A copy of the federal government budget for fiscal year 2024-25 is seen, on Parliament Hill in Ottawa, on April 16.Patrick Doyle/Reuters
Andrew Feindel is a portfolio manager and investment adviser for Richie-Feindel Wealth Management at Richardson Wealth Ltd. He’s the author of Kickstart Your Corporation and co-author of Kickstart: How Successful Canadians Got Started.
The overwhelming majority of Canadian businesses – 97.8 per cent to be precise – are small enterprises with fewer than 100 employees. These are the mom-and-pop shops, eateries and professional services that shoulder nearly half of the private sector’s work force.
As the new capital-gains policy proposal laid out in the 2024 budget looms, claiming to target the wealthy few, we must ask ourselves if these changes will truly lead to what Ottawa promises: tax fairness for every generation and ensuring fairness for businesses, large and small.
Incorporation allows business owners to retain more earnings within their corporation, which are taxed at a lower rate and can be reinvested for future growth. The budget has proposed to tax two-thirds of profits made from such investments, up from half.
It suggests that only a small minority of businesses will be affected by the changes, citing that only 12.6 per cent of businesses reported capital gains in 2022.
But this statistic doesn’t tell the full story.
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That year was marked by a tumultuous investment climate, with soaring inflation and aggressive interest-rate hikes leading to negative returns across both stock and bond markets. With most investment portfolios in the red in 2022, it may be no surprise that only 12.6 per cent of businesses had capital gains for the year.
However, under more typical market conditions devoid of such macroeconomic headwinds, a higher percentage of businesses would likely be reporting capital gains.
It’s also important to recognize that almost all successful businesses will, at some point, accumulate savings and generate capital gains. In the long run, this means that the new policy’s reach will have an impact on almost every enduring business that contributes to Canada’s economy.
The inequity of this is further reinforced by how the tax changes are equally hitting both big and small businesses.
What is a “fair” tax system? Well, in Canada, we implement a progressive approach designed to mitigate inequality by imposing lower tax rates on those with lesser income and higher rates on those with greater income.
However, unlike the new policy for individuals where one can still take advantage of the 50-per-cent inclusion rate on the first $250,000 of annual capital gains, the new rules don’t distinguish between a small business making $10,000 in capital gains and a large business making millions in capital gains.
In the spirit of a fair tax system, it’s worth asking: Should an incorporated professional be taxed in the same way as a corporation like Loblaw?
Perhaps there is a more equitable way – applying the same capital-gains threshold to corporations as we do to individuals to ensure small businesses and incorporated individuals are not disproportionately taxed.
Such a move makes sense when we consider that younger business owners and incorporated professionals will be hit the hardest.
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The theme of the 2024 budget was “Fairness for Every Generation.” However, under the new rules, the younger the business owner, the more severe the impact of the tax implications under the new policy.
Assume a simple hypothetical scenario where a 25-year-old business owner retains $10,000 annually in their business’s investment portfolio and achieves a 10-per-cent return per year in capital gains.
After 40 years, when the business owner is 65 and retires, the individual would accumulate $1.60-million under the new policy, as opposed to $2.05-million under the existing tax regime – a 22-per-cent reduction, or the equivalent of almost an additional four years of work to amass the same savings.
An older business owner would have enjoyed the benefits of the current tax system for years as they saved for retirement. Meanwhile, the younger business owners will face this financial impediment for a significantly longer duration, resulting in a disproportionately adverse effect on their savings.
For many, the key consideration will be whether to trigger capital gains before the June 25 deadline when the new rules are scheduled come into effect. While triggering these capital gains means prepaying taxes and taking a short-term hit, in the long run – at least nine to 14 years depending on the estimates used – this strategy could yield significant savings.
But beyond the tactical considerations, the broader question is whether these changes provide the right incentives when entrepreneurship in Canada is declining and productivity lags behind other developed countries – or if we are adding barriers and exacerbating the issues that could stifle our nation’s progress.