Ontario splits with federal government on small-business tax change

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The Ontario PC government has broken ranks with the federal government and the previous Liberal provincial government, saying it won’t apply one of the controversial federal small-business tax changes at the provincial level. The move, which might reduce the effectiveness of the federal policy on passive investments inside corporations, could be replicated by other provinces, according to small-business advocates.

Ontario’s Doug Ford administration said in its fall economic update that it will not go ahead with the previous government’s decision to mirror a federal Liberal tax change relating to limiting access to the small business deduction for corporations that earn over $50,000 in passive investment income, which is money made from investing in stocks, bonds or other sources not related to the business.

“The change is still negative overall, but the potential penalty is cut by more than half,” says Dan Kelly, president and CEO of the Canadian Federation of Business (CFIB), noting that the small business deduction, which applies to active business income under $500,000 annually, leads to greater savings at the provincial level.

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When Ottawa’s rules take effect on Jan. 1, businesses that earn more than $50,000 in passive investment income annually will begin to have their small business deduction reduced, and will lose access entirely once they earn more than $150,000 a year.

For a small business owner affected, the change means paying 15 per cent in federal taxes on new active business income, instead of 9 per cent for income earned over the deduction threshold. In Ontario, the corporate rate is 11.5 per cent, while the small-business rate will be 3.5 per cent, starting in 2019.

The new Ontario government’s decision to not go ahead with the change means a small business owner with active business income over the deduction threshold will pay the higher federal rate but will retain access to the provincial small business rate regardless of how much passive investment income is earned in their corporation. That means Ontario business owners with passive investments inside their corporation could save as much as $40,000 in provincial tax.

Ontario’s reversal gives business owners renewed incentive to save money in their corporations at a lower tax rate as compared to personal income. Ottawa’s goal with the tax changes was to prevent business owners from incorporating just to avoid paying higher taxes. When asked about Ontario’s decision, finance minister Bill Morneau told reporters last week he believes his government “came to the right policy conclusion,” on passive investment income.

After intense anger from the business community, the Ottawa watered down a previous plan to heavily tax passive investment income directly. Still, the new rules will impact more established, successful business owners who have been in business longer and accumulated more passive investments over the years.

According to an Ontario background paper, 7,900 small businesses would have faced higher provincial taxes due to the new rule. Business owners argue that passive investment income allows them to set aside money for economic downturns and also acts as a retirement vehicle in lieu of a pension plan.

“Small firms need options like this for the good of the business and the good of the business owner,” says Mr. Kelly.

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Tax professionals see Ontario’s move as a small, but significant win for small business owners in the province.

“It’s not a big tax change, but it’s extra money,” says Adrienne Lo, a chartered professional accountant and director of tax and estate planning at Toronto-based Chronicle Wealth Ltd.

“If you were in that top threshold, you do have that extra $40,000 to play with.”

Ms. Lo says she expects business owners will use the extra money to help save for retirement or to expand their businesses.

John Hedden, owner of Burlington, Ont.-based Bryan and Hedden Financial, said the change will lower his tax bill and has him once again thinking about expanding his financial services company.

“For my business, this announcement and its positive signal may … provide me the confidence to expand and add an additional employee in the coming year,” says Mr. Hedden, who currently has seven staff. “This plan was put on hold, however now it can be in my business planning again.”

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The Ontario government said the previous government’s plan to match the federal passive investment income rules would have increased taxes on small businesses by about $160-million per year by 2020-21. “The government is committed to helping small businesses and cutting taxes,” the government stated in its fall economic update on November 15.

Other provinces have also expressed concern about Ottawa’s passive investment income rules and are considering opting out, including New Brunswick’s incoming Conservative government, which listed it as a campaign promise. The CFIB has been actively lobbying Manitoba and Saskatchewan officials to do the same.

Saskatchewan finance minister Donna Harpauer said in an email statement to The Globe and Mail that her province “is reviewing this matter. We have raised the issue with the federal minister. No decision has been made.”

The CFIB’s Mr. Kelly is hoping that if other provinces follow Ontario’s lead, Ottawa may reverse its decision, but acknowledges it may be wishful thinking. Still, he argues it weakens their decision and could become a campaign issue in next fall’s federal election. “I don’t think the federal policy objective will be met if it’s just a federal tax change,” Mr. Kelly says.

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