they are not likely to get many votes from the entrepreneurs that actually create wealth and jobs in Canada, they may as well tax them.
It will only be later, when these entrepreneurs, having lost all incentive to continue to build, simply give up. Then we will see the true cost of these misguided proposals.
