Credit unions have been hit with changes to the corporate tax regime that will oblige them to pay the same tax rate charged to the country’s chartered banks.
Managers and opposition politicians say they never saw the tax increase coming. There were no pre-budget consultations, no warnings, not even a news release.
There are two corporate tax rates in Canada. The general rate for big business is 15 per cent. Small businesses and most credit unions get a preferential rate of 11 per cent applied to the first $500,000 of income. As well, before the 2013 budget, credit unions got an additional tax break that allowed them to apply the 11 per cent rate to most income above $500,000.
Federal budget eliminates credit union tax break
Not so much anymore. The 2013 budget eliminated the latter tax break for credit unions over the next five years. That means by 2018, many credit unions will be paying the full 15 per cent. Worse, the tax hit could more than double if the provinces decide to follow the federal lead and eliminate the lower tax rate – something Quebec already did in 2003. Credit unions will not feel the impact equally. The largest credit unions typically have the largest amounts of taxable income, so they will pay a large portion of these new taxes. Mid-range institutions might pay a mixture of small and general tax rates, while the smallest will continue to be taxed exclusively at the low rate. Nonetheless, the impact across the board is significant. Some 140 credit unions will be affected by the change.
For four decades, financial services cooperatives were taxed at a lower rate to foster the credit union movement and spur capitalization of small businesses. The lower rate – the same charged to small businesses – acknowledged the reality that financial services cooperatives in the country are a tiny fraction the size of Canada’s big banks. The Liberal government of Pierre Trudeau, which set the tax rate, also recognized the value of community-based ownership of credit unions. As well, it took into account the fact that credit unions cannot access capital through the stock markets.
New tax regime puts CUs on same playing field as banks
Glenn Friesen, head of the $4-billion Steinbach Credit Union in Manitoba, says, “The tax increase came out of nowhere. We didn’t get a heads up.” Friesen adds that the government either doesn’t understand, or ignores the fact that credit unions draw all their capital from the deposits of their 11 million members and the profits that are re-invested.
“The tax increase came out of nowhere. We didn’t get a heads up”
—Glenn Friesen, Steinback Credit Union
“The tax difference was brought in during the 1970s to build a strong Tier II competitor with the banks. Now, the tax regime sets us on equal footing with the banks. But we don’t have the same way of capitalizing,” he explains. “So this tax increase represents a big blow to us. Our credit union will see a 40 per cent increase in its business taxes. That’s $1 million directly out of our working capital and from the profits of our members. Right now we are earning enough, but years ago we would have given [more] to our members. Now we have to give it to Ottawa.”
Provincial decisions often mirror federal changes
Friesen worries that in leaner times the tax hike could seriously affect the organization’s operation and services in the Steinbach-Winnipeg region. He also fears that his province will follow the federal lead – and he has reason to be concerned. Federal tax rate decisions and provincial tax policy, in theory, are independent of each other. Still, most provinces typically follow Ottawa’s lead.
For the federal government, the increase will ultimately net $75 million a year. It’s part of a set of tax increases that will augment federal revenue by $550-million per year, and tariff increases that will generate another $333 million.
The credit union tax change wasn’t something anticipated and credit union leaders say there was simply no time to lobby against it. Then, it got worse. In August, accountants discovered a technicality buried deep in the document that bumped the tax rate for credit unions even higher – right into the stratosphere. That detail was noticed two months after the Governor General signed the budget into law. It had been missed in the House of Commons, parliamentary committees and the Senate. And it turns out the item was a mistake.
A massive error puts CUs on the hook for 28 per cent
The hike to 15 per cent was intended, but when the finance department’s lawyers wrote budget bill C-60 last winter, they scrambled some of the technicalities, actually leaving credit unions on the hook for 28 per cent, unless the government changes the law.
“It was pointed out this was a drafting error,” says Gary Rogers, vice-president of financial policy with Canadian Central. “We contacted the Department of Finance and were assured they will fix this retroactively.” In mid-September, the government drafted legislation to do so, which it promised would be introduced before year end.
“It was pointed out this was a drafting error. “We contacted the Department of Finance and were assured they will fix this retroactively”
—Gary Rogers, VP financial policy, Canadian Central
In any event, Saskatchewan Liberal MP and former finance minister Ralph Goodale says making the correction is of little comfort. He emphasizes that the 15 per cent tax rate is going to be tough enough, costing credit unions more than $75 million a year.
As well, it comes at a time when all financial institutions are adjusting to new, stringent capital rules levied on them. International regulations, made after bank failures in the U.S. and Europe at the beginning of the recession, were imposed to protect the industry from another meltdown. That means credit unions must have more cash on hand than ever before.
And unlike banks, most individual credit unions can’t go to the markets to raise that cash, although organizations such as Central 1, which represents credit unions in Ontario and British Columbia, have that option. For the rest, says Goodale, “They have just one source of capital: credit union members. If you tax the capital of credit unions, you make it impossible for them to grow. This tax increase was unnecessary; a gratuitous slap at the credit unions.”
Goodale is an MP from a province that has a very high level of credit union membership. About half of the people in Saskatchewan – some 500,000 people – are credit union members.
“It seems the government has no idea how important credit unions are in small communities. In many places, especially in small towns and rural areas, they’re providing service to people who no longer have access to banks because the Big Five are pulling out of low-profit areas,” he argues.
Tax change a cash grab?
So who’s the villain? Within the credit union system, some people are eyeing the chartered banks with some suspicion. Goodale says his Bay Street sources told him the banks didn’t lobby for the tax hike and were just as surprised as credit union managers when it turned up in the budget. He believes the answer is far less sinister – that the move is a simple cash grab.
“You can see the government’s line of thinking. They’re going to balance the budget, by hook or by crook by 2015,” he says. “That’s why they’ve come up with new payroll taxes on small business and increased import taxes. This decision fits into the category where they think they can quickly grab taxes.
“If the provinces follow suit on this, the increase imposed will more than double the tax burden. The federal move is bad enough, but if the provinces mimic it, this is a huge tax increase.”
Tax hike ‘misguided’
Peggy Nash, the NDP’s finance critic, calls the tax hike misguided.
“Credit unions were started in communities where the banks pulled up stakes,” she says. “Now, credit unions have invested lots of money in small communities. The tax increase was a complete surprise. When I met with credit union managers, they said they were completely blindsided. I can’t think of a good reason to do this.”
FATCA provides another administrative burden
It doesn’t help that financial institutions in Canada are also facing onerous new reporting rules driven by the U.S. Foreign Account Tax Compliance Act (FACTA), which imposes a new administrative burden to report on accounts of U.S. citizens held at foreign and offshore financial firms. Now, the new tax burden is adding to their woes. Take the two issues together and it’s shaping up to be a tough time for the system.
Gary Rogers believes it’s unlikely the government will reverse course on the new tax rate at this point, although he adds that credit unions will continue to seek a roll-back or new tax measure to incent credit union capitalization. Leaders of financial services cooperatives plan to meet their MPs at every opportunity to push the cause, including using Canadian Central’s annual “Hike the Hill” lobby day in Ottawa in early November.
“We’re not used to being shut out of the process like this,” he says of the government’s surprise decision to up the tax rate. “We have always worked in partnership with legislators in the past. As a result, I think the government simply lumped us in with banks. They didn’t look at the broader picture.” ◊