Canada: Day 43 Of The 75-Day Consultation Period – Is There Really A Need For Action?

The Department of Finance's recent consultation paper laments the use of private corporations for use in tax planning. In the section headed "Need for Action," the paper declares that the number of Canadian-controlled private corporations (CCPCs) increased from 1.2 million in 2001 to 1.8 million in 2014, and that the number of corporations in professional services has tripled over the last 15 years. It also notes that more self-employed individuals are choosing to incorporate, and that the active business incomes of CCPCs has more than doubled (relative to GDP) since 2002. 

It would be easy to read these and other comments to be persuaded that there is a "Need for Action." 

The "Open Canada" database provides detailed financial performance information for Canadian small businesses. Much of the data published is for businesses with annual revenues between $30,000 and $5 million, and data is currently accessible for the years 2012 to 2015. It is possible to look at average financial performance data for businesses within different industries, as well as separate data for incorporated and unincorporated businesses. Research into these businesses provides an interesting perspective. 

To keep things simple, I will use the terms "small corporations" and "small proprietorships" to distinguish between incorporated and unincorporated businesses within this Open Canada data, and I will use the term "small businesses" when describing all such businesses, whether or not incorporated. 

The data from Open Canada shows that in 2014 there were 1,173,529 small corporations, a major proportion of the stated 1.8 million CCPCs in existence in 2014. The following year, the number had risen to 1,198,677 small corporations, while back in 2012 there were only 985,401 small corporations. So, yes, there has indeed been a significant increase in the number of small corporations. However, while the number of small corporations has increased, there has been no corresponding decline in the numbers of small proprietorships. Therefore, at least part of the increase in small corporations reflects overall growth within the small business sector. This is not exactly what one would infer from the statements made by Department of Finance about the numbers of CCPCs.

As an aside, I have noted that the above observation is supported by a chart within the consultation paper, which suggests that for CCPCs and self-employed persons combined, active business income has grown from approximately 7 per cent of GDP (Gross Domestic Product) in 2002 to more than 9 per cent of GDP in 2014.  

Because of the reference made by Department of Finance to professional services, I have also considered the number of businesses in the industry segment Professional, Scientific and Technical Services ("PST Services"). For PST Services, the number of small corporations has grown from 146,253 (in 2012) to 177,744 in 2015, an increase of 22 per cent since 2012. However, during the same time-frame, the number of small corporations in Construction has grown from 126,675 in 2012 to 160,780 in 2015, an increase of 27 per cent since 2012. (For both industries, there has been a very slight but virtually negligible decline in the numbers of small proprietorships.) When I consider these comparative trends, it seems likely that part of the increase in PST Services small corporations should be attributed to economic expansion, as opposed to incorporation for tax planning reasons.

Additional analysis raises equally troubling concerns. While certain industries do reflect significant growth in numbers of small corporations, the proposed tax changes will affect all private corporations in all industries. The data shows that PST Services small corporations in 2015 made up merely 15 per cent of all small corporations. Within the Health Care and Social Assistance industry segment, there are a further 8 per cent of all small corporations. I am not sure how the Department of Finance defines professional services, but even if this is defined to include both PST Services and Health Care, all of these professional services small corporations only comprise less than one-quarter of all small corporations. So how serious is the actual problem?

Published Open Canada data shows that average sales achieved by small corporations have not expanded over the years 2012 to 2015 (average sales for all small corporations are approximately $500,000), and average gross profit (calculated as sales minus cost of sales) has remained static as well (note, this may be in part due to the "capping" of revenues at $5 million). A similar observation may also be made regarding the revenues of small proprietorships, whose revenues have also not expanded over the years 2012 to 2015 (for small proprietorships, sales of goods and services are not separately identified; only total revenues can be considered). These observations raise the question: Are small businesses already facing some competitive pressures, and how will business operators cope with a more onerous tax regime? 

Nevertheless, due almost entirely to increases in the number of small businesses, aggregate revenues for all small businesses have increased from $699 billion in 2012 to $786 billion in 2015 (these totals include other revenues of small corporations as well as sales of goods and services). This further confirms the importance of the small business sector to the overall economy (and – at the risk of repeating the obvious – why caution regarding the proposed tax reforms may be required). 

Of course, small corporations in some industries have performed less well than those in other industries (but all stand to be affected by the current tax proposals). Alarmingly, in 2015 there were 12,054 small corporations in the industry segment Mining, Quarrying, and Oil and Gas Extraction, and average net loss for these small corporations was a staggering $320,100. The small corporations in this industry segment have lost money overall for each of the last four years (2012 to 2015). If I was a small business owner trying to survive in this industry segment, I would not appreciate any suggestion that fairness demands that private corporation business operators be treated (for tax purposes) in the same way as employees.

One of the Department of Finance's concerns expressed relates to the income tax advantage of building and/or retaining investments in a private corporation. To the extent such investments are indeed accumulating, one would expect to see that average asset levels, and average levels of shareholder equity, of small corporations are markedly increasing. However, the actual increases over the years 2012 to 2015 were modest; average assets only rose from $925,800 in 2012 to $953,300 in 2015, and average shareholders' equity only rose from $420,400 in 2012 to $434,800 in 2015.

Finally, it is appropriate to consider the number of small corporations in context. According to Statistics Canada*, there were approximately 9.9 million families in Canada in 2015, and a further 6.1 million single persons (not necessarily living alone, but who are not counted in a "family"). Of these, approximately 8.4 million and 3.7 million respectively had employment or self-employment income. By comparison, there were 1.2 million small corporations in 2015 (and according to the Department of Finance, there were 1.8 million CCPCs in 2014). This comparison suggests that the proposed tax changes may have the potential to affect 10 to 15 per cent of Canadian income-earning households. In my opinion, significant changes potentially affecting this proportion of income-earning households deserve very careful consideration – and much more consideration than a 75-day consultation period allows.

While I have attempted to look at the bigger picture, I admit that my analysis is imperfect. For example, it will be affected by the fact that any business whose revenues expand above $5 million falls out of the small business group, and it will be also affected by the incorporation of small proprietorships during the years in question. However, even with such deficiencies, the analysis raises some troubling questions about the necessity for such wide-ranging tax reforms.

In the interests of full disclosure, I also admit to being a professional accountant practising through a private corporation. So I am one of those persons who will be potentially affected by these proposals. However, this article is motivated by much broader concerns.

No-one will argue that the current private corporation income tax regime is perfect. Clearly, it is not. However, with regard to at least some of the Department of Finance's identified concerns, it seems difficult if not impossible to justify the scope of the changes proposed. Has our government looked past the substantial economic contribution of private corporation business operators in an ill-prepared desire to close perceived tax loopholes?

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Daniel Edwards, MA, CPA, CA • IFA, CBV, CFE, CFF
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