Lawyers, doctors, farmers, contractors and other small-business owners in Canada were relieved last week to see Ottawa backing down somewhat on its plan to close what it considered a loophole that gives wealthy Canadians an unfair tax break.
Last week’s federal budget included revisions to Ottawa’s original plan to overhaul the way it taxes income earned by Canadian-controlled private corporations (CCPCs).
The revised plan is to use a sliding scale that will reduce the tax advantage CCPCs currently enjoy, reducing eligibility for the small-business tax deduction according to how much businesses earn through so-called passive investments.
Currently, a private business incorporated as a CCPC is eligible for the lower small-business tax rate on the first $500,000 of earnings.
But companies that put some of their profits into passive investments were facing a massive new tax rate on the income from those investments.
“The huge problem that everybody was excited about in July, the government has completely walked away from,” said Shane Onufrechuk, tax partner at KPMG.
“The notion that they will be taxed in a punitive way on their investment income retained in the company is gone. They’ve put in some other rules that do something totally different but aren’t nearly as bad.”
Last year, Ottawa proposed to essentially put doctors – self-employed – on the same footing as their receptionists – their employees – when it comes to the rate at which their income is taxed.
Ottawa didn’t like that doctors or lawyers with CCPCs would have their business income taxed at the small-business tax rate, which is much lower than the personal income tax rate – leaving them more money to invest than, say, their employees, who would have less money left over because they paid personal income taxes, which are higher than the small-business tax rate.
The federal government had planned to start taxing income earned by CCPCs on their passive investments at a rate of 73%, according to Kim Moody, Canadian tax advisory director with Moodys Gartner Tax Law LLP.
Last week’s budget partly backed off on that plan.
Small businesses that have significant passive investment income from their companies will lose their eligibility for the lower small-business tax rate, on a sliding scale.
Now, any corporation earning more than $50,000 in a year through its passive investments will see its access to the small-business tax deductions reduced accordingly.
Basically, the small-business tax deduction eligibility threshold decreases as passive investment income increases.
For example, a small-business owner who earns $100,000 a year and puts $25,000 away each year to cover things that an employer or government might otherwise cover – parental leave, for example – would be under the threshold and would still qualify for the small-business tax rate.
But a larger private corporation that earns more than $500,000 a year and has amassed an investment portfolio of $5 million will lose its eligibility for the small-business tax rate.
“If that company that wants to claim the small-business deduction earns $50,000 or more of investment income, then every dollar in excess of $50,000 will result in a $5 reduction in the small-business deduction,” Moody explained.
“What the government has rolled out in this budget eliminates many of the concerns that caused our members to react so passionately last summer, when they sent over 28,000 emails on this topic to our members of Parliament,” said Iain Black, president of the Greater Vancouver Board of Trade.
But Black said he still thinks Ottawa’s plan to treat passive investment income by small business as a tax dodge is wrong.
As an example, he cites a small steel company that has been socking away money to save up for an expensive piece of new fabrication equipment.
“If you’re sitting there now, as that little company with $10 million or $15 million a year in revenue, and you’re sitting on $3 million or $4 million because you’ve been saving up your dough to go and buy this piece of equipment, the government is now going to penalize you for that,” Black said.
