Canadians should use TFSAs to invest in small business: MEI

Small businesses with fewer than 100 employees account for a whopping 70% of all jobs in the private sector, says Youri Chassin, research director at the Montreal Economic Institute (MEI), in a report that cites government research.

As such, he suggests modifying TFSA rules to allow Canadian investors to invest in small business, instead of restricting them to listed firms. The result would be a win-win, he argues: investors get more choice, and small business gets funding. Further, Canadians would potentially have the option of investing in promising projects in their own communities, with attractive tax-free earnings.

As it stands, small businesses have difficulty getting bank loans, and they pay higher interest rates on the loans they do get. As a result, more than 84% of the heads of start-up enterprises rely on personal financing, namely their own funds or personal loans. Relatively few of them (17.3%) receive financing from friends or relatives.

Read: Is Canadian business confidence on shaky ground?

With nearly 12 million Canadians having TFSAs, the MEI argues these accounts are an untapped source of business investment. In total, TFSAs add up to $151.6 billion, or about $13,000 on average per contributor.

Family business bill defeated

On February 8, the House voted on private member’s bill C-274, which would have modified certain tax rules that disadvantage family businesses. The bill was defeated 145 to 157, with the opposition parties and 10 Liberals voting in favour. Read more about the tax rules here.

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Qualifying TFSAs for small business investment

All that’s required is a simple modification of article 204 of the Income Tax Act, “qualified investments,” in order to include shares of small businesses, suggests Chassin. TFSA investments would then enjoy the same regulatory protections as ordinary investments not made through TFSAs.

Further, there’s no need to measure the fair market value of the assets for tax purposes, since the purchase and sale prices of a small business share has no fiscal impact for a TFSA, which has tax-free returns.

In exceptional cases where such a calculation is necessary, Chassin suggests using the same guidelines applied to a family business transfer.

Read: How tax rules disadvantage family business succession

In such a case, “the market value of the company is not determined by financial transactions on the stock market,” says Chassin. “But this in no way prevents equity investments. The rules established in situations in which companies are transferred to a member of the next generation could serve as a default method.”

It’s a relatively easy way to boost business growth, which is a current focus of the federal government, as laid out in the recent report of the economic advisory council.

If the change proved successful, qualified investments for RRSPs could be similarly modified. Certainly, the potential modification to TFSAs can be compared to a previous success in Quebec.

In 1979, the Quebec government set up the Stock Savings Plan, which led to the creation of several of today’s large Quebec businesses, notes Chassin. Similarly, “opening up TFSAs to investments in small businesses not listed on a stock exchange could constitute a minor revolution in the development of a culture of savings in support of entrepreneurship.”

Read the full report here.