Pretty much all fishers are remunerated with a share of the catch. Sharing in this manner means that crew members lose some protection from labour laws, but on the flip side they gain in the rewards associated with a big catch. There has always been debate on how the share of the rewards is divided.
Many self-employed fishers have decided to incorporate for a variety of reasons. The most common concerns are the limited liability protections and tax considerations. Limited liability protections limit the owner’s financial responsibility. This is great, in theory, but in the real world I have yet to come across a bank that did not ask for a personal guarantee. That brings us to the tax considerations and the crux of this blog.
The federal government wants to make changes to the tax code in order to “close loopholes”. They expect Canadian small business corporation owners to pay their “fair share of tax” without affecting the “middle class”. In closing loopholes the finance minister means to tackle three concerns; income sprinkling, passive investment income, and the conversion of dividends into capital gains. By “fair share” the Minister is speaking to the principle of tax integration: the premise that every dollar earned that flows back to the owner should be taxed the same over time. It appears that small business owners are being excluded from their concept of “middle class” as they are the direct target of these changes and will be affected, plain and simple.
What are these three concerns? First off, income sprinkling is the process of paying either your spouse and/or your grown children either in salary or dividend. Under the proposed changes, this still can be done but it must be done with CRA oversight. The government contends that this is unfair as it can reduce a family’s overall tax burden as compared to that of an employee with a similar income.
Growing up in the midst of a small business fishing operation, and now a small business owner myself, it is obvious to me that small business fishing operations are virtually always a family affair. Each family member carries the burden of knowing when there is a good season things are good, and when there is a poor fishing season, extra help is needed from all. How they are compensated is now going to somehow be dictated by the government. This could greatly impact fishers and family fishing operations.
Passive investments are basically the retained earnings, i.e. money not paid out in dividends and which are not re-invested into the core business. This could be cash, securities or any investment not related to the core business. The government contends that, even though tax integration exists, when a company pays out its dividends, the small business has an advantage in that it can defer paying those taxes and invest passively (i.e. not core to the business). The government wants to further tax those retained earnings if they are not invested into the core business. How it plans to do this is still unclear. They may decide to flat tax retained earnings at 50% as compared to 15%, and if later transferred to a core investment a 35% tax rebate be issued. Another plan is to over-tax the proceeds of any passive investment thus resulting in a 73% tax when it makes its way back to the business owner. For intergenerational transfers this can increase to a 93% tax on said proceeds!
The consequences of tax policy changes of this magnitude are mind-boggling.
For starters, it drastically reduces the business’ ability to save over time for growth. It also takes the cushion away for those years when catches or prices or both are down. Having retained earnings allows family fishing operations to stabilize income, season over season. All too often retained earnings are what help families through tough years. Without them, the likelihood of business failures would increase.
The other tax loophole the government plans to tackle is capital gains. Apparently some small businesses have been able to convert dividends into capital gains by running them through myriad other businesses. I have yet to find how big this issue is in any government literature. The concern for small family fishing operations is that, within the proposed fix for this issue, another issue is created. If a parent wants to sell the family fishing operation to a daughter or son they cannot claim the long term capital gains exemption. Currently for fishing operations that exemption is $1,000,000. This means that anyone else outside of the family can buy the family fishing operation and the parent will receive the capital gains exemption. On $1,000,000 that equates to $250,000 in tax saving!
The incentive now will be to sell outside the family, likely to bigger corporations. Considering that many fishing operations are family run and all family members have invested countless hours and energy into the business, this does not seem fair. The government recognizes that the proposed tax changes create this issue. They have stated that their goal is to solve it within an allotted 75 days of public consultation. How bizarre is that?! The consultation period is far too short for such dramatic changes, especially for fishers who are extremely busy fishing over the summer months.
I will go even further to say that these were never “tax loopholes”, that they were longstanding tax policy choices that existed for 45 years to support small business in Canada by recognizing the challenges of owning, operating, and growing a small business.
This is not simply changing tax policy but it is, in fact, tax reform. This reform will fundamentally change the way small businesses and, more specifically, family fishing operations are run.
I see the proposals as a nail in the coffin of many family fishing operations on the coast of BC.