The 2018 federal budget: What small firms should be aware of

Before the recent budget, small businesses benefited from a low tax rate on the first $500,000 of active business income. Starting in 2019, this $500,000 limit will be reduced by $5 for every $1 of passive income over $50,000. This means that passive income of $150,000 will completely eliminate the small-business deduction. 

This is a more steamlined and balanced approach in comparison to what was proposed last year. There is no change to the taxation of passive income. Rather, business owners now need to monitor the reduction in the small-business deduction if passive income is greater than $50,000.

For younger lawyers, the impact of this change may be abstract. However, for older lawyers who have saved within their professional corporation for retirement, emergencies or extended leaves, that type of passive income may be a reality. With the proposed changes, lawyers may need to rethink the allocation of savings in their corporation.  

Refundable taxes

The intent of the tax system is that investment income earned in the private corporation is taxed at a higher rate. When the corporation pays this income to shareholders, it claims a refund of a portion of that tax. The problem, however, is that corporations may pay dividends out of active business income (taxed at a lower rate) and still claim the refund. This can result in a significant tax advantage, particularly for larger corporations.    

To curb this practice, the government proposes to make refunds available only for payments to shareholders sourced from investment income. Dividends sourced from active business income taxed at the general corporate rate will not attract the refund. This will require business owners to track investment income and active business income separately.    

Support for women-led businesses

The federal budget supports women-led businesses by way of $1.4 billion over three years in financing for women entrepreneurs through the Business Development Bank of Canada. Further, the government will increase funding to $200 million in the BDC's Women in Technology Fund. These are in addition to other initiatives such as financial support to Status of Women Canada, changes to parental leave to allow women to return to work earlier and other initiatives to eliminate inequalities in the workforce. While these initiatives are encouraging, they may not go far enough to address practical issues faced by self-employed women, such as funding maternity leave.    

Supporting access to justice

The federal government proposes to inject funds to strengthen the judiciary, support the court system and enhance openness and transparency. Some notable highlights in the proposals include:  

•             $77.2 million over four years to support the expansion of Unified Family Courts and the creation of 39 new judicial positions in Alberta, Ontario, Nova Scotia and Newfoundland and Labrador;

•             $41.9 million over five years to the federal courts;

•             $17.1 million over five years for six new judicial positions in Ontario and one position in the Saskatchewan Court of Appeal;

•             $6.0 million over two years to maintain support for the judicial discipline process via the Canadian Judicial Council and the Office of the Commissioner for Federal Judicial Affairs;

•             $2.9 million in 2018-19 to increase the capacity of the Office of the Information Commissioner to handle complaints over access-to-information requests;

•             $10 million to fund the Access to Justice in Both Official Languages Support Fund. 

While the funding to the judicial system is welcome, the provinces will likely also need to increase funding to meet the needs of the public.

As the budget demonstrates, the government has listened to the concerns of the small-business community. Many sole and small-firm lawyers contributed to the opposition to last year’s proposals. While many of the new proposals are a step in the right direction, lawyers and business owners will still need to recalibrate their long-term planning to operate smartly within the changing tax regime.