When it comes to financial services for community-based businesses and individuals in smaller towns in British Columbia, a local credit union (CU) is often the only game in town. Even in larger population centres, CUs offer a key alternative to the banks.

Still, the province has begun a five-year phase-out of a long-standing special tax treatment for its 42 independent CUs. By 2020, the income tax rate for CUs will more than quadruple – to 11% from 2.5% today.

According to Central 1 Credit Union, the Vancouver-based primary liquidity manager and trade association for B.C.’s CUs, as well as 77 CUs in Ontario, this phase-out will cost the B.C. CUs a total of $80 million more in income taxes cumulatively. That equates to more than a $1.2-billion decline in loans to households and small business in the province.

B.C.’s decision to begin the preferred tax rate phase-out follows a decision in 2013 by the previous Conservative federal government to phase out its special tax rate for CUs. That phase-out will be completed by 2017 and means the federal tax rate jumps to 15% from 11% on most CU income.

B.C., Saskatchewan and Ontario all had similar, special tax rates for their CUs and, subsequently, could choose to follow Ottawa’s lead or maintain the status quo. Only B.C. decided to follow Ottawa.

But now that the province’s preferred income tax rate benefit is being phased out, it also makes a separate, government-imposed punitive capital penalty on business lending by CUs, even more onerous.

Since 1989, CUs in B.C. have faced severe financial penalties under the Capital Requirements Regulation for the Financial Institutions Act if more than 30% of their portfolios are comprised of business loans.

The rule was put in place to prevent CUs, particularly smaller ones, from taking on too much risk in business lending. B.C. is the only province with such a penalty.

But the CUs say the rule is no longer needed. “Credit union risk management is much more sophisticated today than it was when this regulation was written,” says Anna Hardy, Central 1’s regional director for government affairs in Vancouver.

“This is proven by the fact that our loan-loss ratios are consistently lower than the banks,” she adds. “B.C. credit unions also have robust investment and lending policies that place limits on the amount of lending they do to particular industries.”

The penalty “is a disincentive for credit unions wanting to increase their business lending in the community,” Hardy says, “even though there is a growing demand out there for business loans.”

If the CU sector is going to get hit by revoking its special income tax status by 2020, then other ways to offset that tax increase should be explored, she says.

“One of the most significant issues we’re dealing with is this 30% ceiling on business loans,” Hardy adds. “Eliminating it would not only help credit unions, it would also do tremendous things for the broader B.C. economy.”

In the meantime, Central 1 and other members of the Canadian Credit Union Association (CCUA) will be in Ottawa in mid-October to meet with members of Parliament. The 2013 preferred income tax issue is definitely on that agenda.

“Some MPs have indicated they want to do something about the federal roll-back,” Hardy adds, “so that’s encouraging.”

Furthermore, she notes the provincial government has indicated that if Ottawa revokes the Harper government’s 2013 rollback, then Victoria may consider following suit.

“Ideally, we would like to see Ottawa roll back its 2013 ruling because it was this ruling that got the ball rolling in the first place,” she says. “When you’re a credit union your capital only comes from one place – your members. Unlike the banks, you can’t go to the markets, so anything that puts a strain on your capital, whether it’s taxes or whatever, will impact your business.

“If we could get relief in the punitive capital penalty area, the increase in income tax would not be so onerous,” Hardy adds.

In addition, Central 1’s CEO Don Wright notes it will continue to advocate for a permanent, lower competitive tax rate and accessible financial services for British Columbians.

The B.C. Chamber of Commerce is among other groups calling on the province to extend the preferred income tax benefit, which CUs enjoyed up until this year, permanently.

“The Chamber’s advocacy for credit unions hinges on the key role that they play in providing financing of B.C.’s businesses,” the B.C. Chamger of Commerce said in a release.

But a provincial Ministry of Finance spokesman says that phasing out the income tax preference for CUs “enhances the fairness and neutrality of the tax system by removing a benefit only available to one class of financial institution.”

However, as Hardy notes, the banks have many other ways of reducing their taxes in Canada and often work in lower tax jurisdictions internationally.

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