Canadian tech leaders warn new tax rules may hinder startups, innovation agenda

Posted on September 12, 2017 in Governance Debates – ROB/Tax Changes

September 11, 2017.   , Ottawa

Canada’s high-tech community is warning that proposed small-business tax changes will undercut the Liberal government’s efforts to boost innovation and expand the sector.

Canadian tech chief executives are discussing how to jump into a roaring debate that has moved to the top of the federal political agenda since Finance Minister Bill Morneau released the controversial proposals in July.

While dozens of other sectors – including doctors, farmers, lawyers, small-business lobby groups and the Canadian Chamber of Commerce – have all spoken out against the changes, the tech community has largely remained on the sidelines.

However, it is expected that in the coming days some organizations – including the Canadian Venture Capital and Private Equity Association (CVCA) and the National Angel Capital Organization – will prepare submissions to the government that will express concern.

In interviews with The Globe and Mail, Canadian tech executives say there are several troubling elements that could hurt the sector.

Tech CEOs say successful businesses often make passive investments in other startups, which expands the sector in Canada. They warn the changes would reduce the amount of investment capital available.

A common concern is the risk that Canada will become less competitive with the United States in terms of overall taxation, influencing corporate decisions over which side of the border to locate or expand.

“It’s going to impact a lot more than the rich 1 per cent,” said Aran Hamilton, president and co-founder of Vantage Analytics, a small company based in Toronto that analyzes online retail data for clients. “It’s going to get a lot less compelling to start up a company in Canada.”

Mr. Hamilton, who describes himself as a life-long Liberal, said he’s already under pressure from American investors to move his company to the United States.

“We have to push back and say, ‘No, we’re going to stay in Canada.’ But you know what? If I don’t have any opportunity of actually cashing out in Canada, I will move down to the States and I’ll take all the jobs with me,” he said.

The tech sector has been heavily courted by the Liberal government as a key target of its innovation agenda. Prime Minister Justin Trudeau frequently uses technology companies as backdrops for federal announcements. Mr. Morneau’s March budget – which signalled that changes were coming to small-business rules – also focused heavily on measures to boost innovation. The government has an innovation and skills plan that promises to double the number of high-growth companies in Canada – particularly in the digital, clean technology and health technology sectors – to 28,000 by 2025 from 14,000 now.

Tech CEOs are aiming to repeat the success they had last year in lobbying against a Liberal promise billed as a new tax on high-income Canadians. In response to push-back from tech executives, Mr. Morneau backed down from a campaign pledge to set a cap on tax deductions claimed for compensation from stock options.

Tech leaders say the government’s focus on promoting the sector is hard to square with the latest package of proposed amendments.

The government is proposing several changes to small-business tax rules. One would limit the ability of a company owner to “sprinkle” income to family members as a way of paying less tax. Another related change would limit the use of the $835,716 lifetime capital gains exemption to the business owner, ending the ability to multiply the exemption several times by including the owner’s spouse and children as shareholders. Another proposal would restrict the use of a small business as a vehicle for making passive investments.

Mr. Morneau has said the changes are about tax fairness. He also said the government is open to suggestions on technical modifications to its proposals.

One aspect of the revisions that upsets tech executives with experience starting a company from scratch is how it would affect the uneven pay that comes with launching a startup. A tech entrepreneur may pay themselves a small salary – or even none at all – during the first few years. If the business is ultimately sold, the owner may receive a big payment in one tax year before a sharp drop in income once the business is sold.

Tobyn Sowden, CEO of Redbrick, a Victoria-based software company, said the passive investments he makes through his business have included five stakes in other Canadian startups worth a total of about $500,000.

“I don’t think I’m a rarity,” he said. “I think there are a tonne of entrepreneurs – a lot in the tech space – that when they have success, they invest back in … in ways to give back.”

CVCA CEO Mike Woollatt, who represents Canadian venture capitalists, said that while the changes were announced in July, it wasn’t until late August that members started raising strong concerns.

“There’s a lot of folks sort of waking up to the fact that this could have a pretty significant impact,” he said. “Our members are really concerned.”

Mr. Woollatt said several organizations that represent the tech sector have been talking behind the scenes about how the community should formally respond before the consultation period closes Oct. 2.

“This government is a pro-innovation government,” he said. “I would just say that this particular initiative looks like it would be a step backwards for innovation funding, frankly, at a time when we really need it.”

Yuri Navarro, the CEO of the National Angel Capital Organization, said his members use private corporations as vehicles for investing in Canadian tech startups and the revisions could make it harder for entrepreneurs to find investors.

However, Mr. Navarro added that based on his conversations with federal officials, he is hopeful modifications will be made that address those concerns.

“I would be surprised if they weren’t looking at these issues seriously, because it doesn’t really align with the massive investments they’re making in trying to support entrepreneurship and I suspect that it wasn’t something that they did consciously,” he said. “Based on the conversations we’ve had with the government, I think that they are very serious about considering the feedback that they’ve received.”

With files from Sean Silcoff

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