Federal Budget

BUDGET 2018: The competition heats up

February 28, 2018

If last year’s budget was largely a wait-and-see response to a new U.S. president with game-changing ideas about trade and tax, well, not a lot has changed. Budget 2018 maintains Ottawa’s cautious position in the face of a continued existential threat to the North American Free Trade Agreement and a new, more competitive U.S. corporate tax regime.

In his speech to parliament, Finance Minister Bill Morneau acknowledged that businesses are “concerned” about challenging trade talks and U.S. tax changes. He said the government “will be vigilant in making sure Canada remains the best place to invest, create jobs and do business – and we will do this in a responsible and careful way, letting evidence, and not emotion, guide our decisions.”

“With the recent tax changes, the U.S. has made it more attractive for companies to do business there,” says Sun Life Global Investments Chief Investment Officer Sadiq S. Adatia. “We hope there will eventually be a policy response from Ottawa, but we recognize that an effective plan will take time and focus. In the meantime, companies – and investors – will just need to live with some temporary uncertainty.”

The budget forecasts a deficit of $18.1 billion for the 2018-19 fiscal year, falling to $12.3 billion by 2022-23. One key measure of economic health – the debt-to-GDP ratio – is expected to drop to 28.4% from 30.1% over the next five years.

Budget initiatives continue to reflect the government’s multi-year pledge to improve the standing of the middle class. In addition, there is a sharp focus this year on promoting gender diversity and inclusivity.  In fact, the budget says “every single decision on expenditure and tax measures” was informed by its gender-based analysis tool.

There’s one stakeholder group that’s likely breathing a sigh of relief: small business owners. After getting off to a rocky start last year with a controversial proposal to revise tax minimization strategies related to passive investment income, the finance ministry is now nailing down more of the details. And the changes are not as punitive as some had feared.

Jennifer Poon, Director, Tax and Estate Planning for Sun Life Global Investments, says she’s pleasantly surprised. “The proposals outlined in the budget are much softer than what was first put forward,” she says. “These changes are far simpler to navigate.”

Those proposals and additional budget initiatives are highlighted in more detail here:

BUDGET HIGHLIGHTS

• Taxation of passive investment income. The budget proposes that companies earning over $50,000 of income from passive investments in a year will see a gradual reduction in the amount of active business income eligible for the small business tax rate (set at 9% for 2019). Eligible income will be reduced by $5 for every $1 of passive income above $50,000. Companies earning more than $150,000 in passive income won’t be eligible for the small business tax rate. The change is proposed to take effect in tax years after 2018. (GBK HAVE DEVELEOPED STRATEGIES ASSISTING WITH THIS CHANGE)
• Gender pay equity. To close the gap between what men and women earn, the budget proposes to introduce new pay equity legislation covering 1.2 million people employed in federally regulated sectors. It would create a streamlined process for employers, set out timelines and provide independent pay equity oversight. There are few details on the impending legislation, but the government plans to continue consulting employers in the coming months.
• Boosting financial support for parents. To support greater equality in the home and workplace, the government proposes to provide $1.2 billion over five years starting in 2018-19, and $344.7 million per year thereafter for a new EI Parental Sharing Benefit. The benefit will provide additional weeks of “use it or lose it” EI parental benefits when both parents agree to share parental leave. The incentive is expected to be available as of June 2019.
• More funds for women entrepreneurs. The government is proposing a number of steps to help female entrepreneurs under a program called Women Entrepreneurship Strategy. The budget proposes to make $1.4 billion in new financing available through the Business Development Bank of Canada over the next three years. It also proposes to increase funding to women-led technology firms to $200 million from $70 million over the next five years.
• A national pharmacare program – baby steps. The government took the first small steps toward a national pharmacare program to cover the cost of prescription medications, starting with the creation of an advisory council to begin discussions and offer recommendations. The budget did not set out any funding amounts for the program.

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Sadiq Adatia says he expects two main trends to continue for at least the rest of the year: higher stock market volatility compared to the last couple of years, and the continued outperformance of foreign markets compared to our own. (For reference, consider that since the last budget day on March 22, 2017, the S&P 500 including dividends has returned 19% in US$, the MSCI EAFE Index representing international developed markets has returned 20% in US$, and the MSCI Emerging Markets Index has returned 29% in US$. Canada’s S&P/TSX Composite Index has returned 5%.)

“Our relatively negative view toward Canadian stocks has been a theme for many years now, with a just a few short periods of optimism sprinkled throughout,” explains Adatia. “We believe an overheated housing market and high consumer debt pose a risk to Canada’s economy and stock market.”

Adatia forecasts higher volatility, but says that shouldn’t scare off disciplined investors. “Even if markets grow more choppy, as we expect, that’s never a reason to stray from the long-term plan. Investment success depends in large part on patience, discipline and strong risk management. Staying invested in a well-diversified portfolio is a strategy that’s stood the test of time.”

Higher interest rates and inflation are also hot subjects these days, but Adatia remains generally unfazed. “What we’re experiencing now in the bond markets is what we’ve been waiting a long time for. We all knew the days – the years! – of record low interest rates would eventually come to an end. We’re not there yet. But the process is underway.”

The bottom line for investors? Stay the course, but also, stay alert. “Stocks and bonds are both at an historic inflection point,” cautions Adatia. “You have a stock bull market with the potential to clock in as the longest ever, and you have a bond market standing by to absorb higher interest rates from ultra-low levels. Change is coming, but no one has to manage it alone. Professional investment management, sound financial advice – these are powerful tools for helping maintain a combination of discipline and flexibility in your portfolio. Ask questions. Take advantage of your resources. It’s your money after all.”