Vibrancy of small business crucial to Canada’s economic prosperity
According to Industry Canada, 98 per cent of businesses in Canada are small (i.e., have fewer than 100 employees).
Approximately 5 million people work in small enterprises, or almost half of the private sector labour force. Roughly 25 per cent of small firms operate in the goods-producing sector; 75 per cent provide services.
Small businesses are active participants in Canada’s international trade, accounting for one-quarter of the total value of exports. Small businesses offer a wealth of opportunities for enterprising individuals, are a source of new products and innovations, and play a crucial role in promoting competition and economic renewal.
Recognizing the important contributions they make to the Canadian economy, both the federal and provincial/territorial governments offer small businesses tax relief to encourage their formation and growth.
Small business tax relief takes many forms
A reduced business income tax rate: Canadian-controlled private corporations (CCPCs) with less than $10 million of taxable capital are eligible for the reduced federal income tax rate of 11 per cent on the first $500,000 of active business income. The $500,000 small business deduction is phased out on a straight-line basis as a CCPC’s taxable capital used in Canada rises from $10 million and $15 million. The federal tax rate jumps to 16.5 per cent once a small business becomes public or its income exceeds the $500,000 threshold. The provinces/territories also provide preferential tax treatment for small businesses although rates and thresholds differ.
Lifetime capital gains exemption: The federal government provides individuals a lifetime capital gains exemption (from personal income tax) of up to $750,000 for gains from the disposition of qualified small business corporation shares (as well as farm and fishing property). To qualify as a small business corporation, a company must be a CCPC and must have all, or substantially all its assets used in an active business in Canada. Although the qualifying CCPC can be of any size, most are small firms.
Capital gains rollover provision: In 2000, the federal government introduced a measure that allows individuals to defer the tax on capital gains from the sale of shares in an eligible small business corporation where proceeds are reinvested in another eligible small business in the year of disposition or within 120 days after the end of that year. Specifically, to qualify for the tax-free rollover, the business may have no more than $50 million in assets immediately after the investment.
An enhanced Scientific Research and Experimental Development (SR&ED) Investment Tax Credit (ITC): Small CCPCs with prior-year taxable income of up to $500,000 and prior-year taxable capital employed in Canada of up to $10 million can receive a refundable tax credit of 35 per cent of up to $3 million in qualifying current and capital SR&ED expenditures carried out in Canada per year. Over the $3 million SR&ED expenditure threshold, the credit rate is reduced to 20 per cent, of which 40 per cent may be refundable. The refund takes the form of a cheque and, therefore, provides an important and predictable contribution to cash-flow.
A non-refundable 20 per cent tax credit is available to large CCPCs and public or foreign-controlled corporations. For these firms the tax credit is only marginally effective because it can only be used to offset Canadian federal taxes payable.
Small business owners face unique challenges
Governments also provide preferential tax treatment to small business owners and entrepreneurs to help offset special challenges not encountered by larger enterprises.
The Canadian Federation of Independent Business (CFIB) found that small firms, on a per employee basis, face regulatory compliance costs five times higher than their larger counterparts. Small business owners spend more time complying with red tape and less on ensuring the success of their businesses.
Entrepreneurs are discouraged from starting a business. The result is less business activity and less job creation.
The CFIB estimates that it costs businesses $12.6 billion annually to comply with their tax obligations, the lion’s share of the burden ($11.4 billion) carried by small- and medium-sized enterprises. Average tax compliance costs range from $3,928 per employee for very small firms (i.e., those with fewer than five employees) to an average of $481 per employee for firms with 50 to 499 employees. Contributing to tax compliance costs are a large amount of paperwork, the complexity of the tax system, frequent changes in tax legislation, different rules across jurisdictions and dealing with multiple audits (federal and provincial/territorial). Complying with sales tax rules is a top frustration of many small business owners.
Small firms face constraints on their ability to raise capital. Access to capital may be particularly challenging for young technology companies with new or unproved products, and startups that typically lack cash-flow and tangible assets to satisfy a commercial bank’s collateral requirements. Indeed, new firms have little experience or history from which to assess their operating performance, thus, information, to base credit evaluations, is sparse or non-existent.
Financial difficulties may arise from taxes that are not related to profitability, more notably payroll and property taxes. Profit-insensitive taxes disproportionately burden smaller businesses.
The formation and growth of small entrepreneurial firms and technology companies may also be hindered by lack of venture capital funding in Canada. The amount of venture capital financing relative to the size of our economy is smaller than in the United States, as is the typical size of venture capital investment per company.
Helping small businesses realize full potential
Creating a business environment favourable to small business creation and growth requires a broad range of mutually reinforcing and supportive policies.
Minimizing regulatory and administrative burdens so business owners can dedicate more time to their business and less time to compliance.
Promoting inward foreign direct investment as a vehicle for smaller businesses to access international markets indirectly by joining the supply chains of multinational enterprises.
Lowering the barriers faced by smaller firms who wish to expand into global markets and become more export oriented.
Making the tax system simpler, more transparent and easy to understand and comply with.
Improving the administrative management of the SR&ED program to ensure SR&ED ITCs are delivered in a predictable, timely and cost-effective manner to make it easier for smaller enterprises to invest in research and development.
Providing formal education and training to support small business owners.
Facilitating access to capital through a wide scope of partners to foster the creation of small businesses, ensure their survival and growth, and encourage investment in productivity–enhancing machinery and equipment and new technologies and processes.
Exploring ways to facilitate the succession planning process.
Working to attract immigrants whose skills levels match those needed by employers of all sizes.
These policy recommendations would go a long way to reducing the disincentives to growth that are part of the small business operating environment. They would also benefit large-size businesses. After all, neither small business nor large business operates in a vacuum. Each is deeply embedded in the overall Canadian economy, with extensive connections to each other.
By building on the strengths of our small businesses and entrepreneurs, we can ensure Canada’s economic prosperity.
Tina Kremmidas is the Chief Economist of the Canadian Chamber of Commerce