Small businesses — those with up to 20 employees — are important to our economy: they account for 20 per cent of all Canadian jobs. The tax rules governing them should be simple and understandable, but many are barely comprehensible. Ottawa should scrap them and start over with a clean sheet.
Here’s an example. Mary has owned a bookstore in Orillia, Ontario, for about 30 years. To help her get started, her mother gave her a zero-interest loan of $50,000 that she hasn’t paid back yet. Mary owns 80 per cent of the shares of her private corporation and her two adult children own 10 per cent each.
Last year, Mary received a salary of $60,000 and, after the salary expense, the company earned $20,000 before tax. In addition, it has accumulated a small investment portfolio over the years that Mary hopes will help fund her retirement.
Mary goes to see her accountant to ask if the company should pay a small dividend to her and her two children. The meeting is a fiasco. Mary’s accountant, Boris, reminds her that, although the company pays tax of about 12 per cent on its business income, its tax rate on investment income is more than 50 per cent.
“Why is that?” Mary asks. “The personal tax on my salary is only 17 per cent.”
Boris explains that the rate of 50 per cent on investment income is in place because that is close to the top rate for high-income individuals. And while fewer than five per cent of Canadians are actually in the top bracket, Ottawa wants to get its hands on as much cash as possible.
“Now, there are a couple of things to think about regarding dividend payments,” Boris says. “First, the company has a small balance in its GRIP account (general rate income pool)” — Mary’s eyes start to glaze over — “so it can pay either eligible or non-eligible dividends. The personal tax cost will be higher if non-eligible dividends are paid, but that is the only way the company will get a refund from its NERDTOH account (non-eligible refundable dividend tax on hand) and recoup some of its tax on the investment income.”
Mary has heard enough and starts to leave.
“Just a moment”, Boris says. “We should really talk about the TOSI rules, as well. If the children receive dividends and the TOSI rules apply (tax on split income), they will pay personal tax at the highest personal tax rate on the entire dividend, unless they are involved in the company’s business on a ‘regular, continuous and substantial basis.’”
“They are not,” Mary says, “and I’ve had it! Eligible dividends; non-eligible dividends; GRIP; NERDTOH; TOSI. If I had wanted to be a tax expert, I would have pursued an accounting or legal degree. I just want to sell books.”
Mary tells Boris she will simply forget about the dividends, because she barely understood a word he said. Anyway, she has to leave to help her mother pack: her mom is moving to Arizona on a permanent basis.
“She’s moving to the States? Can you tell me about her loan to the company,” Boris asks.
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“There’s not much to tell,” Mary says. “The loan doesn’t bear interest: it is convertible into voting shares if it is not repaid, but eventually I will pay it back.”
Boris looks flabbergasted. Right now, the company is a CCPC — a Canadian-controlled private corporation. But the loan gives Mary’s mother contingent rights to control the company. So when she moves, the company will cease to be a CCPC and will pay tax in future at a rate of 26.5 per cent on its business income, not 12 per cent. “And there’s more,” Boris says. “As a non-CCPC, the company would have escaped the confiscatory 50 per cent rate on investment income, except there is a new set of rules — hot off the press from April’s federal budget. The company will now be a non-CCPC for most purposes but will become a ‘substantive CCPC’ and still owe 50 per cent on its investment income.”
Mary decides to close her bookstore and move to Arizona with her mother.
I wish this example were farfetched and that these rules rarely applied. But they and equally unintelligible rules like them affect tens of thousands of small businesses across the country. They rank among the most complex rules in our entire tax code. If the politicians in Ottawa want to do something good for the economy, they should throw them out and start over.
Allan Lanthier is a retired partner of an international accounting firm and has been an advisor to both the Department of Finance and the Canada Revenue Agency.