Budget’s capital gains tax changes divide the small business community

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The federal government’s decision to change the way capital gains taxes work for small-business owners is drawing criticism for arbitrarily creating economic winners and losers.

As part of the federal budget released Tuesday, Finance Minister Chrystia Freeland announced plans to increase the inclusion rate on capital gains for companies and some individuals from one-half to two-thirds. This means businesses will have to pay tax on two-thirds of that income. For individuals, the increase applies only to capital gains in excess of $250,000.

The Finance Minister also introduced a new program, the Canadian Entrepreneurs’ Incentive, that lowers the amount of tax some small-business owners will have to pay when they sell their companies. Eligible owners who sell small private companies will be taxed on only one-third of their capital gains from the sales, up to a lifetime limit of $2-million.

The new incentive, however, will not apply to a range of industries, including restaurants, hotels, the arts, entertainment, and professional services, such as doctors’ offices and small accounting firms.

Dan Kelly, chief executive officer of the Canadian Federation of Independent Business, said these exclusions appear arbitrary and could ignite a political firestorm. He said roughly half of small businesses will be ineligible for the incentive.

“We are struggling to figure out what the policy rationale is behind picking winners and losers within the business community,” Mr. Kelly said. “The auto mechanic is going to get a one-third inclusion rate, but the hair salon is going to get two-thirds inclusion.”

Mr. Kelly predicted small-business owners facing significantly higher tax bills will lobby hard for changes in the government’s approach. “On the entrepreneur side, they are going have a lineup of sectors screaming and yelling, with pitchforks.”

Tuesday’s budget also announced an increase in the lifetime capital gains exemption from $1-million to $1.25-million. “Our early assessment is that most small-business owners will come out ahead or be unaffected by today’s changes as a result of a boost” in the lifetime exemption, Mr. Kelly said.

“What worries me the most about the capital gains changes is the potential to demotivate Canadians from getting into business in the first place, or working hard to grow a small business to a medium-sized business,” he added. “It seems bizarre that the government would single out some sectors of Canada’s small-to-medium-sized business community for higher taxes, including many of those hardest hit by pandemic restrictions, like restaurants, arts and recreation firms.”

Economists said the decision to hike taxes flies in the face of the government’s drive to improve productivity by encouraging business owners in all sectors to invest in their companies.

“The government continues to take a punitive approach to corporate taxation despite waning momentum in profitability and compressed margins,” economist Rebekah Young, a vice-president at Bank of Nova Scotia, said in a report. “Today’s revenue-raising measures would shift a substantial sum in corporate capital to government balance sheets.”