Proceedings of the Standing Senate Committee on
Banking, Trade and
Commerce
Issue 6 - Evidence
OTTAWA, Thursday, June 20, 1996
The Standing Senate Committee on Banking, Trade and Commerce, to which was referred Bill C-36, to amend the Income Tax Act, the Excise Act, the Excise Tax Act, the Office of the Superintendent of Financial Institutions Act, the Old Age Security Act and the Canada Shipping Act, met this day, at 11:00 a.m., to give consideration to the bill.
Senator Jack Austin (Acting Chairman) in the Chair.
[English]
The Acting Chairman: Honourable senators, our first witnesses are officials from the Department of Finance.
Mr. Len Farber, Director, Legislation, Tax Policy Branch, Department of Finance: Mr. Chairman, it is a pleasure to appear in front of this committee to talk about Bill C-36. As you are aware, this bill implements the income tax measures that were announced in the budget of February 27, 1995. The legislation before you this morning has been released in draft form. Draft legislation following the February 27, 1995 budget was first released July 19, 1995. Regulations pursuant to measures in this bill were also released and the draft formed a comprehensive ways and means motion tabled in the House on December 13, 1995. As a result, this legislation has been out in the public domain, has benefited from the input of taxpayers in general, and certain concerns that have been brought to our attention are reflected herein.
The bill can generally be broken down according to measures in two fairly distinct areas. Those measures will increase fairness and tighten up the tax system and there are other measures relating to tax rate increases.
Mr. Chairman, I will give you a brief synopsis of the major items, starting with the measure on the tax deferral of business income. Professionals and other business persons could defer taxation on business income by simply choosing an off-calendar fiscal period. This budget alters that and places everyone on a calendar year basis. The legislation provides a 10-year phase-in period to bring in the amount that had been deferred over that period of time.
Following the budget, there were consultations regarding the mandatory year end. Some professionals and business people were making the case that off-calendar year-ends were required for business purposes. An alternative taxation method in this bill allows people to pick an off-calendar year-end, but they have to pay the notional tax equivalent to year-end, being December 31. They have the option of going to an off-calendar year-end, but also dealing with the deferral of tax at the same time.
As well, this bill has a new measure in it, the film tax credit, which replaces the former tax shelter, capital cost allowance system that was available for Canadian feature film productions. Under the capital cost allowance system, the Canadian feature film production system was a tax shelter type of mechanism sold to investors through a number of different middlemen.
The bulk of the incentive measures were actually taken off the top by the investors and these middlemen or these promoters, such that there was very little left to go into the actual production of the film. The former capital cost allowance mechanism for Canadian feature films is being replaced by this film tax credit, which will be a direct incentive measure for the producers of these films. The dollars will go right into the production. The credit itself will be 25 per cent of qualifying labour expenditures up to 48 per cent of the cost of the film, for a net credit equal to 12 per cent of the cost of the film.
This measure has been applauded by the film production industry in Canada. They have been working through their associations with the department over a number of years, and I think it is a very welcome incentive for the production of Canadian films in Canada.
As well, this bill deals with the issue of family trusts. You will recall the numerous newspaper articles and issues over the last number of years dealing with the 21-year rule and preferred beneficiary elections, and the controversy surrounding the extension of that 21-year rule. This bill deals with those two issues. First, the election to defer the 21-year rule is eliminated. For trusts which have already elected to defer the 21-year rule, there will be a deemed disposition of trust assets at fair market value on January 1, 1999. In addition, the preferred beneficiary election will be restricted to disabled beneficiaries, but other than in that area it will eliminated.
As well, Mr. Chairman, this bill deals with retirement savings issues. The 1995 budget took action to ensure that the fiscal cost of tax assistance for retirement savings is shared fairly. The contribution limit for registered retirement savings plans is being reduced to $13,500 for this year and next, and will rise incrementally to $15,500 in 1999. The limit for contributions to money purchase registered pension plans is also being reduced to $13,500, and it, too, will rise to $15,500 over time.
These changes, Mr. Chairman, are designed to bring the limits closer to the original pension reform targets of providing tax assistance on earnings up to two-and-one-half times the average wage. They will only impact in real terms on individuals earning over $75,000 a year in annual income. In addition, this bill restricts the over-contribution limit to RRSPs, reducing it from $8,000 to $2,000. The leeway can be through inadvertence or otherwise, but the limit will be $2,000.
The next item is retiring allowance roll-overs. The limit on how much retiring allowance an individual can roll into an RRSP is to be frozen at what it would have been at the end of 1995. In addition there is a measure in this bill dealing with donations of ecologically sensitive land. The 20 per cent limitation on charitable donations in any particular year will be lifted with respect to donations of ecologically sensitive land, so that any capital gain that would accrue in respect of a donation of that kind of land will be fully absorbed by the amount of the donation and not restricted to the 20 per cent limitation.
Mr. Chairman, there are measures in this bill dealing with scientific research and experimental development to ensure that the government support for this vital activity is effectively targeted. It deals with contract payments to third parties. It also contains amendments to the investment tax credit provisions which restrict qualified expenditures on which investment tax credits can be earned.
In addition, this bill contains measures dealing with joint and several liability with respect to protecting collection of source deductions and similar withholdings made for income tax, Canada pensions and unemployment insurance purposes. It will ensure that third parties who influence how cheques with respect to those source deductions are cleared through a bank or other financial institution will be joint and severally liable for those amounts in the same way that directors may be.
In addition, the bill contains measures dealing with the old age security benefits. Beginning in July of 1996, tax can be withheld when old age security benefits are paid out. This measure will facilitate the recovery of old age security benefits for high income seniors by eliminating the situation of having to repay them at tax filing time. As well, recipients who are no longer resident in Canada will not be able to escape the recovery of the old age security benefits.
Mr. Chairman, the measures I have described to you increase the fairness and tighten up the tax system. There are also a number of tax rate increases applicable in the corporate sector. There will be an additional 6.66 per cent tax on investment income of Canadian-controlled private corporations. This will bring the corporate tax rate applying to investment income closer in line with the top personal tax rate and therefore reduce any tax deferral opportunities. Bill C-36 also increases the corporate surtax from 3 per cent to 4 per cent of basic federal corporate tax, which will generate additional annual revenues of $115 million to $120 million from the corporate sector.
In addition, the large corporations tax is increased from 0.2 per cent to 0.225 per cent, generating further corporate revenues of approximately $150 million a year. As you know, this LCT, large corporations tax, which was introduced in 1989, applies to all corporations having capital in excess of $10 million. Also, a 12 per cent temporary surcharge is being levied on the capital tax paid by banks and other large deposit-taking institutions under Part VI of the Income Tax Act, and that will be applicable between budget day, February 26, 1995 and October 31, 1996.
That, Mr. Chairman, is a quick overview of the major measures included in Bill C-36. My colleagues and I are here to answer any questions that you and your colleagues may have.
Senator Hervieux-Payette: Will the old age pension benefit be removed from the Canada Pension Plan cheque? What is the mechanism?
Mr. Farber: The old age benefit is not part and parcel of the Canada Pension Plan benefit. They are two separate cheques.
Senator Hervieux-Payette: I know. Which one will be affected?
Mr. Farber: The old age pension cheque. Until now, people earning in excess of $53,215 had a portion of their old age pension cheque clawed back at tax filing time. Depending on your income level in the previous year, effective July 1 your cheque will be reduced by the appropriate amount. If your income is in excess of $84,000, you will not be receiving the old age benefit after July 1. If your income is between $53,000 and $84,000, you will receive only a part of it. Therefore, what you would have repaid at tax filing time, you will no longer receive in the first instance. Those under the $54,000 mark will receive the benefit as they received it before.
Senator Hervieux-Payette: What do they do for the rest of their income tax? Do they pay every three months? Do they have a quarterly remittance plan?
Mr. Farber: They have quarterly instalments for income that they receive. If there is employment income, it is obviously held back at source. If they have investment income, they are subject to quarterly instalments which they will continue to make. The instalment base has not changed.
Senator Hervieux-Payette: I do not know the amounts because I am not collecting yet. Let us presume that a senior is earning $350 a month over the $54,000 a year. How much of a cut would there be on $350? Does this mean that they will receive half of it, or none of it?
Mr. Farber: If he is over, he will be cut back by a proportion of that income up to $84,000. The reduction will depend on how much they were over in the previous year. It could be 10 per cent, 15 per cent, half, depending on what their income structure is. That amount does not get included in the instalment base, so the calculation is not difficult.
Senator Hervieux-Payette: It is adjusted on the basis of the income tax form filed in the previous year.
Mr. Farber: Yes.
Senator Hervieux-Payette: Have you had any major complaints since it has been put in place?
Mr. Farber: Not to my knowledge. As I say, it only really impacts at 100 per cent for those senior citizens who have income in excess of $84,000. Frankly, to the extent that the issue has been raised at all, it is more one of relief. Seniors were finding it a little unusual receiving the cheque and having to worry about paying it back at tax time.
The view was, why give it to me in the first place? So certainly for the high income individuals, it could be viewed as removing an administrative issue that they will no longer have to deal with. There is no impact whatsoever for those below the $54,000 level, so it really is a high income issue that is being dealt with, we believe, in a very appropriate way, and there has been precious little discussion about that.
Senator Hervieux-Payette: So above $84,000, they receive zero cheque. What is the percentage of seniors earning between $54,000 and $84,000? Is it 5 per cent, 3 per cent of seniors?
Mr. Farber: Mr. Chairman, I do not have the percentage with me at the moment. Suffice it to say it is very small.
Senator Hervieux-Payette: How much were you intending to collect -- $10 million, $50 million?
Mr. Farber: It is really not a question of collecting more. The government got the money back anyway through the clawback. It was just a question of timing. So, in this instance they are getting it back a little earlier and, at the same time, removing an administrative burden for those people who had to account for it at tax time.
Senator Hervieux-Payette: You are sure you will collect from those who are living abroad.
Mr. Farber: Absolutely.
Senator Hervieux-Payette: There are a few, probably, who are escaping it.
Senator Stewart: I want some more information on what is happening with regard to family trusts. Refresh my memory on family trusts. As I recall, the provisions that are being dealt with here originated back at the time of Mr. Edgar Benson's tax reform beginning, I believe it was, January 1, 1972. In the new regime there was a provision for a transitional period for family trusts. If that is correct, can you take me forward from there.
Mr. Farber: Mr. Chairman, the honourable senator is correct. The issue came about as a result of the introduction of capital gains taxation in 1972. From that time, assets in family trusts would not be subjected to taxation on any deemed realization for a period of 21 years.
Why 21 years was chosen is really a matter of speculation. It is certainly a long enough period for minor children to reach the age of majority. The assets could very well have been distributed to children on a roll-out basis, which is tax free. The anticipation was that, by and large, assets may only be realized or deemed dispositions within the trust upon death or upon disposition of the underlying assets.
The previous administration -- I do not remember the exact date -- introduced a measure whereby one could elect to defer the 21-year rule for as long as the last child of the settlor was alive.
Senator Stewart: Meaning the person who created the trust?
Mr. Farber: Yes. For example, father sets up a trust for his three children and the 21-year period is about to close. He could file an election to defer the 21-year rule until the last child passed away. The issue became somewhat controversial during a change of government, and it gave rise to a lot of speculation in the media with regard to what was viewed as reasonable deferrals.
These changes respond to that criticism and, as I mentioned earlier, respond in a way that allows a little more time beyond the first anniversary of the 21-year rule for those who had already made the election, to January 1, 1999. In effect, it says that every 21 years, to the extent that assets remain in the trust, the trust will be deemed to have realized on those assets. It is analogous to a disposition, and any capital gains that have accrued over the period from either the date of acquisition or from January 1, 1972, for 21 years, will be paid by the trust.
This measure does not take away the right and the practical application of what will happen in these circumstances, so immediately prior to 21 years assets can still be rolled out on a tax-free basis, and then realization will only arise upon actual disposition of the asset or upon the death of the owner of the asset.
Senator Stewart: Do you have figures showing on a nominal basis what the original provision with regard to family trusts cost, the fisc, and the cost of the change made by the previous government? I put it that way because obviously the value of some of the assets within the trust changed by reason of market circumstances and other such factors. So in a sense it is a nominal calculation, a best-guess calculation. Are there any figures that are helpful?
Mr. Farber: Not really. As I indicated earlier, one never could speculate on what the behaviourial response would be to a deemed tax if the trustees decided or there was a necessity to distribute the assets. This measure was not revenue-generating at all. It was an issue of, I would suggest, fairness and perception.
The only information we have available, which was provided by Revenue Canada, dates back to the 1992 taxation year, but they will give you a perspective of what trusts were doing in Canada and what assets they held. Family trusts had a net income, after allocations to beneficiaries, of $909 million. This is for the 1992 year. Income allocated to beneficiaries was in the order of $2.9 billion for the 1992 year. A fair amount of income was allocated to beneficiaries.
Senator Stewart: Tax would be paid on what was paid out to the beneficiaries?
Mr. Farber: Yes. They are treated as individuals and would be taxed at their marginal rate. Income in the trust, depending on what kind of a trust it is, whether it is an inter vivos or a testamentary trust, would be taxed at the appropriate level as well. However, it is very hard to know what, if anything, would have been garnered by the government in terms of additional tax on account of a deemed realization, because of the ability to roll assets out on a tax-free basis. Tax would only be paid, as indicated earlier, in the same way you and I pay taxes when we hold capital assets, upon disposition or death.
The Acting Chairman: Are there any other questions of these witnesses? If not, I have questions, but I am more interested in closure than in the answers to my questions. Therefore, would you stand down while we hear from the next witnesses. Then I will ask you to come back and comment on the evidence that they give us.
I understand that Shirley-Anne George, Executive Director of the Canadian Advanced Technology Association, is here. I would ask you to take a seat, Ms George, and start in right away.
Ms Shirley-Anne George, Executive Director (Ottawa), Canadian Advanced Technology Association: Mr. Chairman, our original understanding was that we would not be presenting until about twelve o'clock. On their way to us is Ms Debbie Weinstein, member of our board of directors, from Blake Cassels, and Miss Lynn Pratt from Deloitte Touche. However, I am happy to start, and hopefully they will be able to answer any questions that you might have.
The Acting Chairman: I think you heard, we will not be able to continue past twelve o'clock.
Ms George: I am the executive director in Ottawa for the Canadian Advanced Technology Association, CATA. We represent over 1,000 of Canada's best technology firms. These include companies from sectors such as aerospace computing, electronics space software and telecommunications. Our members include such well-known names as Newbridge, Corel, Fulcrum, Nortel, M3I, Icon, CAE, Bombardier, MPR, and many more. These companies are experiencing rapid growth in both revenues and job creation.
The matter that we would like to bring to your attention today needs your support if we are to help our members find a satisfactory resolution. With your permission I will briefly outline the issue, and then, if Ms Weinstein has joined us, I will let her answer the legal questions. We will then answer any questions that you might have.
The bottom line is that CATA is asking the government to reconsider its reporting requirements found in Bill C-36. We do not have a problem with what the government is trying to achieve with these reporting requirements, only the manner in which they are being adapted. Currently the statute requires that the assignment of scientific research and experimental development or R&D tax credits between non-arm's length corporations be accompanied by a written board of directors' resolution. We are asking that this requirement be changed to the less burdensome allocation form signed by an official of the company.
This matter may seem to be a small issue to you, but I ask that you listen to the impact on industry and then to ask the simple question, is the government's requirement necessary? If you feel it is, then of course we will bow to your decision.
There are four reasons why this requirement is a burden: it is outside the existing corporate law, the issue of timing, the issue of cost, and the plain burden of bureaucracy. Canadian law requires that non-public companies have a board of directors meet once per year and that a board of directors need only deal with material matters. This requirement will require additional board meetings beyond once a year, and the assignment of the tax credit is not normally considered to be material.
Corporate tax returns must also be filed within six months of the year-end. A substantial amount of work and effort will be required to meet this obligation, which we are not expecting to change. It is highly unlikely that many companies will be able to complete the preparation and still have time for a regularly scheduled board meeting. This will require the filing of a separate tax return, which is a burden not only to the taxpayer but to Revenue Canada, which has to administer the provision as well.
Second, the R&D tax credit by law must be filed within 18 months of a year-end or the tax credit is forfeited. CATA has no argument with this. This new requirement, however, adds the complexity of getting two corporations with potentially two separate year-ends and two separate schedules of board meetings to each prepare their own resolution after each company's SR&D claim has been prepared. All of this must happen within 18 months.
This is a logistical challenge for publicly-held companies but we are not arguing that they should not be able to manage it. However, technology companies can enter into these types of non-arm's length agreements when they are very small, even 10- and 20-person shops. Small companies do not have the financial management nor the systems in place to be realistically expected to meet this requirement in every case.
There is the very small cost of having an outside counsel prepare a resolution: $250 and $500 is not large, but when you are talking about hundreds of companies it becomes a considerable burden.
More important, technology companies are not "mom and pop" shops with boards made up of relatives, all living within five miles of each other. Even small technology companies will aim to have highly experienced and often geographically dispersed boards of directors. They cannot afford to be flying these members in when there is not a real business reason behind it. Nor would these highly experienced individuals be willing to come to a board meeting on a non-material matter. Even setting up a conference call between such a board can be complex and require significant lead times.
Finally, and most important, cash flow is a critical issue to such small companies. A delay in filing of their refundable tax credit, even if it is only one or two months, can mean the companies could run into significant cash flow problems.
This program is very complex and it is undergoing significant problems. CATA, Revenue Canada, Finance and Industry Canada have all been working very hard and spending countless hours to try to resolve these issues. Our members are experiencing significant delays in processing their claims. This is impacting their cash flow, and they are also undergoing very detailed and time-consuming audits. This program is considered to be absolutely critical to the health of the new economy and it simply cannot afford another hit.
Of course, there is always the other side to the story and I am sure Finance will speak very eloquently to it as well. Our understanding of why Finance needs this resolution and not just a signed form is to protect the Crown from becoming involved in a dispute over the legitimacy of a renunciation.
Informally we have also been told that the board of directors' resolution is a new department policy, that we should expect to see more of these in the future, plus the department wants to be sure that it does not fall victim to the scrutiny of the Auditor General. It demonstrates that the department has officials who are actively trying to protect their employer, and we commend the Crown. It is very admirable to have such dedicated employees. Unfortunately, it is also obvious that they do not understand that requiring a board of directors' resolution for all kinds of tax-related issues is bureaucracy for the sake of bureaucracy. It is not a straightforward matter and it does not give the Crown the protection that it is seeking.
I would now like to turn our presentation over to Ms Weinstein to provide more details on why we believe this measure does not protect the Crown.
The Acting Chairman: All of the members of the committee have seen your correspondence of June 4 and the reply of June 10 on the part of the Department of Finance, given by the parliamentary secretary, Barry Campbell, MP, to yourself. We have seen the details, and the nub of it is whether this is the imposition of an unnecessarily bureaucratic step. That is your position?
Ms George: Yes.
The Acting Chairman: At this stage, I would like to ask my colleagues if they have any questions of Ms George or Ms Weinstein.
Senator Hervieux-Payette: Mr. Chairman, the witnesses have made their point clearly. They know that we will not stop this bill from being passed. I guess there is some possibility in the future that when there is a comprehensive review of the bill the matter could be addressed.
To me, that is not the only matter that should be addressed. It is the whole administration process and the cost to companies in the R&D tax credit program. I have already talked to the Department of Industry asking them how much input they have. I know it is certainly a good source of income for the tax experts and accounting firms. I do not want to deprive them of their work; I just want to know what are the overall costs to the small companies who are involved in R&D, what this filing of R&D credits costs both the government and the private sector, compared to the amount of money that is being returned.
That is one item among many others. Taking the narrow-minded approach that it is not enough, I will just say to CATA that we certainly can relate to their situation, but would prefer to deal with the matter from a more global approach. We will talk again to the people of Revenue Canada and Finance and, of course, to those representing the industry as well.
The Acting Chairman: That is a very helpful statement. I am sure it is made on behalf of all the members of the committee. I would just like to add to it that this committee has been studying corporate governance in its broad terms. We are circulating a draft report in the business community, and we would like you to receive a copy of it. I will ask the clerk to do that.
The tendency in corporate governance in North America is to move more and more responsibilities to the board level. There is an examination going on of the role of management and its accountability. The general view has been that the board is somewhat over-accountable and management is under-accountable, but mechanisms need to be developed before management can truly be addressed as accountable.
Therefore, in support Senator Hervieux-Payette's comments, a broader examination is in fact taking place, and I concur that within that context, both of the specific examination and the broader conceptual examination, these issues need to be addressed, and this committee will, in time, address them.
I thank you for your submission and apologize for cutting the hearing short, but I hope I have been fair. Would you like to say something in addition?
Ms George: I would just like to close by expressing our appreciation for the fact that you were willing to see us. We understand that Bill C-36 is important to the Government of Canada and that it would not make sense to try and stop it at this point with an amendment. I hope that your comments of support when the government is perhaps reviewing this matter in the future will be helpful in getting it resolved.
Senator Stewart: On that point, Mr. Chairman, in our report to the Senate we should say that we want the department or relevant departments to appear before the committee at some time in the future, particularly in regard to the group that has been represented here this morning, to see if their difficulties have been realized and, if not, what can be done to address those difficulties.
The Acting Chairman: Is there any objection to so noting in our report? Concurred.
I would like to ask the departmental witnesses to return for one moment. I want to ask you one question. It relates to an issue referred to in the document entitled "Tax Measures: Supplementary Information", at page 152 under the heading "Reporting of Ownership of Interests in Foreign Properties."
What representations were received or what difficulties may appear in terms of the implementation of the provisions for reporting details of foreign holdings of Canadian taxpayers.
Mr. Farber: Mr. Chairman, as you know, the media has been seized, as well, with offshore trusts, issues of unreported income, tax havens and what not. In response, Revenue Canada has been doing a fair amount of work with regard to the underground economy. Enhanced reporting requirements as a measure of both fairness and equity were being reviewed to ensure that taxpayers understood that offshore bank accounts and offshore capital assets had to be reported in Canada.
As a result, the department developed new reporting requirements for assets having a capital value in excess of $100,000. These forms were developed in consultation with the tax professional community and taxpayers at large with a view to ensuring that on an annual basis we received better information and that those individuals who have assets held through various means in the offshore that in law should be reported in Canada, would be followed accordingly.
The Acting Chairman: I understand the system. The question really is, have you had representations with respect to the implementation of these measures or with respect to the principles?
Mr. Dan MacIntosh, Legislation Coordinator, Tax Policy Branch, Department of Finance: Yes, we have had representations from various interest groups, such as the Tax Executives Institute, the Joint Taxation Committee of the Canadian Bar Association and the Canadian Institute of Chartered Accountants.
A draft of the measures was released in early March of this year pursuant to the earlier budget announcement. That draft has gone out for consultation. We are getting plenty of suggestions and we are taking them into account in making recommendations to our minister in preparation of the legislation.
The Acting Chairman: The legislation or regulations?
Mr. MacIntosh: It involves both Income Tax Act regulations and changes to the statute itself.
The Acting Chairman: You will need further changes to the statute?
Mr. MacIntosh: That is correct, sir.
The Acting Chairman: I will not hold up the proceedings. I must say I have had representations from a number of people in my province of British Columbia who have immigrated from Asia and who have established trusts going back to before emigration under rules with which you are quite familiar. They are concerned about the way in which these matters are being developed.
I will pause there because I want to stay within my mandate.
If there are no more questions of the witnesses, may we proceed to consideration of the bill? Shall we dispense with the clause-by-clause study?
Hon. Senators: Agreed.
The Acting Chairman: Shall I report Bill C-36 without amendment but with the agreed upon observation: The committee wishes to note that it will call relevant departments to appear before the committee to hear how those departments are dealing with issues raised concerning the administration of scientific research and experimental development tax credits.
Does that satisfy you, Senator Stewart?
Senator Stewart: I think that gives us at least a landing point. If the interested parties know that the officials are coming, they themselves might wish to ask also to be heard. So we have a portal of entry. The language will suffice.
The Acting Chairman: It is agreed, then, that Bill C-36 will be reported without amendment but with the observation I just read?
Hon. Senators: Agreed.
The committee adjourned.