Government could earn up to $6B a year with changes to small business tax law: watchdog

One of the controversial changes to Canada’s tax laws that drew heavy criticism over the summer and fall would affect about 2.5 per cent of private corporations in Canada, Parliament’s fiscal watchdog said Thursday, and federal coffers could eventually benefit to the tune of $6 billion a year.

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That windfall would take about 20 years to reach full maturity, the Parliamentary Budget Officer noted in a report titled Analysis of Changes to the Taxation of Corporate Passive Investment Income.

“PBO estimates that these changes could increase annual federal revenues by up to $1 billion in the short term (one to two years after implementation),” the report explains.

That would increase to $3 to $4 billion over the medium term (five to ten years after implementation) and then again to $6 billion over the long term, the PBO estimates.

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The PBO only examined one aspect of the government’s proposed changes to tax law — the one involving holding passive income inside a corporation. The report does not examine the fiscal impact of changes to income splitting among family members, or proposed changes involving capital gains.

Passive investments are being defined by the government as surplus profits held inside corporations that aren’t immediately reinvested in the business on things like new hires or equipment.

The opposition Conservatives have been heavily critical of the policy changes announced last summer, saying that they represent a “tax hike” on small business owners across Canada that will put them at a disadvantage and prevent them from growing their businesses over time.

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The government, meanwhile, has argued that it is trying to change specific rules (which some have dubbed “loopholes”) that allow a small subset of those corporations to be taxed at lower rates.

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The PBO seems to be siding with the government, at least in terms of the projected number of businesses affected by the modifications linked to passive investment.

 “We estimate that about 47,000 (2.5 per cent) of CCPCs would be affected by these changes,” the report notes.

“In terms of distribution, the impact of these changes is likely to be highly concentrated on a relatively small share of CCPCs, which hold the vast majority of passive investment assets … PBO found that in 2014, 2.5 per cent of CCPCs earned 88 per cent of all taxable passive income.”

The number of CCPCs (Canadian-controlled private corporations) has exploded in recent years, and there are distinct advantages to incorporating at tax time.

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But Thursday’s PBO report notes that its estimates for the increases in government revenues over time do not account for behavioural changes.

“The incidence of these policy changes is concentrated on a relatively small percentage of large firms,” it says. “The owners of these firms may change their tax strategies to minimize tax payments, which represents a downside risk to our estimates.”

The government has not yet tabled legislation that would actually bring about the proposed tax changes. It wrapped up a series of consultations this fall with business owners across Canada.

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