As an individual with plenty of interest in the tax rules the reaction to the July 18th 2017 proposals has been incredible to observe. The tax and business community has been swift and vocal to try and make sense of the proposed rules and to outline the errors in the government’s ways. First let me say I agree with them.
One of the many things that prompted me to comment was an article published in the financial post which reported on a survey that said that many small businesses were ok with the proposals. To me it seemed a classic case of how were the survey questions worded and were the questions structured to get to this result. I say that because if the respondents understood the impact the results would likely have been different. I do note more recent newspaper articles are getting a better sense of how negative these tax changes are.
The purpose of my commentary is not to go into the technical rules and comment, but to make other observations based on my 30+ years’ experience dealing with hundreds of small businesses. My experience has almost exclusively been with the SME market. As a CPA, CA, I’ve been with a big audit firm, with banks as a lender, as CFO, as Corporate Director and as an entrepreneur. I’ve dealt with mom and pop shops and billionaires.
As noted above, the reaction by the tax community has been swift. I’ve attended a number of presentations on the technical tax changes so I’m not going to dive into the detail. I’m looking the practical implications of the proposals and what it might mean for the future.
First some statistics on the “so called” wealthy small business owner. Some statistics from the June 2016 Government of Canada’s Innovation, Science and Economic Development Canada Small Business Branch. The report is free and available online.
- Small business is defined as 1 to 99 paid employees.
- A medium sized business has 100 to 499 paid employees
- Large business, more than 500 paid employees
Number of businesses
- In 2015 there were 1.17 million employer businesses and 1.14 million (97.9%) were small business.
- In 2015 small business employed over 8.2 million people or 70.5% of the workforce. Almost half of this number was with employees of less than 19.
- In terms of employment growth, small business accounted for 87.7% of employment growth.
Business owner characteristic
- In 2014 47.4% of small business owners were 50-64 years of age.
- Of the 1.17 million businesses,
- 138K were categorized as professional, scientific and technical services
- 107K were categorized as health care and social assistance.
I note the above as it might be the category the government is targeting. I also understand of the government’s $290 billion budget the tax they are targeting is approximately $250 million.
You can draw many conclusions to the above. What I wanted to point out is
- Small business makes up the majority of companies in Canada
- Small business collectivity is the largest employment sector
- Almost half of owners will face succession planning issues in the next decade
- The breakdown of “wealthy” abusers can’t be determined, but if professionals are one of the key targets, they are not the majority of small business. The figures above speak for themselves.
What other conclusions or observations can be made. If you are involved with small business you know many just earn a living. There is no excess or surplus funds to put away. The majority are focused on sales and operations to either stay alive or grow.
So fast forward 18.7.2017. Experienced tax professionals have studied the proposed legislation and have more questions than answers. Many of the technical rules are unclear and have potential negative tax implications.
If the tax professionals with 10, 20 or 30 years of experience are having difficulty, what does it mean to
- the small business owner, who relies on their advisor for guidance
- the CPA/ tax advisor that is having challenges to understand the new rules
- The CRA auditors. Who’s going to train them in a timely manner in this era of increased tax audits?
Two tax changes stand out to me that will dramatically hit the business owner. The one year window to utilize accrued gains in say family trust situations. But even more significant is when the owner wants to pass the business on to a family member. The tax implications can be particularly negative. People often don’t pay attention to the rules until they are ready to transact, thus I could see a delayed reaction to the rules no matter how often we try to communicate the message. The whole concept of “specified individual” is going to be particularly troublesome. Also, the concept of “reasonable” is going to be tested, but as experts have noted, this is a very difficult proposition. Income “sprinkling” is the other concept put out there. If family members are going to be involved in the business, their compensation can be challenged. Want to help your university children by paying a salary? Not so fast, it will be challenged and may fall under the new rules and high tax rates like the "kiddie tax".
So what will this mean to the small business community when word gets around. Will the underground economy flourish? How will they be able to afford the more experienced technical advice to comply?
So is the government really helping the middle class?
How is the CRA going to administer this? What kind of by the book manual will have to be created for such complexity. A lot of experience and judgement will be required in an audit. The new rules are complex and will not be easily interpreted.
There are always exceptions in life. There are always going to be corporations who find ways to work within the existing tax framework and minimize their taxes. The courts have ruled tax planning is acceptable. If a select few determine tax efficient strategies that provide them temporary advantages then so be it. Trying to solve the problem of a few by taking out the majority is not a solution.
I’ve not touched on the “passive income” discussion as there was no draft legislation and what I hear this topic will be addressed in the future. I also understand that the draft legislation, primarily as presented, is likely going to proceed, thus restricting consultation and the ability to make changes. There are a couple committees the legislation has to pass through, so people have to keep up the pressure for change.
It's interesting to note the U.S. is moving in the opposition direction with their tax reform. The U.S. is looking to dramatically reduce and simplify taxes.
So many small businesses work hard just to make a living. The drafted legislation just made their life that much more difficult.
About the author: Kelly Ehler, CPA, CA, LPA, TEP is a forward thinking, collaborative, CPA, CA that has taken the roles of CEO, audit committee chair, CFO, financial advisor, corporate tax planner, tax preparer in multiple industries to entrepreneurs. He is the President at itaxpartners.