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Joel Fransen, a dentist in the Lower Mainland, says the $50,000 threshold could impact his expansion and retirement plans in the future.

Richmond Endodontic Centre

Ottawa's updated proposal for taxing passive investments made through private corporations is better than before but still doesn't go far enough, say some small-business owners and industry experts.

They argue that the proposal to more heavily tax passive income above $50,000 each year will only benefit small-business owners in the short term and is a disincentive for them to grow into larger companies, at least in Canada.

"It's nice that they have a bit of relief, but it probably doesn't go far enough," said Greg Wiebe, Canadian managing partner for tax at KPMG in Canada. "Everyone wins a little bit, but it's a small win. You wonder if it's going to be sufficient."

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Read also: Liberals set $50,000 a year threshold on taxing investments in corporations

"It's a disincentive for entrepreneurs and for professionals to set up and maintain a practice here in Canada. It's not very business friendly."

On Wednesday, Finance Minister Bill Morneau said the government is proposing to allow incorporated small businesses to generate income of up to $50,000 a year inside their companies without being subject to a higher tax. That's income generated on assets not directly used in the business, such as stocks, real estate or other property. Ottawa used an example of a business owner with $1-million invested that earned a 5-per-cent rate of return, equalling $50,000. Anything above that would be taxed at a higher rate.

The start date will be announced when the government releases draft legislation in its 2018 budget early next year. Ottawa said all investments before that date, and the income earned from them, will be protected from what some experts call the new "supertax."

In its previous proposal, announced in July, there was no threshold. The Liberal government's updated proposal is meant to address concerns from middle-class small-business owners worried that the original proposals would hurt their ability to save for economic downturns, short-term parental or sick leave, or retirement through their businesses.

"For many small-business owners, this will be a high enough limit to be able to leave normal retained earnings in the corporation," said Jamie Golombek, managing director of tax and estate planning at CIBC Financial Planning & Advice.

"However, when it comes to larger small and medium-sized businesses, once you get over $1-million, you'll be above that threshold," Mr. Golombek said.

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Joel Fransen, 47, a dentist in B.C.'s Lower Mainland, says the threshold isn't a problem for him today, but could impact his expansion and retirement plans in the future.

"It looks like a lot of money now, but when you come to retirement, you have to live off of that for the rest of your days," he said. "That's a concern as I build my retirement, it's just going to be hit harder and harder … I'm concerned they're attacking our nest egg."

Dr. Fransen says a higher tax on income above $50,000 could also affect companies that set aside money for years when business isn't as good.

"Sometimes, you have good years and sometimes you have lean years. It can be tough to bridge that gap," he said.

Dan Kelly, the president of the Canadian Federation of Independent Business, says small-business owners may be setting aside money in their corporations for retirement, sick leave or other uses, but also wind up using it to support their company in lean years. He points to the downturn in the Alberta economy as an example.

"Sometimes, the thing you think the passive income is for doesn't end up being used in that way," he said.

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That also includes money used for unexpected business expansion. If the money is taxed at a higher rate, Mr. Kelly argues the business owner has less of it to expand.

He believes the threshold needs to be much higher to help smaller companies grow.

"We do think that this would be helpful for a large number of very small firms that aren't planning to grow to become medium or large-size firms in the future," Mr. Kelly said. "But for companies that are bigger already or are hoping to be bigger soon, the $50,000 threshold doesn't really give them a whole bunch of room to be able save for that expansion or growth. … We're happy to have relief on the small end, but public policy shouldn't be to try to keep businesses from pursuing growth. I worry that's going to happen."

Experts are also concerned about how complicated the tax system will become under these new rules, and the cost for small-business owners to comply.

"Tax systems need to be simple to encourage compliance," Mr. Wiebe said. "I can't imagine a way to make these rules simple for small-business owners to comply. Every time you add more tax complexity it costs them more money."

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