The Small Business Tax Reform in Canada

The proposed reform aims to introduce changes and eliminate tax loopholes that allow self-employed people to pass income to spouses and other family members. This is a hot topic in Canada as a recent Ipsos poll shows that 55 percent of respondents support the reform while 44 percent oppose the changes, especially small businesses. Making changes to the tax law to deal with vague and obscure language sounds like a good idea, but is it so in reality?

Justifications to Implement New Measures

The reform targets self-employed Canadians and the loopholes they use to reduce their tax burden. The focus is on investment portfolios and capital gains. Proponents claim that the new tax reform can help reduce income sprinkling. Income sprinkling enables self-employed persons to divert income to children and other family members by way of paying dividends, wages, and salaries. According to a report by the Department of Finance, this is a common practice, and about 50,000 small businesses in Canada use sprinkling to pay less in taxes. This is also a way to benefit from passive investments, a practice that the proposed measures aim to limit. This can be done by means of a reasonable test to find out whether children, spouses, and other family members participate and actually contribute to the family business. The pay, whether in the form of wage or salary, is reasonable only if it is comparable to the pay another person would get for the work done. When it comes to capital gains, profits generated through the sale of real estate, stocks, and securities fall in this category. In the view of liberals, diverting income in the form of capital gains gives unfair tax advantage to CCPCs. At present, businesses are free to sell shares to another company and thus avoid taxation. Passive investment is also an issue for Liberals. Income generated through an investment portfolio falls in this category. It is different from active income generated through business operations. The problem with passive investments is that businesses benefit from a significantly lower corporate tax compared to active income.

In addition to small business owners, certain professions take advantage of this to reduce their tax burden. These include physicians, lawyers, farmers, and others. The planned reform is targeted at farming families that distribute profits and work responsibilities to pay less in taxes. Physicians also oppose the new measures, and this can be explained by the fact that most of them are incorporated. A report by the Canadian Medical Association proves this. Again, this is a way to pay less. Some physicians support the tax reform but believe that the best way to implement it is through a transition plan.

Proponents note that the goal of the new measures is to establish a fair tax system for everyone. This can be done by closing gaps that offer tax advantages to those incorporated as a Canadian controlled private corporation. At present, the tax system encourages well-paid Canadians in the high-income bracket to use CCPC to reduce their tax rate and increase their net income. The new measures are also expected to increase government revenue to help vulnerable members and communities and citizens marginalized at the fringes of society. And while Prime Minster Justin Trudeau and Finance Minister Bill Morneau noted that this is not the main goal, a tax reform is one way to increase government revenue.

What Opponents Say

Opponents, on the other hand, point to the fact that the proposed changes place an undue burden on small businesses, especially those planning to expand or invest in new products, services, or operations. And many businesses would be affected as figures by Statistics Canada show. Out of 1.17 million employers operating in the country, small businesses account for 98 percent of employers or 1.14 million. More than 50 percent operate in Quebec and Ontario. Opponents also point to the fact that the new tax reform targets small businesses such as corner stores, garages, bakeries, and florist shops, and not just lawyers, doctors, and other professionals in the high-income bracket. Small businesses such as coffee shops, landscapers, family restaurants, roofing businesses, electricians, and plumbers would be affected. And while the proposed reform is not expected to destroy small businesses, the new measures might discourage many from starting a business. At the same time, small businesses are the backbone and driving force of the Canadian economy.

Opponents also warn that cutting tax benefits means less revenue for small businesses. This often goes hand in hand with fewer benefits, basic or reduced health insurance, longer working hours for employees, and layoffs. The government counters this argument by pointing out that businesses with an annual income of $150,000 CAD would be impacted the most. The same goes for self-employed individuals with extra income after making the maximum contribution to their tax-free savings account or registered retirement savings plan.

Salaried Employees vs. Small Business Owners

Proponents believe that the way things are, small businesses get unfair tax advantage over persons working regular salaried jobs. Opponents to the reform, on the other hand, argue that running a business is a costly endeavor. A lack of paid leave is also an argument in favor of more lenient taxation for small businesses. They suffer further disadvantages such as no guaranteed salary, no guaranteed vacation and pension income, etc. To sum it up, the main downsides of running a small business are fewer free benefits, less security, and lack of regular income stream. Proponents to the tax reform counter this argument by explaining that entitlement to state benefits is not a justification to offer tax advantages. Self-employment also offers advantages in the form of financial rewards, especially when it comes to independent contractors. Many large businesses choose to work with independent contractors instead of hiring employees, which is, by itself, a long-term commitment. Basically, it is less expensive to hire a contractor than an employee. To this, contractors are required to supply their own equipment, tools of trade, mobile devices, computers, laptops, software, etc. Independent contractors are also allowed to deduct business-related expenses for taxation purposes. This is yet another way to increase financial rewards.

Finally, whether the new measures are fair or not is a difficult question to answer. Tax experts draw attention to the fact that there are too many exemptions and exceptions in the current tax code. Even if the new measures come into effect, there is plenty of room for improvement.