This is a case study about three Toronto neighbours - Salaried Sally, Proprietor Peter and Dividend David. All three neighbours are solo small business owners. Their entitlement to financial support from the government due to the COVID-19 crisis is drastically different. The rules favour employers significantly. On the other hand, sole proprietors and dividend earners, regardless how seriously affected, may receive no support at all.
The COVID-19 Rules
In late March/early April of 2020 the Federal Government announced a number of legislative measures designed to provide financial support to Canadian businesses and workers. Some rules are already enacted, while others are still in the stage of development (together the "COVID-19 Rules"). It is outside of the scope of this article to describe the rules in details.
The COVID-19 Rules include:
- the Canadian Emergency Wage Subsidy ("CEWS") (worth up to $847/week in subsidy to eligible employers for up to 3 months);
- the 10% Temporary Wage Subsidy for Employers; and
- the $40,000 Canada Emergency Business Account Interest Free Loan ($10,000 can be forgiven)
The Solo Businesses
Prior to the COVID-19 crisis, the three businesses were similar in size, revenues and expenses (excluding owner-manager's salary). All three businesses earned $100,000 in 2019 and have no employees (other than owner-manager). The business structures, however, are different.
Salaried Sally operates an HR consulting business through a corporation, Sally Co. Sally Co pays out its earnings to Sally as a salary.
Proprietor Peter operates an IT support support business through a sole proprietorship. Peter earns and reports self-employed business income.
Dividend David provides party entertainment services through a corporation, DavidCo. DavidCo pays out its earnings to David as dividends.
The business owners' tax liability pre-crisis was generally comparable, although different. Sally's tax/CPP liability was the highest at approximately 29% effective rate. Peter's effective tax/CPP liability was approximately 28.5% and David's combined effective tax liability (corporate and personal) was approximately 25.5%.
The COVID-19 Impact
In March of 2020, all three entrepreneurs felt the devastating effect of the COVID-19 economic crisis.
David's party entertainment business was hit the hardest. His clients cancelled all events, his sales dropped to $0. The Ontario government mandated his workplace to close as non-essential. His rent and other bills continued to pile on.
Proprietor Peter saw a drastic drop in sales too, so drastic that he only completed one or two orders per month, earning less than $100 per month.
Salaried Sally was more lucky. Her sales dropped by 30% but there was still a strong demand for her HR expertise.
Looking for Help
As soon as the COVID-19 Rules were announced, all three entrepreneurs contacted their tax advisors to determine which measures could help them. This is what they learned:
In summary, based on the COVID-19 Rules proposed or in place as of April 4, 2020, Dividend David is not eligible for any of the support programs, even if he lost all his sources of income, and even if he is sick or has to care for someone who is sick. He needs to earn at least $5,000 from employment or self-employment in the last 12 month or in 2019 in order to qualify for CERB, but he only received dividends from DavidCo.
Proprietor Peter did not fare much better. He is currently not eligible for any of the support programs. He can only apply for CERB in the amount of $500/week if he stops working entirely and stops earning any business income.
On the other hand, Salaried Sally's support payments may have put her in a better positions than she was before the COVID-19 crisis. Her monthly revenues before the crisis were $8,333 but fell 30% to $5,833. However, as an incentive to keep herself on the payroll, Sally will receive $847/week in wage subsidy. Her business will have a combined $9,222/month available to it, which is more than she had before the crisis. On top of it, Sally's business should be eligible for the $40,000 interest free loan, $10,000 of which can be forgiven if she repays the loan before December 31, 2022.
If Sally is unable to work and has to close her business in the coming months before October 2020, she can be eligible for CERB. As such, in total, Sally's business can receive well over $25,000 in COVID-19 related government support in 2020.
Lucky Salaried Sally and Unlucky David and Peter: Intended Result?
It is no secret that the government is facing an unprecedented task in developing a very complex set of rules in a short period of time. The changes of similar magnitude normally take years to develop, and we only have days before people across Canada would need the funds to buy basic necessities. As we rush to enact the rules, unintended results are hard to avoid.
There seems to be a clear preference to employers, even those who are doing relatively well financially and even those who pay salaries to themselves.
Meanwhile, dividend paying solo businesses like Dividend David may not see any support under the proposed rules. Some may argue that it's a fair game given the taxes David saved in prior years by paying taxes on dividends only and not contributing to CPP or EI. However, was it really the intention of the rules to leave David with no support during an unprecedented public health disaster?
Sole proprietors are only eligible to the CERB if they cease working for reasons related to COVID-19 and receive no income. Peter would have been entitled to $500/week CERB if he did not earn $100/month.
Should Peter incorporate and should David start paying himself a salary now? Every tax advisor in the country must have heard this question by now from their clients. Joseph Devaney, CPA wrote an excellent article about whether or not it may be a good idea. The fact that the questions arise shows that the COVID-19 Rules as currently proposed go against the principles of neutrality and integration, something the Canadian tax system has been carefully protecting to date.
For now, we hope to see more neutrality in the final version of the COVID-19 Rules.
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Nothing in this article constitutes legal advice and no solicitor-client relationship is created. If you require legal advice pertaining to your specific situation, please contact our tax lawyer.
Please note that this post is only as current as its publishing date indicates, but the relevant rules change constantly.