On 29 July 2017 the OECD published a report entitled SME and Entrepreneurship Policy in Canada.  The report looks at entrepreneurship activity, business structures, federal programmes, productivity and innovation among small and medium enterprises (SMEs). It also considers the business environment, ease of doing business, access to finance and the labor market.

The OECD report notes that Canada’s tax system is generally favorable to business and the ratio of total tax revenues to GDP is 30.5%, below the OECD average. Compared to the OECD average Canada raises more tax revenue from income taxes and a smaller proportion from social security contributions and tax on goods and services. Canada has achieved a high level of harmonization between the federal and provincial taxes and this has made the tax system rather easier for business to deal with. In addition to the generally business-friendly tax system small businesses also enjoy special tax provisions.

Small business deduction

A small business deduction applies to the first CAD 500,000 of active business income of Canadian Controlled Private Corporations (CCPCs). The small business concession is phased out from capital of CAD 10 million and eliminated altogether for businesses with capital of CAD 15 million and above. The provinces also have their own small business tax rates and thresholds.

The small business rate gives incorporated privately owned small businesses additional after-tax income to use for reinvestment and expansion if they choose to do so. However as businesses are not obliged to use the additional income for investment the OECD report suggests that the impact may be smaller than more targeted measures to support specific growth and development activities.

Sometimes this type of measure may cause clustering of businesses just below the income or turnover threshold, thereby effectively discouraging expansion above the threshold for relief. Studies suggest however that this has not occurred in Canada. The small business tax rate could also be used for tax planning by wealthy individuals and families. Measures to counter tax planning strategies were introduced in the 2016 federal budget.

Lifetime capital gains exemption

An individual is given a lifetime tax exemption for capital gains realized on the sale of qualified small business qualification shares. This exemption is intended to boost investment in small business and facilitate transfer of a business between generations. This supports investment and risk-taking by owners and investors of small companies but evidence suggests that it has been used for artificial tax avoidance, for example by large companies providing benefits to specific shareholders through the creation of CCPCs.

Small business capital gains rollover

This measure enables a taxpayer to defer the taxation of capital gains realised on the sale of common shares of an eligible small business corporation where the proceeds are reinvested in common shares of another eligible small business corporation. The CCPC must have under CAD 50 million in assets, of which less than half represent real estate. The OECD report suggests that more flexibility in the time limit for reinvestment would be helpful, perhaps through introducing a capital gains deferral account where capital gains could be deferred without being taxed until the assets are eventually sold for purposes other than general investment.

Income tax deduction for allowable business investment losses

A capital loss on a small business investment can be used to offset income tax. The allowable portion of 50% of a capital loss on shares or debt of a small business corporation may be deducted against any other source of income in the year. This is primarily intended to support start-up businesses.

Small business job credit

This credit introduced in September 2014 applied to a business paying Employment Insurance premiums equal to or less than CAD 15,000 in 2015 or 2016, reducing the amount of payroll taxes. The measure was intended to encourage job creation but the OECD report points out that social security contributions are already low in Canada, so the impact would be limited.

Policy recommendations

The OECD recommends that the trend of reduction in the small business tax rate could be discontinued and replaced by targeted measures to address market failures for specific groups of SMEs and start-ups. Federal and provincial loan guarantee programmes could be expanded to increase bank lending to SMEs and direct government lending could be increased, especially to groups unlikely to be served by commercial banks. The government could also strengthen the apprenticeship training system for SMEs; consider introducing a system of combining academic studies with on-the-job training; and create new work-integrated learning programmes.