Thank you, Mr. Chair, and members of the committee. It's a pleasure to be before you this afternoon.
I am grateful for the invitation to come before this standing committee to present the views of the Investment Industry Association of Canada, the IIAC, on Bill C-74, An Act to implement certain provisions of the budget tabled in Parliament on February 27, 2018 and other measures.
I will focus my remarks on part 1 of the bill and, more particularly, on the sections that pertain to passive investment income, the refundability of taxes on investment income, and income sprinkling.
The principle focus of our remarks is on the impact of the private corporation tax proposals on the capital formation process for new and emerging small businesses. Recent budget changes to the tax proposals have given small businesses qualifying for the small business deduction greater flexibility and scope in managing financial investments.
On the other hand, private corporations are still discouraged from building financial assets and engaging in small company financing and merchant banking activities.
Under the first feature of the tax proposals, the availability of the small business tax deduction—namely, the eligibility for a preferred corporate tax rate of 10% on the first $500,000 of qualifying active income—will be phased out for CCPCs and their associated corporations that exceed the $50,000 threshold for passive investment income in the taxation year. This will be achieved by a sliding scale that will reduce the small business deduction by $1 for every $5 in active income.
This phase-out mechanism limits the availability of the small business tax rate completely once the passive income threshold reaches $150,000 a year. While this is a simpler approach than previously, the inability for many companies to qualify for the preferred corporate tax rate, unless the passive income is below the $50,000 level, unfairly penalizes small business owners by limiting holdings of passive investments to meet unforeseen contingencies, to purchase corporate assets or property, and to expand business operations.
The second feature limits the refundable taxes that private corporations receive on the amount of certain dividends. Under the current policy, private corporations qualifying for the preferred corporate tax rate, or businesses taxed at the general corporate tax rate, are entitled to a refund of taxes paid on dividends from passive investment income. However, the budget provisions effectively limit the tax refund to non-eligible dividends from passive income. While the new proposals are an improvement, this approach will increase the administrative burden for small firms that will now be required to establish separate accounts for eligible and non-eligible dividends.
We urge the government not to proceed with the passive investment income tax proposals. The government estimates that the proposals will affect less than 3% of private corporations, or about 50,000 companies. However, we have little idea of how important these companies are to the Canadian economy. They may be among the largest and more dynamic in the country. In our view, if the government does proceed, the passive income holdings should be grandfathered in determining eligibility for the small business deduction, and the sliding scale should be indexed to inflation.
Our third feature relates to the income-splitting rules. We believe, here, that the government should consider further amendments to the rules, or at a minimum delay the implementation to give greater clarity on the rules and give time for small businesses to comply with the rules.
There are some complicated aspects of these particular income-splitting rules.
The substantive adjustments to the tax proposals for private corporations illustrate the new rules were introduced too quickly and with insufficient analysis. If the government proceeds with its modified new tax rules, we recommend it closely monitor the impact on expansion of existing, growing private corporations, and migration of these businesses to the United States. Canada can ill-afford the loss of available capital for small and mid-sized businesses.
Thank you very much for your attention.