When the federal government introduced new tax rules last year, small businesses said they were being unfairly targeted by “punitive” measures. According to Small Business Association Canada, up to half of the country’s entrepreneurs say they’re already feeling negative effects.
Changes to passive income is one pain point. In the February budget, the Liberals implemented a grind-down mechanism for small business tax deductions by which every dollar of passive income over $50,000 — for example, rent, investments or interest — cuts revenue eligible for the small business tax rate by $5.
Sarwar Qureshi, vice-president of finance for SBA Canada, says this has been particularly difficult for businesses that use passive income to save for upgrades or expansion — to pay for expensive construction equipment, perhaps, or to purchase real estate.
“Those businesses were hit hard because they have a significant sum of investment income, but they were saving up a nest egg to cope with cyclical businesses conditions, or they may have a big upcoming purchase,” he says. “Now their investment income is over that threshold, they’re impacted by those rules and are paying some more tax. It’s unplanned and unexpected.”
Dan Kelly, the president of the Canadian Federation of Independent Businesses, says at least one member — a restaurateur who will not speak publicly for fear of investigation by the CRA — is facing a critical cash crunch because of the tax changes.
His franchise agreement requires him to set aside money for renovations to his multiple restaurants every five years, and top-to-bottom refurbishments every decade. “As a result of doing that, he will be taxed as a large corporation and his tax bill will be $80,000 a year more than it was before,” says Kelly. “There’s a whole new group of losers.”
Patients are among that group, according to Dr. Kulvinder Gill, the president of advocacy group Concerned Ontario Doctors. She says many physicians use passive income to pay for clinic improvements. “All the healthcare infrastructure that you see outside hospitals is funded by doctors,” she says, pointing to the purchase of medical and diagnostic equipment and staffing.
Dr. Gill says the financial impact of tax changes has forced clinics she co-owns in Ontario to lay off staff and cut hours, and to discontinue drug allergy testing services. “With all these other changes that continue to add onto the overhead, I can’t continue to subsidize it personally any more.”
Physicians in her area have also had to cut back on basics like flu clinics. “Many doctors would run flu clinics, where they have additional hours set aside or a nurse that would help to administer the shots. Many have cancelled that entirely.”
Don Paton, who owns an industrial machine shop called Ontario Crane Service, was irate when passive income rules were first proposed in August 2017, which took effect on the first dollar earned. But he says concerns like his have been addressed by the government.
“The way they legislated after all the complaints wasn’t too bad, actually. It allowed for up to $50,000 per year which was more than most businesses can generate,” he says. “They did listen to small business owners across the country.”
Some are getting hit by one (tax) and some hit by the other. Some by both
Sarwar Qureshi, Small Business Association Canada
However, passive income wasn’t the only tax change for small business owners. Last January, the federal government effectively removed the marginal tax rate for dividend payments. This means that small businesses can no longer pay, say, a spouse or adult child dividends at a reduced income tax rate unless they can navigate a complex set of rules to prove that they have been working for the business or are heavily enough invested in it.
Using income splitting to help fund children’s education is particularly problematic, says Qureshi. He says healthcare professionals are a prime example: Instead of banking money in an RESP, they often put it into their companies, then split income with their children when they turn 18. “When their kids go to university, they would help fund those post-secondary years by paying a dividend.”
Now that is no longer an option, he says, which means parents who have been using this strategy for five or more years in anticipation of future university costs are in an unfortunate position. “Now you’re stuck.”
Qureshi says close to 50 per cent of his clients will experience significant consequences from changes to small business taxes — whether they have passive income or have been employing income splitting. “Some are getting hit by one and some hit by the other. Some (are) hit by both.”
Worse, Kelly warns, because of the complexity of the new tax rules, many businesses are not as prepared as they could be. “Most of them have made no changes to their business practices, and I firmly believe that many of them will get a rude awakening once their tax file is passed by the CRA,” he says. Companies that have already filed their taxes may only notice the implications of the changes — particularly income splitting — after the CRA queries their tax returns and begins auditing.
“We are gearing up for an onslaught of calls once the audits begin for the 2018 and 2019 tax years,” he says. “That’s where the real heat is going to be felt.”
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