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Proposed changes to the tax treatment of Canadian-Controlled Private Corporations 

Small businesses are the engine of the Canadian economy. In the manufacturing sector alone, there are nearly 68,000 establishments with fewer than ten employees and another 20,000 with fewer than 100 employees. Many of these manufacturers are CCPC’s and collectively they employ over 1,000,000 Canadians.  Many of these companies are our members, engaged in risk-taking as they build their businesses and compete locally and internationally. 

CME believes that an internationally-competitive tax system is critical to attract new manufacturing investment to Canada and to foster entrepreneurship and growth. From this, we have three specific guiding principles that we believe must govern any and all changes to the tax system for manufacturers to thrive in Canada. The tax system should: incentivize investment and growth; reward and support risk-taking, innovation and entrepreneurship; and be simple, clear and fair. 

Background 

In its 2017 budget, the federal government announced that it would be making changes to the tax treatment of Canadian-Controlled Private Corporations (CCPCs). These changes were motivated by the government’s desire to treat like income earners alike: There are a number of strategies available to incorporated individuals that reduce the amount of taxes they pay compared to someone earning the same income as a salaried individual.

The Budget highlighted three specific issues:

  • Income sprinkling: Individuals who own a CCPC are able to distribute their income among family members through a variety of means, allowing more of that money to be taxed at lower brackets and therefore reducing the overall tax paid.
  • Treatment of passive investments inside a corporation: Because of preferential small-business tax rates, individuals making passive investments (in stocks, bonds or other assets not directly related to the business itself) inside a CCPC pay less in tax compared to someone investing the same amount out of their normal wages.
  • Conversion of income into capital gains: Because half of capital gains are tax-exempt, if an individual uses a CCPC to convert its regular income into a capital gain, they pay a lower tax rate on that income.

On July 18 2017, the federal Department of Finance issued a paper, Tax Planning Using Private Corporations that spelled out the specific issues and proposed solutions in considerable detail. The release of that paper also triggered the beginning of a 75-day consultation process on the proposed changes, some of which could be in place as early as January 1, 2018. 

Concerns for Manufacturers

CME understands the motivation behind the proposed changes to the taxation of CCPCs,  However, based on our analysis and consultation with members, we are concerned that the proposed changes will impact a much broader range of business activities and will strike well beyond their intended target, potentially resulting in significant negative unintended consequences for small manufacturers.  

Some of our specific concerns include the following: 

  • The proposed tax changes reduce the incentive and economic return on entrepreneurship, risk-taking, business investment and job creation; 
  • In an effort to treat like income alike, they fail to account for key differences between small-business income and employee salaries; 
  • They raise the cost of doing business and add to the complexity of an already burdensome tax system; and 
  • They inconsistently apply the “tax fairness” principle and create new instances of unfairness in the process. 

Recommendations

CME believes that the Government of Canada should not rush to apply significant but flawed amendments to the tax code. We urgently recommend that the Department of Finance should indefinitely postpone its proposed changes to the tax treatment of CCPCs. Instead, it should undertake a broader and more comprehensive approach to reform. The goal should be to create a tax system that is simple and fair; that encourages business investment and growth, and that rewards entrepreneurship and innovation. 

If, however, the government is intent on proceeding with immediate tax reform, we recommend the following amendments to the current proposals. These recommendations should be considered as interim steps in advance of comprehensive reforms and not a substitute for those reforms: 

  • Income splitting for spouses: In recognition of the important role they often play in private businesses – especially in the early stages of a start-up – spouses of CCPC owners should continue to be eligible for income splitting benefits.  
  • Incentives for growth: Amend the proposed changes to better distinguish between legitimate business operations and those individuals who use CCPCs for tax sheltering purposes. In our formal submission to the Department of Finance, CME offers several options that would allow the government to achieve its goal of tax fairness while also creating an incentive for small businesses to expand and prosper. For example, introducing a parallel tax credit on labour income and capital expenditures would reward companies that are trying to grow, while still allowing the government to eliminate instances of personal tax avoidance.  
  • Reduction of administrative burden: Steps urgently need to be taken to reduce the complexity and administrative compliance burden these changes will impose on small businesses. Our submission offers two proposals in this area. Foremost among them is the need for clear and explicit definitions and guidelines on the record-keeping and compliance requirements created by these tax changes.

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