Positioning Canadian SMEs for world leadership

A CMA Canada submission on government’s 2004 budget calls for key tax incentives to foster small business growth

By David Fletcher

More than 97.7% of all businesses in Canada are small- or medium-sized — that is, they employ fewer than 100 employees. But without the right taxation and economic policies in place to support them, it’s unlikely they will improve their competitiveness and become positioned to be world leaders. This is the message at the heart of CMA Canada’s recent submission to the House of Commons Standing Committee on Finance.

The submission was made as part of the Committee’s consultations with stakeholders on development of the 2004 federal budget. For the coming budget, the Committee asked participants to focus their advice on changes to taxation and spending measures. The central themes included, among others, ensuring economic growth and job creation while maintaining balanced federal budgets. The recommendations made in CMA Canada’s submission fell primarily under this theme.

The current situation

Canada has an abundance of micro-businesses. These are businesses with fewer than four employees. Nearly 60% of all Canadian businesses are micro-businesses. By comparison, in the U.S. only 43% of businesses have fewer than four employees. Canada’s greater dependence on micro-businesses requires a tax regime more sensitive to their challenges and more nurturing of their growth.

Large- and medium-sized businesses are generally more productive than small businesses, so it’s not surprising that, given Canada’s dependence on micro-businesses, U.S. productivity rates are higher. To overcome this problem, the bar has to be raised in Canada and small businesses have to improve their performance. Part of that involves public and private sector action aimed at improving small business’ knowledge database, its access to skilled workers, and its access to the high technology equipment it requires to improve productivity.

CMA Canada has taken an active interest in this area through a variety of initiatives, including entering into a long-term partnership with the school of business and economics (SBE) at Wilfrid Laurier University to establish the CMA Canada Centre of Excellence in Management Accounting for Small- and Medium-sized Enterprises. Housed within the Schlegel Centre for Entrepreneurship, the CMA Canada Centre provides small business managers with an important resource to build their knowledge and skills, thereby enhancing the competitiveness, innovation, and productivity of Canadian SMEs.

While such initiatives are important, alone they can only do so much. As the submission states, government needs to do more to encourage the growth of Canadian small businesses and make them more competitive. The solution, as CMA Canada sees it, rests largely within the tax system. With this in mind, the following recommendations have been made to the federal government as it considers its 2004 budget:

• Implement immediately an increase in the threshold for eligibility to the lower corporate tax rate from $225,000 to $500,000;
• Allow small business owners a tax credit for investments made in training and business-related education of employees;
• Change the capital cost allowance (CCA) applicable to the purchase of computer equipment from 30% to 50% per year;
• Raise the lifetime capital gains exemption to $1 million; and
• Establish a royalty tax credit mechanism.

Corporate tax rates

Small businesses are constantly struggling with resource scarcity. Recognizing this, the federal government has historically maintained a lower corporate tax rate for business net income under ,000. This has remained a significant incentive for small business owners and provided a much needed tax break for many of these nascent and growing businesses.

But the current threshold of $225,000 hinders development and influences small business budgets and order books. In some cases, the effort to improve profitability disappears at year end when income exceeds the current threshold. Instead, projects and sales are deferred and motivation remains low for senior management.

The government has recognized that the current system is in need of change, and in its 2003 budget phased in an increase in the threshold to $300,000 over the next four years. While this is a move in the right direction, CMA Canada contends in its submission that the increased threshold and timetable for implementation are still inadequate.

Instead, CMA Canada recommends that the government increase the threshold immediately to $300,000, and strongly recommends taking it up to $500,000 in short order. “Such an increase could reduce the tax liability for a small business with income of $500,000 by as much as $45,000 — money that could be used to hire additional staff, acquire new equipment or expand existing product offerings,” the report notes.

Education and training

A survey conducted by the CFIB in 2002 showed that 265,000 full-time jobs were vacant across Canada due to a lack of suitable candidates. This isn’t surprising. Small businesses are generally unable to compete with larger firms in recruiting high-demand employees. They can’t match the remuneration and benefits offered by larger firms, so they have to hire less skilled employees to fill vacant positions.

This, unfortunately, could lead to significant shortages in skilled labour in a variety of professions.

Though small businesses can hire skilled employees externally, it makes more sense in this market for them to look internally for people they can train and develop for more responsible positions. But paying for additional education or training can be expensive and risky for a small business. There is, after all, no guarantee that employees will remain with the business once they complete their course or training, and the company has to forgo an employee’s productive output while he/she undergoes training and education. For these reasons, there’s not much incentive for small business owners to invest in training programs.

CMA Canada believes that the government should provide businesses with additional incentives to invest in employee education or professional training. This could come in the form of a 50% skills development tax credit, to a maximum of $5,000, payable to businesses that invest in employee education or training.

Productivity through technology

Technology remains the backbone of the Canadian economy. Indeed, Canada is even more dependent on digital systems and computer technologies than it was only five years ago. Technology helps us increase outputs, improve employee productivity, and increase per capita incomes.

To remain competitive, small businesses need to keep pace with the rate of change — change that’s happening faster every year. However, a key tax incentive — the capital cost allowance (CCA) rate — itself isn’t keeping pace with this change. Computer hardware investments are subject to a CCA rate of 15% in the year of purchase, with a 30% rate applied in subsequent years. This allows small businesses to deduct the value of the equipment over an eight-year period, with a residual value of approximately 10% remaining undepreciated. Yet the useful life of a computer is now only about three years, which means small business owners don’t have the incentive or possibly even the means to make significant improvements in technology on a timely basis.

The House of Commons Standing Committee on Finance has considered revisiting this issue in the past, and CMA Canada is urging it to do so promptly. The association is recommending the creation of a new high tech class of CCA, with a 50% depreciation rate on a straight-line basis. If the government applied its half-year rule to this new class, businesses could depreciate their computer equipment over a period of three fiscal years from the date of purchase.

Capital gains exemptions

Small business owners are currently eligible for a lifetime capital gains exemption of ,000. Though this is beneficial, CMA Canada is encouraging the government to raise this exemption to $1 million. This would leave small business owners with more money to reinvest in the economy.

Last year, the government eliminated the restrictions on capital gains from investments made in small businesses. This change has made investing in small businesses far more attractive, and expanded the access of small business owners to new and important sources of capital. Since most angel investors are former small business owners, increasing the lifetime capital gains exemption will increase the amount of venture capital available to small businesses.

Royalty tax credits

Royalty revenue includes revenue earned from licensing of intellectual property, such as patents and copyright, the results of innovation and research and development (for more on this subject, see our profile of Debbie LeValliant, CMA, on page 40). At the moment, however, such revenue is considered for tax purposes to be income from property, whether domestic or international in origin, and is subject to tax at regular corporate rates.

CMA Canada wants the government to take a different approach. Considering the relatively low rates of R&D in Canada as a percentage of GDP, the revenue from technology licensing should be treated more favourably. This would encourage badly needed R&D in Canada, improve compensation for intellectual property, and stimulate employment opportunities.

As a country, Canada is ranked 15th among developed nations on its research and development, yet ours is a country built on SMEs, many of them innovators. Canada has a shortage of venture capital and other financing mechanisms and, as a result, has had relatively poor results in the domestic and international commercialization of innovation.

The answer to this problem is to embrace a tax stimulus — a royalty tax credit that would encourage SMEs to pursue R&D and exploit the intellectual property arising from such property through the business of technology licensing.

The basic facts can’t be disputed. Small business is Canada’s lifeblood. CMA Canada’s submission provides critical advice to the federal government on how it can foster small business growth and competitiveness while maintaining fiscal responsibility. The next budget should tell us a great deal about the government’s plans in this regard.

David Fletcher is the publisher of CMA Management and VP of public affairs for CMA Canada.

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