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The Right Honourable Justin Trudeau, M.P. and The Honourable Bill Morneau:
This letter has been sent to you from the website of of the law firm of Anurag Gupta Professional Corporation by a concerned small business operator. I, Anurag Gupta, am a corporate-tax lawyer in Oakville, Ontario and represent a large number of small and medium enterprises (SMEs) in Canada. I write this letter in response to the Government of Canada’s new tax proposals, on behalf of my own business, my clients, their families and employees, as well as other SMEs owners.
We trust that you will review the contents of this letter and consider the impact that these measures, combined with increased wages for employees in Ontario, will have to dentists on all privately-held corporations and every family business, as well as dentists.
Given the integral role of SMEs in Canada, the ripple effect of the proposed tax measures will be severe and far-reaching on the Canadian economy, affecting businesses, business owners, employees and consumers. We trust that you will advocate on behalf of all business owners and will not allow such measures to be implemented by our government as these family owned businesses are not part of the 1% that the Liberal Government is stating is the issue. Rather, the proposed measures will have a direct negative impact on the middle class that the Liberal Government is allegedly stating that it is attempting to assist. The owners of small and medium businesses depend on the current rules for their well-being.
Individuals who choose to run a business typically have the following characteristics:
SMEs are fundamental to the Canadian economy, and their impact is reflected in Industry Canada’s 2016 Report, summarized as follows: SMEs :
In total, SMEs employed 90.3 percent (10.5 million) of the private sector workforce, highlighting the important role SMEs play in employing Canadians.
I am an experienced owner-operator. I own my law firm and have run family businesses in the past. I am also legal counsel to various SMEs and family business operators, all of whom take significant risks in operating their businesses.
For example, an initial capital contribution is required from the owner, and the capital contribution can be a significant amount. In many cases the owner may not qualify for a bank loan. Even when they do qualify, banks will collateralize the owner’s business and ask for personal guarantees. If an owner is unable to secure a bank loan, they would need to obtain funds from other sources, such as: obtaining lines of credit on their homes, borrowing from family and friends, or obtaining private financing, where interest rates can be as high as 25% and be subject to additional fees. Employees do not bear the same degree of risks, yet the government would like to place the employee and business owner on par.
Industry Canada’s 2016 Report states that SMEs are significant players in Canada’s lending market.
In 2014, 51.3 percent of SMEs sought external financing, compared with 48.7 percent that did not request external financing. The total authorized amount to SMEs in 2014 was over $53 billion.
$53 billion is not a trivial amount but a significant source of revenue of lenders. Furthermore, these figures likely do not include capital injection from private equity firms, friends, family, or other non-traditional non-institutional financing. I have many clients who have obtained financing from non-institutional lenders because such family owners were unable to meet bank credit requirements, but required working capital to keep their business afloat and maintain jobs for employees. If SMEs were to close down or less individuals took the initiative to launch businesses because of the measures, banks and other lenders will have less profits, which will result in layoffs and less distributions to shareholders.
Additional risks that business operators take include, but are not limited to: a) procuring, maintaining and servicing clients, and b) carrying hefty operating costs such as employee salaries and rent, all of which add to the risk of not being able to increase revenues.
SMEs have to maintain their services and goods at an affordable price in order to maintain a competitive edge in the market place. Accordingly, SMEs have to set their price within the market’s price tolerance by balancing their operating costs and profit targets. Unfortunately, the Ontario’s government’s proposal to increase hydro rates and raise the minimum wage will further erode profit margins for business owners. Contribute the increasing costs of hydro and rent with an 38% wage increase for employees in Ontario, and many business owners may be forced to either lay off employees or close down permanently, particularly those that barely survive. In a recent Toronto Star article, Metro Inc., Canada’s third largest grocery chain, is seeking to accelerate its automation process. This is one example of many companies. While many small business owners may not rely on automation, they will likely replace certain employees with family members to meet the “reasonable test”, which is absolutely ridiculous.
There is also an emotional component to operate a business. For a large majority of business owners, there is no separation between business and home, as we breathe eat, sleep, drink and work 24/7. This emotional burden bleeds into a business owner’s quality of life, and affects each of their family members. Time and again, my clients’ spouses have shared with me the emotional stress that they endure in assisting the business owner with the family business.
The same cannot be said about employees. While I do not discount the fact that employees also stress about work, there is a key difference: Many have the luxury of “shutting down” from work. Employees do not carry the same financial risk of losing their houses, or answering to creditors if their business fails. While employees might be laid off if their employer’s business fails, employees can obtain EI from the government. While employees are protected in the event of their employer’s bankruptcy or insolvency, and further protected from wrongful termination or discrimination, business owners are not afforded the same protections. For example, if a business owner is unable to sell a product due to low demand, he would have to make alternative arrangements to move such inventory, which might reduce his profit margins. However, the business owner cannot ask his employee to take a pay-cut, and if an employer did make that offer, the company might potentially be sued for constructive dismissal.
Employees can take jobs with employers who offer benefits, stock options, and contribute to their pension. Employees can also contribute to their retirement planning using employer resources, but the same cannot be said about business owners. A business owner is rewarded if the business is successful, but if the business fails, the owner may also have to declare personal bankruptcy. In contrast, an employee can seek government assistance and obtain EI, using funds that were contributed by the employer. Not all business owners are successful, and success has many spectrums. Some business owners barely survive, while others may flourish. For all business owners, profit is the one measure of success, and the sole source of their retirement planning.
Unlike employees family-operated business owners are the creators of their own retirement planning. Parliament recognized the difference between the two by passing tax legislation that granted business owners the ability to structure their affairs in a manner that takes into account the risks that owners take, such as the ability to income split, lifetime capital gains exemption and the ability for business owners to passively invest – the same measures that the government is seeking to eliminate or restricting the ability to use perfectly permissible rules.
Currently, the Income Tax Act allows business owners to plan their retirement through a number of mechanisms, mainly: (i) the ability to share the profits of their business with the family members; (ii) to share the profits from the sale of shares of the business (lifetime capital gains exemption); and (iii) the ability to invest surplus profits inside the corporation. The government’s proposed tax amendments will remove all this. On a side note, the rules of my law society do not allow lawyers to income split with family members, so I am uncertain of why the Liberal government has called lawyers “tax cheats”.
More often than not, legal and accounting professionals will advise business owners to structure their financial affairs in a manner that involves a web of corporations, trusts, partnerships, or other vehicles permitted by the Income Tax Act. Each of these structures serves both a legal and tax purpose. For instance, family trusts are used for legal reasons to grant certain family members a stake in the company without granting such members de juris control over the company. At the same time, family trusts also allow for a tax benefit that has been codified in the Income Tax Act for years.
Most business owners can income split and multiply the capital gains exemption between family members, if there are sufficient retained earnings. The ability to income split also allows a family to spend more, invariably, injecting more into Canada’s economy and helping other business owners.
Dividend sprinkling amongst family members also allows a family to provide for the educational expenses of their university age children. This in turn decreases the government’s educational burden and increases the pool to allow the government to distribute loans to students who desperately need the funding. Many of my business owner clients provide for their children’s university needs and do not rely on government funding.
In respect of the life time capital gains exemption, not every business owner is able to capitalize on the sale of the shares of the business. However, when a business operator is able to do so, the ability to multiply the capital gains exemption amongst family members, such funds inevitably are reinvested into the Canadian economy in some form or another. If the government proposes to implement the measures by eroding the income splitting, lifetime capital gains exemption and not allowing to business owners to passively invest the retained earnings, then less funds will be injected into the Canadian economy.
The passive investment of retained earnings is another mechanism that business owners use in their retirement planning. Not all business can be readily sold – for instance, a doctor’s medical practice because lack of goodwill —and such business owners have to invest what funds they earn for their retirement planning. If the proposed tax amendments are implemented, the government would effectively remove the business owners’ main means of retirement planning. In the long run, this could potentially become burden to our government and society. This is particularly important to professionals.
The government has relied on a consultation report to support its proposed tax amendments. According to the consultation report, business owners are taking advantage of tax “loopholes” to gain an unfair financial advantage over other Canadians. However, income splitting and the utilization of family trusts to multiply the capital gains exemption are not loopholes. Rather, they are tools that business owners use to optimize their business affairs, and such tools have long been permitted under the Income Tax Act.
Under the new proposed measures, imposing a reasonable test on family members will cripple the family business and the family. As you are aware, under the current system, owners can freely distribute dividends from companies to their family members without reason, provided that they are shareholders of the company. If the new measures are passed, each family member would have to meet a reasonable test – eg contributed to the company such as provided a labour component as if the family owner is an employee. Many family operators may force their children to fully participate into the business, possibly replacing the employee. Recently, I was asked by several clients on what to do if these measures are implemented. My immediate simple answer: state to you your family members that they now have to work.
The implementation of the proposed tax measures would also hamper capital injection from private equity firms or other family members with significant resources. For example, a physician who can make use of tax efficiencies would have more incentive to contribute capital into a family member’s another business owned by Canadians. In contrast, that same physician would have significantly less funds to invest in another venture if the tax measures are implemented, and also much less an incentive to do so if he is not able to meet the proposed reasonableness test.
As hereinbefore detailed, the government’s proposed tax amendments would have a severely negative impact on SMEs, our economy and our society. Canada may see a spike in its unemployment rate, an abuse of the underground economy, less entrepreneurs taking the initiative to launch businesses, and an exodus of business owners, particularly professionals. All of these are vital to any country’s economy. Falling numbers of SMEs would lead to a drop in the employment market, as well as decrease export trade and economic production. In addition, more people would rely on EI and other social benefits, thereby putting a drain on the government’s resources. In light of these far-reaching effects, I trust that you will consider the impact that these measures will have on business owners and their families, and the subsequent effects they will have on employees and the job market. Canada has been rated one of the better countries for businesses to thrive because of the tax advantages it provides to SMEs, but Canada’s unemployment rate is the third highest amongst the G7 nations. Let us not increase this rate because of the inadvertent effects that the proposed measures may have on business owners. I urge you to consider the significant contribution and the impact that SMEs have on the Canadian economy.
Thank you for your time and consideration.
 OECD (2017), Unemployment rate (indicator). doi: 10.1787/997c8750-en (Accessed on 16 August 2017) @ https://data.oecd.org/unemp/unemployment-rate.htm
Anurag Gupta, LL.B.