Morneau assures tech community tax changes won’t squeeze out investment capital

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Finance Minister Bill Morneau ‎promised Canadian innovators and their backers Friday the government won't crimp capital available to grow domestic startups, capping off a week in which he backed off a series of controversial small-business tax proposals.

Speaking at Communitech, a centre that supports technology companies in Ontario's Kitchener-Waterloo region, the minister pledged that any changes to passive investment rules for incorporated small businesses will ensure "the critical importance of making sure we maintain the ability for businesses to access capital from angel investors and venture capital investors."

The announcement was aimed at providing additional assurance to Canada's tech community, which had been among those expressing concern with the package of proposals Mr. Morneau originally introduced in July.

Canadian tech leaders had warned that proposed higher tax rates on passive investments held in an incorporated small business would leave entrepreneurs with less capital to invest in other tech companies through what is known as angel investing.

"We heard from people that we needed to get that right and so what I want to do today is to make sure that people understand that we will maintain incentives for people to be angel investors helping startup businesses to get going," he said. "We'll maintain the opportunity for venture capital to play an important role in our economy and we're going to get that right."

Several Canadian tech leaders said Friday that they were pleased the government is taking their concerns seriously.

"It's a positive start," said John Ruffolo, CEO of OMERS Ventures and co-founder of the Canadian Council of Innovators.

Adam Belsher, CEO of Magnet Forensics, a Waterloo-based company that makes digital investigation software for law enforcement and other clients, said he is cautiously optimistic that the government is listening.

"Having the opportunity to actually be consulted is a step in the right direction. That being said, I would say I'm holding my celebration or any kind of applause until we actually see what that final proposal looks like," he said.

"In general, making it harder for businesses to raise capital from private investors is a big deal. If all the capital is coming from the U.S., there is pressure on growing companies to locate more of their people, more of their growth activities in that market … which doesn't necessarily help the long-term prosperity of the Canadian economy."

Mr. Morneau's news conference marked the end of a week of announcements aimed at adjusting the original tax proposals.

The July package included three main elements: A draft bill aimed at discouraging income "sprinkling" to family members who are not directly involved with the business; another draft bill that would have restricted the conversion of dividend income into lower-taxed capital gains; and a third proposal that would discourage – through a higher tax rate – the use of a small-business corporation as a vehicle for making passive investments unrelated to the business, such as shares in other companies.

On Monday, the government announced that it will be lowering the small-business tax rate from 10.5 per cent to 9 per cent by 2019. It also announced that it would better define the income-sprinkling rules and that they would not apply to the lifetime capital gains exemption.

On Wednesday, the government said an incorporated business will be allowed to receive up to $50,000 a year in passive investment income – equivalent to a 5-per-cent return on savings of $1-million – under existing tax rules. Passive income above that amount would be subject to higher taxes.

On Thursday, he announced that the government will not move ahead with the draft legislation related to dividends and capital gains.