Proposed Liberal Tax Changes: Anticipated Results & Strategies for Small Business

calgary small business accountants

To start with, I’ve read through the monster of a discussion paper that the Finance Minister had issued earlier this summer. I’ve also been keeping up to date on what other professionals have been saying about this topic. It has taken me a couple months to write this post because I’ve been too busy working with our clients to come up with tailored strategies.

Businesses are a very interesting living entity, it is a collection of people, processes, assets and liabilities. It does not have emotions and its only true moral responsibility is to remain profitable. While a business can certainly decide to have more moral responsibilities, but remaining profitable is the undisputed constant for all businesses. With these new tax changes being proposed by the Liberals most are saying that this will hurt small businesses. I personally think it will make small business more resilient.

I remember a few years ago talking to several franchise owners when the threat of a minimum wage increase was pending. Both the franchise owner and the head offices had already considered how to deal with that situation. It resulted in strategically less hours for staff but the remaining staff simply had to work harder. This is what businesses do, we persevere. We will adapt and be more aggressive. Any policy that seeks to hurt businesses will usually have the opposite result and hurt the counter party.

Small business will respond to this tax proposal that threatens profitability for its shareholders. There will be many strategies that a small business can employ…

 

The Obvious Business Solutions

Option #1 – Staff downsizing – Everyone knows this one is going to happen. The belief is it would be a challenge convincing the remaining staff to work harder filling the holes for those who have been let go. The truth is it won’t be a challenge as I have seen among my clients in my Accounting practice in Calgary that rate cuts, wage cuts, benefit cuts, post layoff, the fear factor of the result is going to be enough to convince remaining staff to produce a higher capacity. Alternatively, if you have a consulting business you may have the ability to offshore and outsource to a lower cost third world country.

Option #2 – Investing in automation – We’re all seeing it, the automated check out machines, or simply processes no longer being done by humans. In the past it may have been more profitable to hire humans to do a certain task but many businesses will revisit the topic of automation and see if simply an investment into automation is going to keep profitability up.

Option #3 – Exit Canada Altogether – This is a real thing. Professionals are a large group of important businesses that are being most affected by these changes. In my parent’s government generation it was perceived that it was unfair that professional businesses didn’t have a method to split income using dividends with their spouses. This encouraged a brain drain to the USA. Now we’re going backwards. This type of anti-professionals rhetoric is always going to cause some professionals to leave altogether. In my accounting practice, conversations about exit taxes are being had all the time.

 

What happens to Taxes & Government

The obvious strategies that will be employed above will ultimately cause tax revenues to go down. While the Liberals are anticipating a higher tax revenue it is unlikely to happen due to several factors…

  1. Personal incomes taxes account for the most tax revenue – with wages and salaries overall being paid by small business anticipated to be a smaller proportion, tax revenues are likely going down.
  2. Shareholders can choose how to pay themselves – Even with punitive income splitting strategies no longer being applicable, there will be another way devised to pay shareholders efficiently. From my accounting practice here in Calgary, we’ve observed that in fact shareholders will deliberately pay themselves less, thus generating less taxes.
  3. Offshoring & Exiting businesses will lead to additional tax revenues being reduced. Corporate taxes are a part of it, and with both personal and corporate taxes being reduced there’s really not much meat left on the bone…

The result of a reduced tax base is going to lead to additional tax increases is my speculative opinion. We can anticipate the next several years of tax changes that will lead to several more policies that are intended to hurt small businesses. You can already observe this phenomenon by looking at the last 2 budgets, progressively increasing tax rates at the highest levels and increase dividend tax rates. Both of these are targeting small business owners. We have been a group targeted for more revenue for the last two years and I project many more changes for years to come. Who else would pay for the Liberal Deficit?

Business owners are a smaller voter base than non-business owners. Some small businesses in fact have the ability to pay more but that’s simply not Canadian, we don’t live in a Communist society. If we look to our neighbour to the south we will see that continuous attack upon businesses will lead to a change of a more populist government. Eventually, it is possible for us that a government change will happen. Lets be honest, small businesses would love to see Mr. Trudeau out the door by next election but that’s probably not happening because he has an extremely high approval rating overall. If the Liberals go to election today, they’re probably staying.

We will have to be patient, pro-actively plan and anticipate government’s next moves and already have in place strategies for our small business that will counter-measure any possible future developments. It’s not hard…

 

Pre-emptive planning for Small Business

Here comes the fun part…

Small businesses and their shareholders are adaptive and resilient people, they simply would not just sit back and allow the government to confiscate their belongings. If you look at Communist regime takeovers in the last century you’ll notice that the first to leave are usually the business owners. They see it coming and they leave in advance of any full takeover.

These are the questions our Clients are asking us for solutions…

  • What do I do with my stock portfolio in the company?
  • What do I do if I can’t pay my spouse a dividend?
  • What will happen to the rental properties in the company?
  • When will these changes come into effect and how does it affect me?
  • My spouse works hard for my business you mean I can’t pay them anymore?
  • Is there a point in keeping money in the company anymore?

All good questions that I have answers to but are all individual specific depending on your circumstances. Here’s some broad based ideas…

Part One – Adjust to the tax regime – I have been talking to many clients and updating them all individually on what the anticipated results would be for their business. Everyone has a different scenario. The first step you need to take is to talk to your accountant and strategically change the way you pay yourself, your family, and where or how you accumulate wealth. We have found methods of changing passive income into business income. We have also been anticipating how to keep income splitting available to owner families after the tax changes. There are going to be metrics and measurement of whether a family member “deserves” a dividend from the company. There are many examples in the tax act that allude to how this will be achieved. The best thing to do is to pre-emptively consider and employ methods that will keep you compliant for the future. For most of our clients this type of planning has been the most important. Have you thought about how you’re going to keep income splitting for your family? otherwise a private discussion with your accountant is recommended.

Part Two – Adjusting retirement planning – For small business owners our accumulated wealth in the company is our retirement savings plan. If you’ve already reached this stage of your business, then you’re going to need to employ strategies to convert passive income into business income. Not all types of passive income will qualify for conversion into business income that’s why we need to look at what types of income you are generating in retirement and look at the cost benefit of employing conversion strategies. When we receive new clients we often see this being an overlooked component of retirement planning, that you have always qualified to convert your passive income into business income but the previous accountant will not consider these options out of keeping the tax filing simple for themselves. Looking at your personal tax picture is even more important when you’re retired, you want to find ways to keep your Old Age Security (OAS) and balance that with a reduced income splitting capability. For many of our 55+ small business clients this is something we’re being asked everyday. Have you thought about what to do with your passive income in the business or post retirement? If not then you need to talk to an accountant.

 

Perhaps the Liberals have a hidden agenda

I always like to think that people in power are smart, why not right? If that’s the case, then the Liberals must already know that their tax policy is all about optics, and is actually going to generate less tax revenues for them in the long run. They must also know their spending policy is not sustainable. If they know this, and they’re smart, then they must have a plan to counter this right?

This leads me to distrust them in a way that I don’t think their optical policy is truly what is going to be enacted. In the last 2 fiscal budgets they would threaten heavy handed tax changes and then back off at the moment of truth. I hear a lot of my professional peers believing that this is going to stick, and I will probably tend to agree with them. This change is coming down but it is likely going to be a watered down version, just based on prior year examples of their regime.

Buying votes is one thing, but the Liberals are going to need to give small business owners and their shareholders a breathing space to continue to profit healthily. I for one believe the final version of the tax changes will contain many areas of weakness compared to the language they’ve been using in the discussion paper. For each business, you’re going to need to deploy different custom strategies with your accountant; that’s what we’re doing.

 

Concluding Remarks & Take aways

Talk to your MP. Email the Finance minister. Sign petitions. These things do help and is how we’ll reach this watered down version of the discussion paper.

You need to pre-plan regardless. You need to think about how you’re doing business, how to do it better, and how the tax changes will affect you. Chances are your accountant will have a strategy to protect you.

Lets be patient and see what happens but pro-active in thinking up strategies.

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