A Note on Business Tax Policies

By Grant T. Smith

business-tax-policies-clearline-cpaThis morning, when I woke up, I turned on a weekly news program that I tape, so that I can stay in touch with some of the political and business news of the week.

The lead story was about a man who had, at some time in the past, recorded a loss for taxes of approximately $1 billion. The story went on to discuss how this meant the business person was taking advantage of loopholes to avoid paying taxes for the next 18 years. The story does not understand the principles of tax and so I thought it might make sense to write an unimpassioned explanation of the tax policies behind that story.

The first question is, what is government’s agenda in taxing business? The goal of taxation policy is to support investment in the economy. If we tax businesses without such an expectation or understanding, we would drive business out of our country and into another.

We want for a business to pay a tax rate that will:

  • encourage them to invest in new equipment and facilities to grow their business,
  • support them in developing staff through training and growth,
  • provide funds for government to use in building national, provincial, regional and local infrastructure.

The second question is, what does business want from tax policy? Business needs to know that they will be taxed on sustainable profits. Entrepreneurs take risks. In many cases, a new business will make substantial investments in building infrastructure for the business (e.g.: developing new ideas, creating sustainable processes, training staff, or building equipment or technologies). In the process of doing that it is more than likely that that business will sustain a loss.

Imagine you and I decide to open a restaurant, we find a perfect location, we sign the lease, we hire some staff, we develop the recipes, we buy all the food and supplies, and we spend a bunch of money on advertising. We open our doors and although things go fairly well (the future looks bright!) in our first year, it’s pretty understandable that we don’t make any money. It’s also pretty understandable that we don’t pay any tax because we didn’t make any money.

The next year we do phenomenally well and we make a huge profit, so one expects we might pay taxes. As a business making money we expect to pay tax, but we also expect some respect for the fact that we took risks to build these jobs and make this profit. As an entrepreneur taking risk, one expects to pay tax fairly over the life of the company. This means that if we lose money in year one and make money in the year two, we should pay tax on the amount of money that we made in the two years and that is what the income tax policy supports. To put it very simply: the policy supports the need for an entrepreneur to take risk.

After that it becomes more complicated. We need to put in a lot of rules to make sure people are not manufacturing losses – many such rules are in place. There are rules that limit the amount of years you can carry a loss forward. There are rules that sharply restrict carrying a loss backward, since that would be easier to manipulate. There are rules that ensure that losses can’t be sold without meeting specific criteria. This article is not about rules but principles, so let’s leave a detailed discussion of those rules for another time.

This article is also not about examining the capabilities of business or a management team to lose $1 billion in a given year. Although it seems beyond the pale to believe that a well-run business could lose that sum of money, it would take a great deal of specific knowledge to conclude that it was either appropriate or inappropriate. We simply can’t tackle this here.

What this article is about is understanding that business losses and taxation policies are not mutually exclusive.

I applaud entrepreneurs and I applaud small business — they are the engine that drives the success of our country. They are critical to the well-being of our nation. Taxation policy supports businesses small and large. It is appropriate for businesses to work within the rules and regulations of tax to minimize their taxation. It is appropriate taxation policy that businesses should pay tax over their lifetime and that means that losses and profits should be aggregated to support people who take risks in developing their business.