The federal government’s efforts to close a tax “loophole” are drawing backlash from industry observers who say the “ill-conceived” legislation could end up hurting entrepreneurs and small businesses.
The new regime would limit the owners of private companies from “income sprinkling,” or spreading out income to family members as a way to reduce payable taxes. It would also place restrictions on passive income investment in businesses and on converting regular income into capital gains, both of which are taxed at a lower rate.
Announcing the proposed tax changes last month, Finance Minister Bill Morneau says these moves will prevent wealthy individuals from gaming the system in order to avoid paying more in taxes.
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“We see these approaches to managing people’s affairs through a private corporation as creating an unfair playing field,” Mr. Morneau said.
Since that time, professionals such as doctors and small business owners including farmers have expressed their dissatisfaction with the proposed rules. Advocates and observers of the high-tech industry also believe the legislation would hinder Ottawa’s startup scene.
“We have fallen off the cliff, as far as I’m concerned, in terms of innovation leadership,” says John Reid, CEO of the Canadian Advanced Technology Alliance.
Mr. Reid says the new rules create an environment that discourages small business owners from hiring, taking risks and starting new ventures in the first place. Changes such as these create obstacles to local business priorities, he argues.
“We’re putting a lot of emphasis on Invest Ottawa, the need for startups, business creation … think about how this affects that mission,” he says. “I think this is really important for Ottawa and what we’re trying to do here in the city.”
Paul LaBarge, founder and partner at law firm LaBarge Weinstein, says the proposals are “ill-conceived,” and create a “false equivalency” between employer dollars and employment dollars. Whereas employees are on the receiving end of salaries and benefits, the burden falls to employers to bear the liability.
“If you’re an employee, you’re the first guy to get paid. If you’re an entrepreneur, you’re the last guy to get paid … If there’s a shortfall at the end of the year, you don’t get paid,” he says.
From this perspective, the tax “loopholes” that the government is seeking to close are necessary balances to help encourage employers to take risks while still being able to save for retirement or plan an in-family succession.
Issue of fairness, minister says
However, the federal government says the changes will bring more “fairness” to the tax system. Speaking at the annual meeting of the Canadian Medical Association in Quebec City on Monday, federal Health Minister Jane Philpott argued that the reforms will create a more level playing field.
“Does it make sense to create a system where some of you in the room can take advantage of those mechanisms in a way that others can’t?” she asked, referring to such tax deductions as income splitting.
“If you are someone who has a spouse that makes significantly less income than you or you have children of a certain age of 18 to 24, then you can take advantage of legitimate rules that currently exist to reduce your personal income tax burden.
“But the person sitting beside you or across from you who is single, who has very young children, no children, children who are grown up and making their own income, are going to pay much more tax than you.”
Mr. LaBarge worries about the ripple effects if the legislation is passed when it’s tabled in October. Some small businesses could outright pack up shop, while others may decide that having employees isn’t worth the burden, leading to a hiring slump. Charities may find it more difficult to solicit donations from small businesses, which Mr. LaBarge says are often the most significant philanthropic contributors.
Mr. Reid adds that the changes would make Canada less attractive for investment and for global entrepreneurs looking for a North American locale for expansion.
Both Mr. Reid and Mr. LaBarge are turned off by the timing and tone of the proposal and accompanying consultation. The legislation was announced in mid-July, when many stakeholders were on vacation, and given only a 75-day comment period before being taken to the house.
“What really bothers me is that this legislation was really tabled in midsummer with the proviso that we cannot question the ‘underlying principles.’ And it’s really the underlying principles that are creating this backlash from the medical profession, from entrepreneurs, from small business owners,” says Mr. Reid, who is hopeful the government may reverse its position and reconsider its proposals.
“A responsible government will pause and have a meaningful consultation period,” he says.
– With files from the Canadian Press