Ontario offers small business owners a tax cut in fall economic statement

Small business owners in Ontario are getting a break on their taxes.

This week Minister of Finance Charles Sousa delivered a fall economic statement that will lower the corporate small business income tax rate on the first $500,000 of business income to 3.5 per cent from 4.5 per cent, by January 1, 2018. The change will see the combined federal/Ontario small business income tax rates drop to 12.5 per cent by December 31, 2019, from the current 15 per cent. Combined with the recently announced federal small business tax reductions, eligible corporations in Ontario could realize an additional annual tax deferral of up to $7,500 in 2018, and $12,500 thereafter.

The pre-election tax cuts are designed to offset the Wynne government’s proposed increase to the province’s minimum wage, set to spike to $15 per hour on January 1, 2019. Despite widespread criticism around the timing and pace of the minimum wage changes, the government made clear that it has no plans to delay the increase.

“We will not back down from these commitments,” Sousa said as he delivered the statement to the provincial legislature. “An increase to minimum wage cannot wait. People cannot wait. Delaying an increase is denying an increase.”

The budget update left Ontario’s personal income tax rates on regular income unchanged. Ontarians earning in the top income tax bracket (income of more than $220,000 per year) currently pay at a rate of 53.53 per cent. The exception is the dividend tax credit rate for non-eligible dividends, which will decrease to 3.2863 per cent after 2017, from the current 4.2863 per cent.

General and manufacturing and processing income tax rates will remain unchanged, at 11.5 per cent and 10 per cent, respectively.

Sousa also announced the replacement of Ontario’s Apprenticeship Training Tax Credit with a new Graduated Apprenticeship Grant for Employers. The GAGE will offer employers a grant of up to $5,200 for hiring employees who complete an apprenticeship program or attain a certificate of completion in various qualifying areas.

Lastly, Queen’s Park plans to crackdown on the province’s underground economy by boosting information sharing across departments, targeting ‘high-risk’ sectors in cooperation with the Canada Revenue Agency, while also publishing tax convictions as a form of deterrence and to encourage compliance in the business community.

So, what do the government’s changes mean for small and medium-sized business owners across the province?

While the tax cuts seem appealing at first, it’s important to note that the top rate on ineligible dividends is going to exceed 47.4 per cent by the time these reductions are factored in. This effectively makes it more expensive to earn passive income through a corporation. Currently on a full flow through basis, it costs approximately 55.5 per cent to earn passive income through a corporation. With these changes that rate will increase to approximately 57.8 per cent, resulting in serious under-integration. Also, it will cost more to remove retained earnings from a corporation previously taxed at 15 per cent, because there is now an additional 2 per cent plus cost, at the high rate of taxation on ineligible dividends. That means you’ll need to leave income in your corporation longer to make the deferral worthwhile.

In the end, the decrease in the small business rates both federally and now in Ontario only exacerbates the very problem federal Finance Minister Bill Morneau has been aiming to solve–namely, the practice of leaving income behind in corporations to be taxed at lower rates. It also creates a larger divide between taxation at capital gains rates versus dividend rates, thereby encouraging the taxpayer to seek ways to get the lower of the two rates, perhaps by implementing some of the capital surplus stripping plans the Minister was trying to shut down with his initial proposals introduced last July.

Governments at the provincial and federal levels are trying to cushion the blow from new measures designed to improve tax fairness and level the playing field between employers and employees (in Ontario). The unfortunate reality is that SME owners continue to pay the price, to the detriment of their bottom lines.

Armando Iannuzzi, Partner