We know to what extent small and medium enterprises (SMEs) in Canada contribute to economic growth and job creation. To encourage people to start their own businesses and take certain risks, governments have for a long time relied on tax benefits as incentives. But with the current federal government, the trend is changing. Justin Trudeau’s government seems to want to considerably reduce all Canadian-controlled private corporation (CCPC) tax incentives.
In its latest federal budget tabled on February 27, 2018, the government is penalizing all CCPC passive investment income above $50,000. For years, many entrepreneurs chose to forgo RRSPs to allow benefits to grow within their companies. But now, the new measures will have a major impact on the retirement of many entrepreneurs.
Normally, the CCPC benefits from a reduced tax rate on the first $500,000 of the company’s active income. These new changes reduce access to the preferential small business tax rate for CCPCs with a passive investment income between $50,000 and $150,000. Changes will be enforced after 2018 and will have the effect of reducing the deduction limit for small businesses by $5 for every $1 of investment income exceeding the $50,000 ceiling. This means that any CCPC whose passive investment account is $150,000 or more will see this deduction completely eliminated.
Here’s an example: if a CCPC earns a passive investment income of $75,000, the first $50,000 will be exempt and will not affect the deduction for small businesses. For the remaining $25,000, this will reduce the deduction limit by $5 for every $1 above $50,000. As it happens, the deduction will be reduced from $125,000 onwards. So, private businesses can benefit from the preferential small business tax rate only for an active business income of $375,000.
It is always unfortunate to see the rules of the game changed along the way. I sincerely hope that this new measure will not have too negative an impact on economic growth, job creation and entrepreneurs’ desire to make Canadian SMEs flourish. What’s certain is that the tax impact of financial decisions have always been significant, but with this reform, they become even more so.