Mom and pop are not the bad buys
The sad reality in Canada today is that demographics, combined with myopic tax measures, could effectively wipe out 600,000 small to mid-sized enterprises (SMEs) across the country within the next five years. I only wish I was exaggerating.
According to Succession 2020 (a succession planning manifesto authored by professional financial advisor, Fred Dodds), over a million baby-boomer-generation SME owners will turn 70 by 2020 (that’s only 24 months away). Now, consider that an estimated 66 per cent of them are banking on the sale of their business to finance their retirement. The equity they’ve built up in their companies is, in effect, their retirement fund. They must sell their businesses—but to whom? Baby-boomer retirees outnumber working-age people by a ratio of 5:2.
Those are nightmarish figures. And it gets worse.
Statistics gathered by the Canadian Federation of Independent Business show that populations across the Atlantic provinces (excepting Prince Edward Island) are forecast to collectively decline by 85,600 people over the next 20 years. With all due respect to P.E.I., their anticipated 27,300 increase won’t do much to offset the coming labour drought.
There’s even more bad news… while populations and SMEs free fall, provincial debt is marching double-time in the reverse order. Across the region, net debt grew from 24 to 109 per cent between 2001 and 2016.
As if this vomitus vortex of fiscal calamity wasn’t horrific enough, our federal government stirred the pot even more when it defeated Bill C-274. But more on that in just a bit.
For now, let me draw your attention back to federal Finance Minister Bill Morneau’s July 2017 announcement. To paraphrase: he said he intended to close tax loopholes so rich Canadians paid their fair share of taxes. Here’s the official quote from the Government of Canada website: “We know that businesses, including small businesses, help grow the Canadian economy.…We want to make sure those rules are used to do just that, and not to give unfair tax advantages to certain—often high-income—individuals.”
The idea of tax fairness and increased revenue to pay down the debt sounds reasonable enough, laudable even, in its broad strokes. But, oh—those devilish details.
Take, for instance, the all-too-familiar Atlantic example of a typical mom-and-pop operation with less than a dozen employees. Over time, one or more of their kids joined the business to help grow the firm and build their own career. Today, mom and dad are in their seventies and finally ready to retire. So, they move forward with their long-held plan to sell the company to their son or daughter.
If you’re someone “arm’s length” from the owners (i.e. a non-relative), the tax laws work in your favour. You can create a holding company to buy the shares from the existing owners and use future profits to pay for the purchase. The sale would benefit from the lifetime capital gains exemption; the company would continue operating; and the founders would be able to monetize the fruits of their labour. That’s if you’re not a relative.
However, if you are the next generation business owner (in the familial sense), Section 84.1 of the federal Income Tax Act prevents you from purchasing those shares through a holding company. Which means you’ll have to pay tax on every dollar you take from the company to repay the share purchase.
In other words, it’s significantly more advantageous from a tax perspective to sell the company to a stranger than to a family member.
Remember Bill C-274 that I referenced a few paragraphs ago? This private member’s bill, tabled by NDP Member of Parliament Guy Caron, would have allowed limited exemptions for transactions valued at less than $15 million so children and grandchildren could keep small family firms, well, in the family. The bill was defeated by the Trudeau government in February 2017.
To recap: we’re looking at a baby-boomersize wave of retirees that needs to sell their businesses to a generational cohort less than half their size… a federal government that is effectively blocking those retiring owners from selling to their most logical successors… and a tax strategy that levies higher taxes on the very SME sector it claims to be protecting.
There may be tax dodgers out there, but they aren’t in the mom-and-pop shop down on the corner. Come on, Justin—you’re smarter than that.