Economic Update: What small businesses need to know

Small business trends

Canadian small businesses have been facing growing uncertainty due to the political and macroeconomic developments this past year. It’s increasingly important for businesses to source the best available information and make proactive strategic decisions to prepare for all eventualities. Here are the top three developments we’re following this quarter: 

Small business tax reform

Since the federal government released its tax proposal in July 2017, there has been a lot of input and pushback from many stakeholders. This is a fluctuating issue, but how does this proposed legislation actually impact small businesses?

The changes to the tax code are aimed to ensure that high-income earners will not use the small business tax status to reduce their personal taxes, as well as to close some commonly used tax loopholes. Since the public consultation period ended in early October, the government has been introducing new proposals. Here are the key items to watch:

  1. On January 1, 2018, the federal tax rate on small businesses will be reduced from 10.5% to 10%. On January 1, 2019, the rate will drop further to 9.5%. This is projected to save the average small business around $1,600 per year.[i]
  2. To receive compensation, family members must pass a reasonableness test to demonstrate they “meaningfully contribute” to the business – either through labour, capital, equity or assuming financial risk. This test will make it more difficult to use income splitting to maximize a family’s total after-tax income.
  3. Limit the benefits of leaving excess earnings inside the business in the form of a passive investment portfolio.

If your family members earn income from the business, evaluate if their contributions can pass closer scrutiny, and assess if your company holds any passive investments (i.e. unrelated stocks). The changes are expected to be enforced on January 1, 2018 – speak to your accountant or tax specialist to revise your tax planning strategy under the new rules.

The announcements are short on detail, and it’s important to review the finer points of the full proposal to understand the impact on your small business. Click here to stay updated on the on-going developments – more releases are expected to come out in the coming weeks.

Interest rate hikes

For the first time in seven years, the Bank of Canada increased the overnight rate in July and September 2017[ii]. These increases soon pass on to affect variable-rate mortgages, lines of credit, and other loans. While rising interest rates imply a greater cost of borrowing, we should see this as good news – regions and industries across Canada have achieved robust, sustainable economic growth, primarily fueled by consumer spending[iii]. Most analysts anticipate the positive economic outlook signals a trend of further interest rate hikes over 2018[iv].

Among small businesses that seek external acquisition financing, over 70% use personal loans towards the business, and over 60% use credit from financial institutions[v]. Here are a few tips to navigate the waters of changing lending conditions:

  1. Check up on your business plan: Rising interest payments take a greater chunk out of your income, leaving less behind to execute on your business strategy. It is important to re-evaluate your growth plan to understand the effects of further interest rate increases. Prioritize an optimal allocation of the leftover resources to innovation, expansion, and sustaining growth momentum.
  2. Check up on your financing plan: As the economy – and your business – grow, it is important to stay updated on the various financial products available. Business needs and the ability to qualify for different types of loans evolve over time. For example, a business with three years of consistent operating history often qualifies for lower-cost financing that is difficult to obtain for a start-up. Understand your business’ unique borrowing needs, and how to most efficiently meet them.
  3. Check up on your cash flow management: Many small businesses operate with a limited cash buffer, and rising interest payments can further strain working capital. Consider if your business can tighten its receivables terms or extend payment terms to close cash flow gaps – while retaining strong relationships with customers and suppliers.

Changing trade frontiers: CETA & NAFTA

While the Comprehensive Economic and Trade Agreement (CETA) – our second-largest ever trade deal – went into effect with the European Union in September 2017, the once stable North American Free Trade Agreement (NAFTA) was on its way to the renegotiation table.

With a population of over 512 million[vi], the EU accounts for approximately 25% of global GDP[vii]. CETA was a tremendous milestone in strengthening Canada’s trade relationships, and offers great opportunities for small Canadian businesses. It eliminates tariffs on 98% of goods and services, removes or reduces many non-tariff barriers such as rules of origin and import quotas, and facilitates direct investment, procurement of government contracts and labour mobility. Click here to learn more about what CETA can offer your small business.

The outlook for NAFTA is much more uncertain – since renegotiations began in August 2017, the United States has introduced a half-dozen blows, such as the sunset clause, which could terminate NAFTA after five years, weaker enforcement mechanisms, and non-starters on the dairy, textiles, automobiles industries with ‘Buy America’ rules. The Canadian and Mexican governments have committed to staying at the negotiating table, but the path ahead is unclear.

There are three possible roads forward:

  1. Modernizing NAFTA: Updating the existing agreement to reflect the new digital age by incorporating data privacy and intellectual property rights, as well as strengthening labour and environmental obligations.
  2. Bilateral Canada-U.S. Free Trade Agreement: Should the United States withdraw from NAFTA, Canada can pursue a bilateral agreement without Mexico. However, negotiations here too may be stalled by the issues currently frustrating NAFTA, such as dispute settlement, the structure of Canada’s diary industry, and ‘Buy America’ clauses.
  3. No Trade Agreement: Without a trade agreement in place, all three countries would continue to be governed by the rules of the World Trade Organization. Most goods could still be traded tariff-free, however, some industries will be hit harder than others (such as the automotive sector).

Politics is likely to play as important a role as economics. Canada has a relatively balanced trade with the United States, and is the most important export market for several American states. Multiple lobbying and interest groups within the United States have strongly spoken up for NAFTA. The Canadian government has been bolstering support from these groups, and other branches of the American government such as the powerful Committee on Ways and Means in the U.S. House of Representatives. The Trump administration can withdraw with a six-month notice but must work in concert with Congress to completely pull-out.

Even if you operate a local business, it’s important to evaluate how this could impact your suppliers, customers, and competitors. Could your raw material prices increase? Could customer demand for your products decrease? How might competitors respond to these changes?

Remember: the default scenario without a trade agreement also provides mostly tariff-free or low-tariff trade. A broad industry analysis will help your business navigate these uncertain waters – under any tide.

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