February 16, 2018

Federal Government is Exiling Canadian Entrepreneurs


Small businesses are the lifeblood of the Canadian economy. They support millions of jobs, and increase the GDP with their productivity. Their owners are keenly aware of the obstacles: a high chance of failure, slim chances of obtaining external capital, long hours for often low pay, no pension plans or health benefits, not to mention unexpected surprises and sleepless nights. They assume these personal risks for the chance of shared success.

One assumption made by entrepreneurs is that government policies will remain reasonably stable and competitive over time. Tax rates may bob up and down, but the business environment will always be one in which entrepreneurial activity is encouraged and rewarded. Few would choose to invest in a climate of high uncertainty, where shareholders’ net worth is usurped, or where the government demonizes its entrepreneurs as opposed to lionizing them. Unfortunately, the business environment in Canada may be becoming just that.

The Federal Government has raised the concern that Canadian private businesses are utilizing the difference between the corporate tax rate and the personal tax rate to purchase investment (passive) assets. The Government has now proposed that investment income over $50,000 per year will be subject to integrated tax rates upwards of up to 75% in a one-size fits all solution.

This policy will not impact public corporations or foreign-owned businesses operating in Canada, leaving the competition to private corporations unscathed. Why have they been excluded from this proposed policy? Could you imagine attracting Amazon or Google when they could only earn $50,000 of investment income before being subject to exorbitant tax rates?

New and aspiring entrepreneurs also ought to be concerned that this policy creates a two-tiered tax system between old and new businesses by grandfathering existing wealth. New Canadian businesses will be competing with public corporations, foreign-owned business, and established businesses – each with perpetual tax advantages. The policy skews the whole competitive landscape.

How could Canadians change their behaviour?

  • Entrepreneurs will consider starting businesses elsewhere. Many require little more than a laptop and Wifi and are therefore ultra-mobile. Growing businesses that need to compete internationally will be at a tax-disadvantage for operating in Canada, unless they’re one of those directly  subsidized by the Government.
  • Investors may grow weary of Canadian compliance costs and challenges and insist that Canadian private corporations move outside of Canada wherever possible. Capital seeks higher returns, and will flow to jurisdictions that provide that opportunity. With tax rates in countries such as the USA and the UK being lower (especially on investment income), we should expect less capital to be invested in Canada.
  • Advisers will need to think about the tax rates of their clients at present, what they might be in the future, and if they might exceed the passive income threshold. Tax has always been central to cash-flow management, shareholder returns, and financial planning, but now market volatility – uneven investment income year to year – can have a huge impact on your long-term tax bill.
  • Angel investors and venture capitalists could now be put in a situation where they are subject to 75% tax rates while building relationships. Finding the right deal and putting it in place can take time. A successful entrepreneur that sells their business on Friday does not normally invest in a new business on Monday, and the ensuing tax cost in the interim will discourage investment in Canada.
  • Foreign-controlled and public corporations will likely acquire more Canadian businesses. As the proposal does not affect these groups, they’ll have a comparative advantage over Canadian private businesses. Suddenly, any business is worth more in foreign hands.

The productive ecosystem of Canadian entrepreneurship could dissipate with this one policy. The impacts will surely be felt in the broader economy, beyond just the direct effects on those targeted. According to recent statistics from the Canadian Taxpayers Federation, 8.4% of tax filers in Canada were responsible for 52% of all income tax revenue collected by the Federal Government. Due to the concentration of revenue from this group, it is critical that the Government does not jeopardize this contribution to our tax base with poorly-conceived policies.

This month I met with Ministry of Finance advisers in Ottawa, and provided a detailed report with alternatives to the passive income proposal. The ideas address the Government’s perceived concerns around the corporate tax deferral while maintaining Canadian competitiveness. The Federal Budget is scheduled for February 27th – hopefully the Government has revised its position based on these and other ideas from the business community.

The Government must recognize the importance of being globally competitive, and appreciate entrepreneurial contributions to the Canadian economy. Otherwise, we can expect to watch Canadian entrepreneurs and capital seek friendlier investment climates, and a reduction in Canada’s tax base.

 

Jay Goodis is the co-founder and CEO of Tax Templates Inc. He has broad expertise in Canadian taxation from nearly a decade of practice in national and mid-market accounting firms. Mr. Goodis, is a member, CATA Innovation Leadership Council and national spokesperson on tax and finance issues (view TechNow interview with Mr. Goodis).

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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