October 31, 2017

Time for an ‘Active’ Discussion on the Benefits of Passive Income as CATA seeks a complete tax support strategy for innovative businesses


The difficulty with adopting or advancing a series of proposals without a preliminary consultation is the risk – evident from the reaction to the July 18 proposals – of a substantial backlash. Having started the debate on the basis of fairness, everything they (the federal Liberals) do going forward will be measured against that ruler.  (
CATAAlliance)

Ottawa, ON…CATAAlliance, Canada’s One Voice for Innovation Lobby Group has reached out today to its consultation groups to engage them in a discussion on the benefits of passive income.

CATA CEO, John Reid, said, “ We are kickstarting this important conversation with a Blog Post and Video Interview and have been encouraged by the apparent willingness of the federal Liberals to listen to and act upon the concerns expressed by Canadians with respect to propose changes to the Income Tax Act.”

Blog Post and Video Briefing


Paul Labarge, member, Innovation Leadership Council and Partner, LaBarge Weinstein LLP (view 8 minute video briefing)

As context, the high-tech sector is characterized by start-ups, small and medium-size enterprises and a few large companies. Few of these companies have pension plans and most rely on a combination of stock option plans and profit-sharing to ignite and engage the enthusiasm of their employees. In the startup and small business environment, the early years are characterized by low salaries and sweat equity.

Recent proposals by the Minister of Finance suggest that the Liberal Government will be looking at the question of accrual of savings (i.e., passive income) within corporations that benefit from the small business tax rate and fixing limits with respect to the accrual of those funds so as to avoid any undue benefit being conferred as a result of incorporation and the low business rate.

Here are six reasons why we should care:

  1. passive income is effectively the return an SME gets on their retained earnings
  2. SMEs rarely have ANY retained earnings until MANY years into their company’s development
  3. under the proposed tax regime and the new Equal Pay provisions, entrepreneurs will ultimately be paying their employees, especially at retirement, MUCH more than they would be able to receive themselves
  4. this whole approach is a disincentive for entrepreneurs to even start a business
  5. it is also a disincentive to hire employees and a push to find ways to achieve the same results through less expensive technology (completely contrary to the government’s “Innovation Agenda” rationale)
  6. ANY so-called “passive investment” for the company doing the investing is only passive because it is not part of the normal daily business activities. However, the fact this money is “invested” means it drives a significant share of our economy from our stock markets, to venture capital, and angel investors. Taxing 73% of this ironically shifts what are active investments into passive taxes

Commentary to date suggests consideration of retention of funds in “passive” investments based upon a series of criteria relating to operational liquidity, provision of maternity and paternity buffers, retirement savings, debt retirement and other unspecified criteria.

Furthermore, the Ministry of Finance has itself recognized  that TFSA’s and RRSP’s are inadequate vehicles for retirement savings for these companies. As we move forward on what constitutes “passive” investments we will need to define the parameters of what constitutes comparable fairness for Canadians.

We believe that every Canadian should have access to a fair regime of retirement savings. As a country, we have substantial disparities between the vehicles that are available and accessible to Canadians for ensuring a reasonable retirement. The mixture of regimes is complex and the legislation dealing with the Constitution of retirement funds and the taxation of these funds is equally complicated. Many defined benefit plans reference some entitlement based on best years of service.

To illustrate, the public service pensions use two thirds of the best five years as a guideline for entitlement at full pension ability. If that is the gold standard and reflects best practice since it is supported by public revenues and provided to the public service – then a similar standard should be made available to all Canadians in determining a fair retirement funding by reference to actuarial comparisons.

Notably,  a suggested reserve within a CCPC of $1 million yields today an annual revenue of approximately $50,000. Under the existing rules that $50,000 would be taxed fully within the Corporation and then integrated with individual taxation when paid out and subject to an effective rate in excess of the rate currently applicable to pension payouts. To suggest that the threshold applicable to all CCPC’s should be a limited amount is to predicate a level of income that may be a minimum but certainly not reflective of a comparable position to other pension structures.

If we are to avoid the politics and language of envy in the amendment of the Income Tax Act then these types of analyses should be done in consultation prior to the initiation or suggestion of limits. We need a consensus or at least a common language and analytical platform that forms the basis and support for any changes.

Why should a private sector entrepreneur be afforded less opportunity and at higher taxation rates to match the pension entitlement that would be available to a public servant?

These entrepreneurs do not have matching employer contributions that continue to grow tax-free within a pension plan that enjoys a top up feature in the event of shortfalls.

Speaking on behalf of CATA’s Innovation Leadership Council, Reid said,  “ Listening is good but consultation is better. The difficulty with adopting or advancing a series of proposals without a preliminary consultation is the risk – evident from the reaction to the July 18 proposals – of a substantial backlash.”

Reid concluded, “  The key is to have the government understand that the determination of fairness is a societal principle and not a public service employee determination. The inherent conflict of interest of one group benefiting differently from others being the sole arbiter of fairness is simply not sustainable or defensible. And, tax based reform needs to be holistically applied against a genuine Plan to advance Canada’s innovation and competitiveness rankings. ”

Contact: CATA CEO, John Reid at jreid@cata.ca or post a commentary on a CATA Social Network

Related:

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The Canadian Advanced Technology Alliance (CATAAlliance) is Canada’s One Voice for Innovation Lobby Group, and is crowdsourcing ideas and guidance from thousands of opt in members in moderated social networks in Canada and key global markets. (No Tech Firm Left Behind)

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Contact: CATAAlliance CEO, John Reid at email jreid@cata.ca, tel: 613-699-8209, website: www.cata.ca, tags: Innovation. Leadership, Entrepreneurship, Advocacy