The head of the Investment Industry Association of Canada
(IIAC) is saying that instead of hurting small businesses’ capital-formation capabilities, the federal government should explore ways to promote equity investment in small businesses.
Joining a chorus of other small-business advocates, IIAC President Ian C.W. Russell explained in a letter that taxing income from passive investments held in private corporations will weaken an important source of capital for Canadian entrepreneurs.
“Under one likely option in the new proposals, the corporate tax paid on the income earned on passive investments is not refundable when income is paid out to the shareholder,” Russell said. The resulting effective tax rate of 73% paid by the corporation and individual shareholders will dissuade private corporations from accumulating diversified financial investments — which, aside from being a useful contingency reserve for a business, can provide capital for other small businesses.
“The Canadian economy needs steadily expanding capital flows, not stagnating flows, to drive capital formation, job creation and economic growth,” he said, noting that small-business financing transactions have fallen by a third over the last 10 years. Rather than tax private corporations’ passive investment income, Russell said, the government should pursue proactive reforms that would promote equity investment in small private and public businesses.
One option is a “roll-over” provision that would mitigate the capital-gains tax paid by investors who sell at least a portion of “locked-in” passive-investment capital and reinvest the proceeds in equity shares of small business. As Russell explained, this would effectively result in a tax deferral, as capital-gains tax would be levied on the private-equity or venture-capital investments when they’re eventually sold.
He also suggested a Canadian take on the UK’s Enterprise Investment Scheme (EIS), which provides a personal tax credit for purchases of small-business shares as well as a capital-gains tax exemption on shares held for more than three years. Policymakers could adopt the program, he said, adding size restrictions and other eligibility criteria to limit the tax expenditure. “Moreover, the taxes paid on salaries from increased employment and taxes on increased corporate income from the expansion of the business mitigate the government tax expenditure,” Russell added.
Finally, he proposed a modest expansion of the TFSA program’s allowable contribution limit from $5,000 at present to $7,500. TFSAs, Russell said, have been used by middle-class Canadians to invest in various financial assets, including shares in small businesses.
“A modest increase in the allowable limit would still leave these savings vehicles within reach of middle-income Canadians,” he said.
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