Employees and the Cost of Owning a Small Business
Hugh Faloon, CPA, CA, TEP
When the Department of Finance announced earlier this year that it was planning to end “income sprinkling,” GGFL was at the vanguard of local protest.
It’s not news to anyone that the protests have grown and the issue has since become a major thorn in the federal government’s side.
Along with the nation’s accountancy community and, collectively, our millions of clients, we anxiously await what we expect and hope will be significant changes to the proposed legislation.
But, despite all that has been said in opposition to the proposals during the late spring and summer, an important aspect has been overlooked: A close examination of what it costs a business owner to create middle class jobs, and the financial risk of adding employees to a growing business.
We have seen many entrepreneur business owners start businesses, and expand businesses, and lose money during those early phases of the business cycle. The old saying is true: “The last person paid is the owner.” Employees get paid, as they should, but they don’t take the financial risks.
The Canada Revenue Agency, in its publication “Employee or Self Employed,” has a good summary of some of the financial risks of an employee vs. employer. See https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/rc4110-employee-self-employed/employee-self-employed.html#financial_risk.
The federal government apparently feels that the tax system should be the same for incorporated business owners and the people they employ. This flies in the face of previous government policy (both Liberal and Conservative), that created incentives for Canadian controlled small corporate businesses to encourage them to pursue their dreams in spite of the personal risk required to see their businesses succeed.
The current Liberal government characterizes these incentives as “tax loopholes” for the rich.
Previous governments have accepted that these so-called “loopholes” are legitimate, well-established policies that help business owners take financial risk, invest in their businesses, and hire additional employees.
We know that our clients take these existing tax incentives into consideration when they invest in expanding their businesses and hire new employees.
The top personal tax rate in Ontario is 53.5%. Under the new federal proposals, many business owners may consider reducing expenses, including payroll (in the form of cutting staff) and other costs to make a profit, since the proposed changes increase tax to the family business owner, which they feel is not worth the additional risk.
Let’s look at the numbers.
For every $1.00 an employer invests in an employee, that employee on average must generate at least $3.15 of revenue for the employer to keep $1.00 after taxes at the top rate of 53.53%.
Here are some of the direct and indirect contingent costs of businesses investing in employees.
- Canada Pension Plan:
- Employers match 100% of employees’ contributions. Increased by Consumer Price index
- In 2017, a salary of $55,300 costs an employer $2,564.10
- Note: In the future, the federal government is looking to drastically increase CPP for both the employer and employee
- Employment Insurance:
- Employers pay 140% of the employees’ contributions
- A salary of $51,300 costs an employee $836.19; cost to the employer is $1,170.67
- Ontario Health Tax equals 1.95% of payroll over $450,000
- Worker Compensation Cost:
- Average rate in Ontario is $2.43 per $100 of payroll – the 2nd highest in Canada
- Employee benefit cost, i.e., health care
- IT hardware and licencing
- Rent for work space – lease commitments for 5–10 years equal $100,000s to $1M of future liability
- Professional association fees are often absorbed by the employer
- Ontario Premier Kathleen Wynne proposes a minimum of three weeks’ vacation for workers with five years or more service, which is reasonable
- Business owners have trouble taking vacation. The loan company OnDeck Small Business Owner Survey shows just 57% of business owners plan to take vacations: 9% will take two full weeks; 26% will take a few days; and 61% will take one week
- Employers pay 11 stat holidays to their employees:
- This equals 4.23% of the annual standard of 260 working days
- Statutory holidays are subject to all the related payroll taxes mentioned above
- Free to employees – 11 extra paid non-work days
- Business owners are not paid for statutory holidays
- Liability insurance for claims against the employee’s work
The human resource cost, including:
- Sick days
- Health and maternity/paternity leaves:
- Labour laws require holding these positions for a specific period of time, meaning that the employer must hire and train temporary staff replacements
- The employee has no responsibility to advise the employer if they are returning, and the employer cannot ask
- Severance cost:
- There is no mandatory retirement age
- Long-term employee severance can cost over a year’s salary
- Short-term layoff/firing of an underperforming employee can cost several weeks’ to a month’s salary
- Head Hunting fees are 20-30% of a prospective employee’s salary; it is not refundable if the employee fails after their initial probationary period
The bottom line is that employing Canadians is costly. That is not to say that the costs are necessarily unfair or unjustified. They are a part of doing business and an aspect of doing business that – to repeat – has long been recognized by successive governments as an essential underpinning of our economy.
Major Canadian banks are risk adverse when it comes to loaning money to business owners. Personal guarantees of loans are generally required, and this puts family assets, usually the family home, at risk of being repossessed.
The Business Development Bank of Canada will also loan funds. While they may be more flexible than chartered banks, they will also ask for personal assets, including mortgages on personal homes, for security for the business loans.
A big difference between an entrepreneur and an employee is the willingness of the entrepreneur to risk personal assets, and family assets with the permission of their spouse, with no guaranteed return or salary.
It makes no sense that the federal government is planning to take away a vital incentive that for decades has given 1.14 million small business owners (98% of all employer businesses in Canada) some financial stability while they grow their business – and, most importantly, offers millions of Canadians and their families stable employment.