Canadian entrepreneurs see changes to passive investment rules as ‘unfair’ by 2:1 margin

Canadian entrepreneurs see changes to passive investment rules as ‘unfair’ by 2:1 margin
  • Changes to passive investment rules seen as more unfair than those related to income sprinkling

  • Size of small business key driver of opinion among owners

  • Three-quarters of non-owners say new businesses should receive tax breaks

September 20, 2017 – As Prime Minister Justin Trudeau’s government doubles down on plans to change the way Canadian small business owners are taxed, entrepreneurs themselves are skeptical of one of the proposed changes: New rules for taxing passive investments held by businesses. 

A new public opinion survey from the Angus Reid Institute – conducted in partnership with MARU/Matchbox – canvassing both entrepreneurs and Canadians who don’t own businesses finds two-in-five small business owners saying their organizations would be negatively affected by the proposed passive investment changes. Extrapolated based on the number of small businesses currently operating in Canada, this works out to nearly 500,000 entrepreneurs who expect to suffer as a result of the government’s proposal.

That said, small business owners do not react in a monolithic way to the amendments.

Fewer say proposed alterations to income sprinkling will negatively affect their business (24%) and are unfair (44%).

Overall, Canadians are evenly divided as to whether the changes will make the tax system fairer or harm business investment. Households where someone works for small businesses lean more to the latter view.

 

Key Findings: 

  • Nearly two-thirds of small business owners (63%) say proposed changes to income sprinkling will have “no impact” on them. One-quarter anticipate a negative impact (24%)
  • On the “fairness” of rules to restrict income sprinkling – just over one-third of the entrepreneurs surveyed see the change as fair (36%), while a plurality view it as unfair (44%). The rest aren’t sure
  • Proposed changes to passive investment rules are seen as unfair by a margin of more than two-to-one over small business owners who think it is fair (55 per cent versus 22 per cent).
  • Small business owners are near-evenly divided about the potential impacts of passive investment amendments: 42 per cent say they will be negative, the same number (43%) say “no impact”
  • Small businesses with five or more employees are the most likely to anticipate harm to their ventures over the proposed measures. These respondents are found more in the retail and manufacturing sectors where capital may be a more essential component of their business operations
  • Just over half (54%) of non-business owners surveyed say professionals who incorporate – such as doctors – shouldn’t be eligible for the same tax advantages as other small businesses. This falls to 41 per cent among small business owners
  • Small business owners emerge as figures of respect: 68 per cent of Canadians disagree with the statement “the role small business in the economy is overrated”
  • Non-owners are split down the middle regarding the overall impact of the proposed changes: half (50%) say they’ll make the tax system fairer. They other half (50%) see them as harming business investment. Among households where someone works for a small business, this latter view rises to 61 per cent.

Index:

Part 1 – What small business owners say

  • Small business owners’ perceptions of tax fairness

  • Business size correlates with risk, capital investment

  • More concern over changes to passive investment than income sprinkling

Part 2 – What non-business owners say

  • Perceptions of small business

  • Views on fairness

  • What Canadians say about the proposed tax changes overall

 

Part 1 – What Small Business Owners Say

Business owners’ perceptions of tax fairness

More than half of the small businesses in Canada have four employees or fewer, according to Statistics Canada. The federal government has said that the tax changes it has proposed are aimed at people who fall into the smallest-of-the-small category: many of them professionals such as doctors or lawyers – who incorporated their practices and are eligible for tax benefits available to small businesses.

Small business owners are overwhelmingly supportive of such benefits, but divided on whether these benefits should extend to professionals. While most business owners disagree that these professionals “should not get the same tax benefits as other small businesses,” a sizeable minority (41%) of owners do indeed feel this way.

This division provides a stark contrast to the more than eight-in-ten business owners (84%) who agree that “people starting new businesses deserve ongoing tax breaks to help offset their financial risks”.

That said, business owners view executives and government employees as more unfairly advantaged than professionals, while professionals are more likely to be seen as having unfair advantages than sole proprietors and the owners of small stores or service businesses:

Business owners’ views on tax fairness is also demonstrated in their reactions to certain statements: More than three-quarters (77%) agree with the statement “Government civil servants get the biggest breaks by far because of their tax-supported pensions.”

Also, two-in-three small business owners (65%) agree with the statement “The top one per cent of income earners in Canada don’t pay their fair share of taxes.”

Business size correlated with risk, capital investment

This survey finds “larger” small businesses – those that have five or more employees – express the greatest level of concern about the government’s proposed changes. Results of the survey show these business owners are paying closer attention to the proposals, and tend to be more concerned with what they see, as will be discussed in the following section.

Among the reasons for this difference in opinion:

  • First, businesses with more than one employee tend to report carrying more inherent risk:

  • Second, the risk in these businesses is distributed among a greater number of people: most of the owners of businesses with more than one employee say they are “part owners” of their venture:

  • Third, owners of these larger small businesses say they are more capital-intensive than their smaller counterparts, requiring more cash and other investments on-hand to manage growth or protect against downturns

More concern over changes to passive investment than income sprinkling

Owners of businesses with five or more employees are more than twice as likely as sole proprietors to be paying closer attention to the government’s proposed tax changes (see comprehensive owner tables for more information) and are also more likely to have “heard a lot about” both the proposed changes regarding income sprinkling and those regarding passive investment income:

Small business owners were shown the following explanation of the proposed income sprinkling changes:

 

One proposed change relates to a practice called “Income Sprinkling” – business owners paying out income or capital gains to family members in order to avoid income taxes at the highest tax bracket.

The government proposes to extend current rules that prohibit income splitting with minors to include all adults, and to introduce a “reasonableness test” to determine whether a family member or other acquaintance is making a legitimate contribution to the business.

 

And they were shown the following explanation of the proposed changes to passive investment rules:

 

One proposed change relates to the tax treatment of passive investment income held by a business – that is, money earned by a business that it then saves in a bank, the stock market, real estate, or some other investment vehicle.

Currently, income from such investments – when distributed to an individual – is taxed at the same rate regardless of how the individual accumulated the principle that was used to make the initial investment. So, salaried employees in the highest income bracket will end up paying $50,000 in personal income taxes for every $100,000 they earn, leaving them with $50,000 in capital to invest. A business, in contrast, would pay just $15,000 in small business taxes on the same $100,000 in profit, leaving it with $85,000 in capital to invest.

The government proposes to change its rules for taxation of passive investment to account for this initial imbalance, charging an additional tax on passive investment income held by businesses when that income is distributed as dividends.

 

Owners were then asked what effect, if any, each change would have on their business and their personal financial situation if it were implemented.

As seen in the following graph, relatively few respondents feel they would be affected negatively by income sprinkling changes, while considerably larger numbers say they stand to lose if changes to passive investment are implemented:

Those with higher numbers of employees are considerably more likely to say their business would be negatively affected by each change, with a full majority of those with five or more employees expecting bad news if passive investment rules are modified:

Asked to set aside their personal stake in these changes and consider whether each proposal is fair or unfair, small business owners are considerably more divided on the issue of income sprinkling than they are on passive investment:

Similarly, the owners of the smallest businesses surveyed are more likely to say the income sprinkling changes are fair than unfair, while majorities of those with larger numbers of employees say such changes are unfair:

Views on the fairness of the government’s proposals are also correlated with the political leanings of individual business owners.

Those owners who voted for the governing Liberal Party are substantially more likely to view proposed income sprinkling changes as fair (49% do) than unfair (33%), and small business owners who voted for the New Democratic Party skew even more in this direction. Those who voted for the Conservative Party in 2015, meanwhile, view the change as unfair by a nearly three-to-one margin:

This finding – that Liberal- and NDP-voting business owners are more on-board than not with changes to income sprinkling rules – suggests that this specific change may not be a crisis for the federal government in the way some have characterized these changes overall.

That said, responses from partisans on the question of passive investment paint a far less rosy picture for the Liberal government.

Past Conservative voters who own small businesses view this proposal as unfair by nearly seven-to-one, and they are joined in this opinion by a plurality of Liberal-voting business owners (43%), as seen in the following graph:

Ultimately, these findings describe a small business community that is far from monolithic when it comes to the tax reforms the government has proposed. While there is considerable unease about the changes, the intensity of that feeling varies significantly depending on the specifics of the proposal, the size of the business, and the business owner’s personal political beliefs.

 

 

Part 2 – What Non-Business Owners Say

Perceptions of small business

The Canadian perception of small business in this country is a positive one. Advocates point to the large role these business play in Canada – employing close to half of the working population – and Canadians appear to share some of this enthusiasm. Two-thirds (67%) of non-small business owners disagree with the sentiment that the importance of small businesses in this country’s economy is overrated, and more than half (53%) say that they would start their own business if they had the opportunity.

Further, three-quarters (75%) say that people starting new businesses are deserving of ongoing tax breaks, due to the risk that they’re taking on in pursuing such a venture.

Views on fairness

While Canadians are supportive of tax incentives for new small business ventures, many take a more critical view of other areas of tax fairness. Fully seven-in-ten non-owners (71%) say that the top one per cent of income earners, some 270,000 Canadians, don’t pay their fair share. This group pays an estimated $160,000 on average, per person, each year according to recent estimates.

Overall Canadian non-business owners are divided over whether this country has a fair system of taxation. Slightly more say they disagree (48%) than agree (44%). This group is equally divided over the benefit they themselves receive. Half (50%) say don’t feel they get a fair return for their taxes, while 45 per cent say they do. Past Conservative voters are more negative on each of these measures:

More views on taxation and fairness are seen in the table below:

Canadian small business owners and non-owners share a significant amount of commonality in terms of where they perceive fairness or unfair treatment in the tax system. Indeed, their responses to many of the agree statements asked are quite similar. Only about one-in-ten non-owners perceive unfair advantages for sole-proprietors (12%) or owners of small businesses (9%). About four times as many say either those groups are treated fairly under the current system, or that they don’t know enough to say.

The main beneficiaries of unfair advantages, both in the minds of small business owners and non-owners alike, are executives leading large corporations. A nearly identical number, just over six-in-ten in each case, say that these individuals have unfair benefits.

And as with business owners, a substantial portion of Canadians who don’t own a business also perceive an unfair advantage for government employees. However, while this group ranks second on non-owner’s list of groups receiving undue benefit, just four-in-ten say this (41%) compared to 59 per cent of small business owners.

Overall, six-in-ten Canadians (60%) say they are treated fairly by the tax system. The table below offers a summary of responses to each of the sectors canvassed.

What Canadians say about the proposed tax changes overall

When it comes to the Trudeau government’s tax changes, non-owners are divided down the middle. Exactly 50 per cent say that these changes will harm business investment and don’t adequately consider the risks involved with small business ownership. On the other hand, an identical number say that these changes will make the system fairer, and that they should go forward even in the face of protest by some.

Conservative opposition leader Andrew Scheer stated that the Prime Minister’s “arrogance is astounding” on this issue, taking aim at the Liberal leader Monday morning as Parliament resumed for the fall session. Trudeau defended the changes by stating that the current rules “favour the wealthy, rather than the middle class”.

Politically, past Conservatives voters align more closely with Scheer’s criticism than past Liberals align with Trudeau’s defence of the changes. While a majority (58%) of Trudeau’s voters say the changes will indeed make the system fairer, a significant portion of both them (42%) and past NDP voters (45%) say the new plan will be harmful:

Perceptions of this issue are also partially driven by a person’s relationship with small business. Among those who either work for a small business currently, or live with someone who does, six-in-ten (61%) say the changes will be harmful – 13 per cent higher than those who are not employed by a business of that size.

Regionally, people in Quebec (63%) and British Columbia (55%) appear most supportive of the changes, while majorities in all other regions show concern that the changes will have a negative impact on small businesses:

The Angus Reid Institute (ARI) was founded in October 2014 by pollster and sociologist, Dr. Angus Reid. ARI is a national, not-for-profit, non-partisan public opinion research foundation established to advance education by commissioning, conducting and disseminating to the public accessible and impartial statistical data, research and policy analysis on economics, political science, philanthropy, public administration, domestic and international affairs and other socio-economic issues of importance to Canada and its world.

 

For detailed non-owner results by age, gender, region, education, and other demographics, click here.

For detailed owner results by size of business, click here.

Click here for the full report including tables and methodology

Click here for the questionnaire used in this survey

MEDIA CONTACTS:

Angus Reid, Chairman: angus@angusreid.org
Shachi Kurl, Executive Director: 604.908.1693 shachi.kurl@angusreid.org @shachikurl


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