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August 2003

Promoting Entrepreneurship and Small Business

Entrepreneurs and small businesses are a key source of jobs and economic growth in Canada. The Government is strengthening support for this sector by reducing taxes on small business income and capital gains.

Background

In Budget 2003 the Government of Canada announced measures to strengthen the Canadian tax advantage. These measures build on the Five-Year Tax Reduction Plan introduced in 2000—the largest tax cut in the country’s history. The plan reduced personal income tax rates at all income levels and introduced a number of tax measures to promote investment and entrepreneurship in Canada. (See end of document for a list of tax reduction measures.)

Tax Rate Reductions for Small Business

In the 2003 budget the Government announced an increase in the amount of annual income eligible for the 12-per-cent small business rate from $200,000 to $300,000. The increase will be phased in over four years, starting with a $25,000 increase in the limit for 2003. This initiative builds on a measure implemented in 2001 to reduce the 28-per-cent corporate tax rate on annual business income between $200,000 and $300,000 to 21 per cent.

What About Business Income in Excess of $300,000?

Another part of the tax reduction plan is to reduce the 28-per-cent general corporate income tax rate. As of 2003 the rate has been reduced to 23 per cent, and in 2004 it will be reduced to 21 per cent. This benefits businesses of all sizes that have income that is subject to the general corporate tax rate.

Capital Gains Tax Reduction

In 2000 the Government reduced the capital gains inclusion rate from three-quarters to one-half. The inclusion rate is the portion of a capital gain that is subject to income tax.

Example—Tax Savings on Capital Gains

In 1999 an individual would have paid $2,284 at most in federal income taxes on a $10,000 capital gain. Today the maximum that the individual would pay is only $1,450—a savings of $834. The table below provides details on the tax savings.

Tax-Free Rollovers for Small Business

In 2000 the Government introduced a measure that allows individuals to defer the tax on capital gains from the sale of shares in an eligible small business corporation where proceeds are reinvested in another eligible small business. Specifically, to qualify for the tax-free rollover, the business may have no more than $50 million in assets immediately after the investment.

To encourage greater access to risk capital, the 2003 budget eliminated the $2-million limits on the amount of the original investment and reinvestment that may be eligible for the deferral, and extended the allowable period for the reinvestment to any time in the year of disposition or within 120 days after the end of that year.

Example—How the Tax-Free Rollover Works

Charles earns $65,000 per year and owns shares in an eligible small business corporation. He sells shares so that he can free up some cash to invest in shares of a new small business with some other partners. He realizes a $10,000 capital gain on the sale of the shares.

In 1999 three-quarters of the capital gain (i.e. $7,500) would have been taxed at the 29-per-cent top federal rate, plus the 5-per-cent federal surtax. This means that Charles would have paid $2,284 in federal income tax on the capital gain. About $1,418, on average, of provincial tax would also have been payable, leaving only $6,298 available to be invested in the new small business. In 2003, as a result of the rollover measure, tax on the capital gain would be deferred, which means that the entire $10,000 would be available to be invested in the new business.

For Further Information

For general information about federal tax cuts, visit the Department of Finance Canada Web site at www.fin.gc.ca. Information is also available from the Canada Customs and Revenue Agency (CCRA): visit the CCRA’s Tax Web page at http://www.ccra-adrc.gc.ca/tax/menu-e.html; or phone your local tax services office (www.ccra.gc.ca/tso) or the CCRA’s toll-free general enquiries line at 1 800 959-8281.

This is part of a series of bulletins designed to give Canadians useful information about individual elements of the federal government’s Five-Year Tax Reduction Plan introduced in 2000. Bulletins on tax measures and other publications may be viewed on the Web at www.fin.gc.ca, and copies may be obtained by calling the Department of Finance Canada Distribution Centre at (613) 995-2855.

About the Department of Finance Canada’s Tax Bulletin Series

Below is a list of the tax measures included in the plan:

• Full indexation of the personal income tax system was restored as of January 1, 2000, to protect taxpayers from inflation.

• Personal income tax rates for all taxpayers were lowered effective January 1, 2001.

• The Canada Child Tax Benefit (CCTB) was substantially increased to help low- and middle-income families with children.

• Additional tax assistance was provided to those who need it most, including persons with disabilities and caregivers.

• Tax support for students in post-secondary education was substantially increased.

• The 28-per-cent general corporate income tax rate has been reduced to 23 per cent in 2003, and will fall to 21 per cent in 2004.

• The capital gains inclusion rate was reduced to one-half as of October 18, 2000.

• Employees may defer the income inclusion from exercising certain employee stock options in publicly listed corporations until the shares are sold.

• Individuals may defer qualifying capital gains on small business shares to the extent that the proceeds are reinvested in other eligible small business shares.

• As of January 2001, self-employed individuals may deduct the portion of Canada Pension Plan and Quebec Pension Plan contributions that represents the employer’s share.

• Under the plan, further measures have been legislated that will provide tax relief in 2004. These measures will:

• increase the basic personal amount (the amount an individual can earn tax-free) to at least $8,000 (from $7,756 in 2003);
• increase the spouse or common-law partner amount to at least $6,800 (from $6,586 in 2003);
• raise the second bracket threshold to at least $35,000 (from $32,183 in 2003);
• raise the third bracket threshold to at least $70,000 (from $64,368 in 2003); and
• raise the fourth bracket threshold to at least $113,804 (from $104,648 in 2003).

In the 2003 budget the Government announced additional measures that build on the plan and the Canadian tax advantage:

• The National Child Benefit supplement of the CCTB, which provides assistance to low-income families with children, is being increased.

• A new Child Disability Benefit for low- and modest-income families with a child with a disability is being introduced.

• Tax assistance for persons with disabilities will be enhanced.

• The limits on tax-assisted savings in registered pension plans and registered retirement savings plans are being increased.

• The federal capital tax will be eliminated over five years, and will be completely eliminated for medium-sized corporations in 2004.

• The taxation of resource income will be improved by reducing the corporate tax rate of the sector to 21 per cent over the next five years while making changes to the tax structure of this key sector.

• The amount of annual income eligible for the 12-per-cent small business tax rate is being increased from $200,000 to $300,000 over four years.

• The small business capital gains rollover measure has been enhanced by removing the $2-million limits on the amount of the original investment and reinvestment that may be eligible for the deferral, and extending the length of time available to make a qualifying investment.