More Punishment of Successful Canadian Businesses – Passive Investments in an Active Business

The July 18 punitive tax proposals include commentary about tax changes for investments within active corporations. The rules have not been set out as of yet, so we still have an opportunity to share our feedback with the politicians.

In my conversations with my clients I see that the concept is not well understood. Here is the deal.

A small business owner is occasionally so good at their business that they accumulate funds which they are not using in the business at the time. Often the business owner will park this money in a term deposit or a Guaranteed Investment Certificate. Or if the business is very successful then they might buy shares of other companies. This is considered to be a passive investment and any income earned from this investment does not get the small business deduction, so is taxed at a higher rate. So far — so good, these are the existing rules.

The commentary in the tax releases suggest that any funds which are accumulated and not used in the business should be subject to even more punishment than the loss of the small business deduction. The concept is that there are more funds left over in the small business because they only paid the active business rate when they earned the income — so this is not fair. The feds want to create some sort of rule that will increase the amount of tax paid on the original profits so that small businesses do not have as much money left to invest.

A small business owner is prudent to build up funds in the business in case there is a business downturn or the business owner is disabled or sick. In this way the business can withstand these risks — remember that a business owner does not have access to the EI program so they self fund for the types of risks that an employee does not have to worry about.

A small business owner could also be saving money in their business to use in their retirement. Remember a small business owner does not enjoy the defined benefit, indexed pension that a public sector employee takes for granted.

Perhaps you could contact your Member of Parliament and suggest that any provision that reduces the amount of money that our small business owners will have available for investment and retirement is not fair.

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