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Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce

Issue 18 - Evidence

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OTTAWA, Thursday, June 7, 2001

The Standing Senate Committee on Banking, Trade and Commerce, to which was referred Bill C-22, to amend the Income Tax Act, the Income Tax Application Rules, certain Acts related to the Income Tax Act, the Canada Pension Plan, the Customs Act, the Excise Tax Act, the Modernization of Benefits and Obligations Act and another Act related to the Excise Tax Act, met this day at 11:00 a.m. to give consideration to the bill.

Senator E. Leo Kolber (Chairman) in the Chair.

[English]

The Chairman: We are here to take testimony on Bill C-22. Leading the delegation from the Department of Finance will be Mr. Roy Cullen, who can only stay for about eight minutes because the bells are ringing. The department officials will assist us.

Mr. Cullen, please proceed.

Mr. Roy Cullen, Parliamentary Secretary to the Minister of Finance: Honourable senators, I apologize in advance. The bells are ringing in the House of Commons and the Whip wants me back. Hopefully I can get through my remarks.

I appreciate the opportunity to discuss Bill C-22, the Income Tax Amendments Act , 2000. I will keep my remarks brief so we have time for questions.

[Translation]

This bill implements key elements of the government's Five-Year Tax Reduction Plan, which was introduced in the 2000 budget and expanded in the October 2000 Economic Statement and Budget Update.

[English]

It also includes the technical amendments introduced last fall in Bill C-43, which died on the Order Paper when the election was called.

I will begin with a discussion of some of the personal income tax highlights.

The five-year, tax-reduction plan provides for tax reductions at all income levels as of January 2001. The low- and middle-income tax rates fall to 16 per cent and 22 per cent respectively. The top 29 per cent is reduced to 26 per cent on taxable incomes between $61,000 and $100,000, which means that the 29 per cent rate applies only to taxable income over $100,000. The 5 per cent deficit reduction surtax is also eliminated as of January 2001.

In addition, the bill affirms the 2000 budget commitment to increase the basic personal amounts to $8,000 by 2004 and to increase the tax bracket thresholds to at least $35,000, $70,000, and $113,804 by then.

Families with children will also benefit through increased support under the Canada Child Tax Benefit, the CCTB, which will come into effect in less than one month from now on July 1. The maximum Canada Child Tax Benefit for the first child increases to $2,372 as of July 2001, well on the way to the government's five-year goal of $2,500 for the first child by the year 2004.

Together, the changes in Budget 2000 and Canada Child Tax Benefit enrichment announced in the October 2000 economic statement will increase annual benefits to families with children by $2.6 billion by the year 2004-05.

Other measures in this bill are specifically designed to help those who need it most. For example, the bill increases the maximum annual amounts for the disability tax credit, the childcare expense deduction for children eligible for the disability tax credit, and the caregiver and infirm dependent credits in 2001. It extends eligibility for the disability tax credit to individuals who must undergo extensive therapy to sustain their vital functions and expands the list of relatives to whom this credit can be transferred.

In addition, it also includes certain incremental costs under the medical expense tax credit when a principal place of residence is built for people who lack normal physical development or who have severe and/or prolonged mobility impairments.

[Translation]

Further, up to $3,000 in scholarship, fellowship and bursary income is tax exempt where it is paid in connection with education programs that qualify for the education tax credit, and self-employed individuals can deduct the employer portion of CPP/QPP contributions paid for their own coverage.

[English]

The technical amendments include measures such as clarifying the rules under which clergy can claim a deduction for their residence and exempting municipalities from filing T-4 slips for volunteers to whom they paid less than $1,000 in the year.

Honourable senators, the five-year tax reduction plan also helps to make Canada's business income tax more internationally competitive. Federal corporate income taxes will drop to 21 per cent from 28 per cent for businesses in the highest tax sectors to make them more internationally competitive, beginning with a 1 per cent point cut effective January 1, 2001.

By the year 2005, the combined federal-provincial tax rate will drop to 35 per cent from an average of 47 per cent in 2000, 5 percentage points lower than in the U.S. This change will put our businesses on a more competitive level with other G-7 countries.

The bill also allows tax-deferred capital-gain rollovers for investments in shares of certain small- and medium-sized active business corporations and drops the capital gains inclusion rate to one-half. This will make our top federal-provincial tax rate on capital gains lower than the comparable combined top rate in the U.S.

[Translation]

In addition, the employee stock option deduction increases from one-third to one-half; tax on certain stock option benefits can be deferred until the shares are sold; and an additional deduction is permitted for certain stock option shares donated to charity.

[English]

Unfortunately, time permits me to highlight only a few of the remaining measures. They include, for example, a comparable tax system for both Canadian banks and foreign bank branches operating in Canada, strengthening the thin capitalization rules, phasing out of the special tax regime for non-resident-owned investment corporations, a temporary 15 per cent investment tax credit for grassroots mineral exploration and a clarification of the tax treatment of resource expenditures and the rules governing gifts of ecologically sensitive lands.

The bill also introduces new rules for the taxation of trusts and beneficiaries, measures that ensure Canada retains the right to tax emigrants on gains that accrue during their stay in Canada and changes in the deductibility of advertising expenses under the 1999 Canada-U.S. foreign periodical agreement.

Those are the highlights of the bill.

As I said earlier, I must go back to the House of Commons for a vote. The very capable officials here can deal with your questions or comments. I would be prepared to come back after the vote, if that is the pleasure of the Chairman. If you call my office, I will be happy to do that. I am sure the officials here can deal with any questions or concerns you may have.

Senator Tkachuk: I have a couple of questions on stock options. Currently, they are subject to a $100,000 annual limit on the amount of options eligible for a tax deferral. Therefore, I assume the $100,000 net gain is tax deferred. Is the government considering in any way increasing that limit? For larger companies, and even smaller ones, that amount of money is not very large. What is that government policy based on? Why are you forcing people to pay the tax over $100,000 which, up until this past year, you were forcing them to pay at the beginning even though they had not sold the asset? What is the government's overlying policy as to why there is this policy in the first place?

Mr. Gérald Lalonde, Senior Chief, Tax Legislation Division, Department of Finance: The $100,000 is not the figure for the implied gain on the realization of the stock option. That figure is the value of the securities at the time the option is granted. In fact, there could be well in excess of $100,000 of benefit on the option when it is eventually exercised. That will qualify fully. It is the value of the underlying securities at the time the option is granted rather than at the time the option is exercised. In fact, it can be a much larger number than what you are anticipating in the way you posed the question.

Senator Tkachuk: It is the value of the granting of the option. Let us suppose that a chief executive officer has 200,000 options at a dollar apiece. Is $200,000 the value at the time that the option is granted, not necessarily if it is exercised?

Mr. Lalonde: That is right. The benefit at the time the option is exercised could be a lot more.

Senator Tkachuk: When does the tax take effect?

Mr. Lalonde: Under the general principles, if you had not claimed a deferral, tax is imposed on the benefit realized at the time the option is exercised. For example, if you had a share with an option price of $2 and the fair market value at the time you exercised the option was $102, then under the general rules you would realize a taxable benefit at that time of $100. To the extent that the option is a prescribed option, that is, an option that was issued at a price that was no less than the fair market value of the share at the time the option was granted, so that there is no bargain price at the time the option is granted, then, on exercise, there is a deduction in computing taxable income with the amendments in this bill of one-half of the stock option benefits. Therefore, in that example, there would be $50 net included in your income. Under proposals also included in this bill, that $50 net inclusion can be deferred until the time you dispose of the security. The ability to elect for that deferral is limited to $100,000 worth of securities per year.

Senator Tkachuk: Do you have a deal with accountants or something? I understand this stuff pretty well, but you have lost me. Let us do something really simple. Let us go to a buck and two bucks. I understand the difference between when the option is granted and the value of the stock. Let us assume that the option price is the same as the value of the stock at the time that it is granted. There is no gain there, it is just a buck; is that right?

Mr. Lalonde: Yes.

Senator Tkachuk: Take me through it, please. Just keep it between $1 and $2 and the price is exactly the same. Perhaps I will understand better. I am a little slow.

Mr. Lalonde: Are you assuming that he exercises the option at the time the share is worth $2?

Senator Tkachuk: Is there a tax? If it is the case of just granting an option, is there any tax on that?

Mr. Lalonde: No.

Senator Tkachuk: Let us say that six months later the stock goes to $2. He exercises the option and pays $1 for the stock. He has to write a cheque, right?

Mr. Lalonde: Right.

Senator Tkachuk: He could sell the stock at $2. Therefore, he would realize a capital gain of $1.

Mr. Lalonde: Do you mean to say that he actually sells the share?

Senator Tkachuk: No, he does not sell it.

Mr. Lalonde: He exercises the option and buys a share. He now has a share that is worth $2. He paid $1 for it. He gets an income inclusion of $1 and a deduction in computing taxable income of 50 cents. The net income inclusion is 50 cents, unless he elects to defer that income inclusion, in which case that net income inclusion of 50 cents is deferred until such time as he sells the share.

Senator Tkachuk: But he pays the tax on anything over that. Let us say it is worth $.5 million. Would he pay the tax on the other $400,000 net?

Mr. Lalonde: The gain after the time he acquired it would be considered to be a capital gain.

Senator Tkachuk: Even though he had not sold it?

Mr. Lalonde: No, when he sells it. If he sells it for half a million dollars 10 years in the future, the gain over and above the value at the time that he exercises the option would be considered a capital gain. Under the rules proposed in the bill, half of it would be included in computing income.

The Chairman: Is that not a fair improvement over what it used to be?

Mr. Lalonde: Yes, it is an improvement on two counts, one because of the reduction in the inclusion rate for capital gains. The net taxability has been reduced to half. The ability to defer is something new that is introduced in this bill as well.

Senator Tkachuk: What is the policy reason for doing this at all? What is the reason for making people pay tax on unsold stock?

Mr. Lalonde: In your example, the reason you have the ability to buy something for $1 when it is worth $2, the bargain price, if you will, is because you are an employee. Generally speaking, all benefits from employment are included in income. It is considered to be a replacement for salary.

Consider, senator, another employee who did not have access to a stock purchase plan but had normal employment income, paid tax on that normal employment income and then used the after-tax income to buy the exact, same share. That is the basic policy behind the taxability of the bargain price on a stock option.

One might then ask, "Well, that being the case, why is it that you allow a half deduction in computing taxable income when you do not do that for the employee who buys whatever share he wants from his or her after-tax income?" That policy relates to an incentive to encourage corporations to provide stock options to their employees as a way to encourage employees to align their interests with the interests of the corporation to increase productivity. It is supposed to be a productivity-increasing measure to reduce the taxation on what would otherwise be considered to be employment income where that income is offered through the guise of a stock option, which, of course, increases in value as the fortunes of the corporation increase.

Senator Tkachuk: If what you say is correct, then I am just a little confused on the policy option. By charging any tax at all on the increased value of the shares, you are really giving a tremendous incentive to that employee, being the president or a board member or whatever, to dispose of the stock to pay tax.

If you wish to provide an incentive for the employee to further the productivity of the company, you should give absolute encouragement for him or her to keep the stock as it increases in value. Then there is no measure to force sale of the stock to pay tax. That, to me, would seem to be a productivity incentive.

Insiders should not be forced to unload stock to pay tax. You want them to keep the stock. Would that not be a better incentive?

Mr. Lalonde: Between the act as it currently exists and the amendments in this bill, we tried to draw a balance between encouraging the holding of stock and fairness to the employee who buys shares with after-tax income and holds onto them.

In that respect, the act does two things. First, it drops the taxability from full rates to half rates by effectively allowing a half deduction in computing taxable income. The new measure allows deferral of taxation on that stock option benefit until such time that the share is disposed of, which, in effect, ameliorates the incentive to dispose of the option immediately after having exercised it.

Senator Tkachuk: I am saying you should get rid of it all and charge it on the sold stock.

Senator Angus: As a supplementary question, what about the other side of the coin? You have your option at $1. The stock goes to $2 in this example. You exercise the option. It is vested, you exercise it, and under the present law you pay income tax at regular rates on the $1 gain. Right?

Mr. Lalonde: You get an offsetting deduction in computing taxable income, so it is effectively a half rate.

Senator Angus: Under the new provision, will there be no tax at that stage?

Mr. Lalonde: Under the proposals here, subject to an annual cap of $100,000 based on the value of vesting of stock options, that 50-cent inclusion in the example we discussed would be deferred until such time as the individual disposes of the share.

Senator Angus: Does that take care of the problem of the guy who exercises at $2, his option was at $1, but instead of going up, the stock goes down two cents? We saw these problems last year with the tech meltdown. There were huge gains. Many exercised their options and had tax problems. By the time they filed their income tax returns in April, they faced a tremendous situation where the stock value was much lower than the value on which they were paying tax. The policy seemed unfair then because there is no offsetting deduction. Does this amendment take care of that? It sounds as though it does.

Mr. Lalonde: There is nothing in the bill that takes care of that problem directly. It does ameliorate it because of the ability to defer the taxation of the income inclusion.

Senator Angus: It is only a deferral. It becomes a liability on the date that you exercise it, but it is deferred until sale. If you sell at one cent, it is tough bananas. Right?

Mr. Lalonde: It still considered to be income from employment, the half inclusion. Therefore, to the extent that there are any capital losses that arise after that time from the share going down instead of up, that is considered to be a capital loss. Capital losses are, under general principles, deductible only against capital gains.

Ms Lise Potvin, Senior Chief, Employment and Investment, Personal Income Tax Division, Department of Finance: Any subsequent loss, as Mr. Lalonde said, is a capital loss and can be used to offset capital gains. That being said, we have heard representations from people who had losses recently and we are working on that.

[Translation]

Senator Angus: Would you agree with me that this is a major problem at this time?

Ms Potvin: I would not go so far as to say that, but we do know that this issue has been raised. We are in the process of reviewing the matter, but there is no easy solution. We are dealing with equity problems in the case of individuals who have lost their shares, shares that were not stock options. It is a complex issue, one that we are looking at closely.

Senator Angus: Have any proposals been advanced on ways of either correcting or improving the situation?

Ms Potvin: At this stage, we are still studying the situation. There is no clear solution and no decisions have yet been made.

[English]

The Chairman: Some of us - I am sure this includes you, Senator Angus - have been involved in companies that give options to directors. The companies I ran always gave options. It is not a simple thing.

Senator Angus: In my world, there are a lot of sad people these days. No one was shedding any tears for them, of course, when their stocks were at $100, but when the stocks went down to $2 by April 30 many of those stockholders were facing big tax liabilities and they had no money to pay. We saw this often at our law firm.

The Chairman: When a company gives an option, it is a win-win situation for the recipient really.

Senator Angus: It is not necessarily because, in many cases, there is no salary. The option is all you get and, if you decide to exercise it, the tax is payable at that moment under the present law, which is much worse than under this bill. What if between that date and when you file your tax returns there is a substantial reversal? For you, with all due respect, Mr. Chairman, those are the vagaries of being in the investing world. For many others the loss may involve their only asset and they are wiped out.

The Chairman: At that point, the person is taking a gamble and should be advised to sell the stock. Is that not really the answer?

Senator Angus: What I am saying is we lived in this time. They were exercising and they were not selling.

The Chairman: Exercise and sell.

Senator Tkachuk: My point is that the policy statement was that options are granted to give incentive to employees and people involved in the company to continue to be productive. In my view, you are actually forcing people with options to sell their stock to pay the tax when, in reality, you want insiders to retain the stock and build the company.

The Chairman: Then they should not exercise it.

Senator Tkachuk: That is true, but at some time if you are not getting paid, you must sell.

The Chairman: I understand that, but they do not have a tax problem with that then.

Senator Tkachuk: There is a big difference if you are a member of a company that pays salary to a board member who puts in a lot of time. Many companies have no remuneration for board members except the option itself.

You say, "Do not exercise the option." The board member can continue to work without pay. You want insiders to retain the stock and to increase the value of the stock. That is the whole reason for options in the first place. Otherwise, companies would just pay people up front.

The Chairman: I do not know why we are debating this.

Senator Tkachuk: The minister is not here, so we are talking to each other. That is good. This is a policy area. The bureaucrats can answer the technical questions very well.

The Chairman: Many people who get options will, at some point, want to spend that value - perhaps for a house or a car - so they exercise the option and they pay their tax on only 50 per cent of the gain. Our committee got this thing going. Now capital gains are reasonable. I understand what you are saying, Senator Tkachuk, but I just do not think there is a policy that can look after it.

Senator Tkachuk: My view is that we should not charge a tax until the stock is actually sold. That would solve the problem.

Senator Furey: Why are people exercising their options? Is it because they are running out of time?

Senator Angus: In some cases it is because there is a limit in the vesting period. For whatever reason, they may exercise the option at a certain price, thinking the stock will go higher, and they want to roll it into an RRSP. That is a common thing. At that moment the tax is due. What the gentlemen are saying is that at least, under this bill, you will not have to pay it right away. It will be deferred until you ultimately dispose of it.

Senator Furey: That does not change anything.

Senator Angus: If it goes way down, you still have to pay that tax at the high end. That is where there have been some very terrible cases. There is a capital loss provision which Ms Potvin just explained to us, but I do not think that solves the whole problem.

Senator Oliver: It does not, particularly if you do not have capital gains.

Senator Furey: Can you hold onto it forever and a day? If the tax is not payable, can you hold onto it and not have to pay the tax?

Mr. Lalonde: That is true.

Senator Kroft: Does your policy contemplation also have a view on revaluation of options?

Mr. Lalonde: I will respond to some of the issues that have come up before I answer that question.

In the context of people who exercise stock options and then put them into their RRSPs, presumably that would not give rise to a very serious tax problem. That is because, notwithstanding that the tax could become due at the time the option is exercised, by virtue of having contributed the shares to an RRSP they would get a deduction on income account which would more than offset the income inclusion. In fact, it would at least double the offset that would happen on the exercise of the stock option.

In terms of the incentive to aligning employee interests with the corporation, as the Chairman has suggested, that incentive works best before the individual has exercised the option because at that point the individual is in a win-win situation. If the fortunes of the share keep going up, the value of his right to exercise the option keeps ongoing up. There is no downside because if the value of the shares tanks at that point, having not exercised it, there is no gain or no loss. It is only after the time that individuals exercise the option that they have both the upside in terms of the share growth and the downside in terms of the share drop in value. It is at that time that they have effectively made the decision to invest in the shares of the corporation as opposed to just keeping the option. That is why it is called an option; it is an option to exercise the shares. The Chairman is quite right that common practice is to exercise the option only at such time as you intend to dispose of the share. That is not inconsistent with the policy of having employees align their interests with the corporation.

On the other hand, there are times when people exercise options for other reasons, one of which might be that the option is about to expire. Another reason might be that they are interested in getting dividends on the shares as opposed to capital gains. In those circumstances, as we have discussed, this is effectively making an investment in the corporation at that time. Just like anyone else who makes an investment in the corporation at that time, the employee get capital gains or capital losses arising from that point on.

Under current tax policy, capital losses are not deductible against income from other sources for anyone. They are only deductible against capital gains. However, as Ms Potvin pointed out, we are aware of the issue. The department and the government are examining the issue in circumstances which may give rise to - I would not say unintended results, but results that may prove to be of some hardship in the circumstances.

In terms of revaluations, at the beginning of the discussion we prefaced the whole issue by saying that the ability to get the half deduction in computing your taxable income is conditional, at least in the case of public corporation stock options, on the option having been granted at a price no less than the fair market value of the share at the time the option is granted. For example, if a share is trading at $25, you cannot grant an option at that time for less than $25 - the notion being that you cannot give an immediate bargain element and expect to get preferential tax treatment on it.

That being the case, when you revalue an option, you have to ensure that the revaluation does not give rise to a situation where you created an immediate bargain compared to what the status quo ante was immediately before the revaluation. There are rules in this bill that deal with revisions to stock options and effectively facilitate reorganizations of a stock option so long as there is no increase in the bargain element at the time of the revisions to the option.

The Chairman: Are you saying it is straightforward that if you had an option at $40, the stock is at $20, the company cancels all the options and gives you a new option at $20, this is okay?

Mr. Lalonde: If you replace one option with another, yes. There are variations. You could have a stock split where you used to be able to buy stock A and now you can buy stock B, but stock B is only worth half as much so the option price is now adjusted so that the exercised price is half as much, taking into account the amount of the bargain price.

[Translation]

Senator Poulin: One of the changes proposed in Bill C-22 is to make all benefits taxable, whether they are received by a member of the board of directors, the CEO or an employee, just as vehicles, apartments and so forth are taxable.

What I do not understand is that since shares are not taxed until they are sold, that his until the employee exercises his stock option, what difference is there between Bill C-22 and the legislation currently in effect in so far as employee "benefits" are concerned? I do not quite understand this difference.

Ms Potvin: Basically, the difference between the old and new regime is that in the case of certain options, employees are not taxed on the benefits prior to selling their shares, whereas in the past, they were taxed every time they exercised their stock options.

[English]

The Chairman: I understand Senator Angus' point. It is a hell of a problem. However, by and large, is it not a fact that the only time someone exercises is because they are going to sell, otherwise what is the point? I hear what you have said about dividends. You would need one whopping dividend because you are not getting a dividend on the whole thing; you are paying half tax. If the dividend is four, you need a dividend of eight to make up for it.

Ms Potvin: I think the major reason an employee would exercise and hold onto the share is probably because the option is about to expire.

The Chairman: That would be the only reason. For those who exercise when the option is not expiring, it is clear they want to sell; they have some need for the money.

Ms Potvin: That is right. That is the rationale.

The Chairman: Or they think it will go down, obviously.

Senator Tkachuk: You should get together with the securities people on these options. I think this should all be based on policy. I am not arguing just on the fact that I think it is unfair to tax people on unrealized income, I am arguing on the basis that for investors in public companies, like myself, if we are investing in a company we want to know why insiders sell stock. That is a big signal to the market. I want to know right away. I think the time period is too long before people know that insiders are selling stock. In today's electronic world, people should know whether insiders are selling stock that day, or within three days or five days. When tax is charged the way it is on options, we are giving reasons to sell stock that have nothing to do with anything except paying tax. When I see an insider selling stock, I wonder whether he is selling it to pay tax or because things are going badly and that is a signal to the marketplace not to buy that stock. When I see an insider selling stock, I am out of there.

That is important and through tax policy you are sending signals that are not good for the market or for investors, which is the secondary reason I am bringing this up. I do not want people selling stock to pay tax. If people are selling stock, that signals to me that the company is going down and I am out of there.

The Chairman: What do you mean by people selling stock to pay tax?

Senator Tkachuk: You are charged tax on income that is not earned yet because you have not sold your stock. You have an exemption for $100,000, but over that you have to pay, do you not?

Mr. Lalonde: It is $100,000 worth of shares in the year they are vested. At the time you exercise your option, the bargain price may be more.

Senator Tkachuk: At $1 million you would be paying tax, would you not?

Mr. Lalonde: Not necessarily. If you were given an option to buy shares for $100,000 that were currently worth $100,000 and in the year that you exercised the option they are worth $3 million, such that there is $2,900,000 of gain, all that gain could be deferred under the proposals in this bill.

Senator Tkachuk: That is up to $100,000.

Mr. Lalonde: It is $100,000 worth of securities at the time the options are granted.

Ms Potvin: The limit is annual, so you get $100,000 every year. For employees who are granted shares every year there is potentially a large amount of stock option benefit on which tax can be deferred. The limit is generous. It is the same as in the U.S. I think it is not very likely that many people will be in a situation where they are so cash-strapped that they would sell the stock to pay the tax.

Senator Angus: If they roll it into an RRSP is that deemed to be a sale and the deferral disappears?

Mr. Lalonde: That is right, but they would get the deduction for contribution to the RRSP.

Senator Angus: Yes, if there were any room left.

Mr. Lalonde: It could not be contributed to an RRSP if there was no room left.

Senator Angus: Can one sell stock to an RRSP?

Mr. Lalonde: One can sell stock to an RRSP, yes.

Senator Angus: That would be a disposition.

Mr. Lalonde: That would be a disposition, yes.

Senator Tkachuk: You have come a long way on options, but I would like to see you go further. I want to go back to capital gains. We have not gone far enough on them.

When you make a capital gain, under the tax law 50 per cent of that capital gain is considered income and you pay one-half of it in taxes if you live in Saskatchewan or Newfoundland and are in that tax bracket. Is that not correct? That is considered income.

Mr. Lalonde: That is correct.

The Chairman: You pay 25 per cent on the whole gain.

Senator Tkachuk: I understand that. I have this all figured out. However, if you have a loss, you do not consider it income but rather a future tax deduction on a future capital gain.

Mr. Wallace Conway, Chief, Corporate Reorganization and Capital Gains, Department of Finance: That is right. A capital property is a property that produces a capital gain or a capital loss. You are correct that, when you accrue a capital gain, half of it is included in income. You are also correct that you can only deduct a capital loss against capital gains.

That is by design in order to create a matching. The reason for that is capital gains and losses are only realized when you actually sell a property, whereas income and losses are accrued. You could sit on a capital gain and defer the tax by not selling the property. However, you can realize a capital loss knowing that you can wait a month and buy it back again. You can then deduct that against your income.

In order to create fairness in the system, we only allow you to deduct capital losses against capital gains.

Senator Tkachuk: I know that, but you treat it differently and you make assumptions. The property has not been sold, so there is no income realized; it is only an asset that is realized. So you are treating that increased asset as income and we should be paying tax on it. You are saying that it is bad not to pay tax on it because my asset has gone up. However, I am also running a risk because that asset could decline the next year and I could lose a lot of money.

Why do you not treat it all the same and allow losses to be deducted from income?

Mr. Conway: Ultimately everything winds up in income. To the extent that you can deduct a capital loss, it affects your income. Just as capital gains go into calculating your income, ultimately when you can deduct the capital loss it reduces your income. The tax system only allows deduction of capital losses against capital gains and that is because you can cherry-pick. You can select what losses you will realize.

Senator Tkachuk: Of course you can, but you have not sold that so there is no income - unless the government thinks it should have a piece of the action if my asset has increased a bit, even though I have not sold it.

Mr. Conway:It is realization versus accrual. Also, there is a three-year carry back and an indefinite carry forward, so to the extent that you ever have a capital gain you can deduct the loss and it will reduce your income. When the taxation system for capital gains was implemented, in order to stop games playing with regard to realization, deduction of capital losses was restricted because you can select. That is the reason for it.

Senator Tkachuk: I do not agree with the reason.

Mr. Conway: Yes, but that is the reason.

Senator Tkachuk: Thank you.

Senator Hervieux-Payette: I move that we proceed to clause-by-clause consideration of the bill.

The Chairman: I wish to thank the witnesses for their appearance today.

Is it agreed that we proceed to clause-by-clause consideration of Bill C-22?

Hon. Senators: Agreed.

The Chairman: Is it the intention of any honourable senator to propose an amendment to this bill?

Hon. Senators: No.

The Chairman: Shall the title stand postponed?

Hon. Senators: Agreed.

The Chairman: Shall clause 1, the short title, stand postponed?

Hon. Senators: Agreed.

The Chairman: Shall Part 1 clauses 2 to 63 carry?

Hon. Senators: Agreed.

The Chairman: Shall Part 1 clauses 64 to 195, carry?

Hon. Senators: Agreed.

The Chairman: Shall Part 2, clauses 196 to 237, carry?

Hon. Senators: Agreed.

The Chairman: Shall Part 3, clauses 238 to 248, carry?

Hon. Senators: Agreed.

The Chairman: Shall Part 4, clause 249, carry?

Hon. Senators: Agreed.

The Chairman: Shall Part 5, clause 250, carry?

Hon. Senators: Agreed.

The Chairman: Shall Part 6, clauses 251 and 252, carry?

Hon. Senators: Agreed.

The Chairman: Shall Part 7, clause 253, carry?

Hon. Senators: Agreed.

The Chairman: Shall Part 8, clause 254, carry?

Hon. Senators: Agreed.

The Chairman: Shall Part 9, clauses 255 and 256, carry?

Hon. Senators: Agreed.

The Chairman: Shall Part 10, clauses 257 to 262, carry?

Hon. Senators: Agreed.

The Chairman: Shall Part 11, clause 263, carry?

Hon. Senators: Agreed.

The Chairman: Shall Part 12, clause 264, carry?

Hon. Senators: Agreed.

The Chairman: Shall clause 1, the short title, carry?

Hon. Senators: Agreed.

The Chairman: Shall the title carry?

Hon. Senators: Agreed.

The Chairman: Shall the bill carry?

Hon. Senators: Agreed.

The Chairman: Shall I report the bill?

Hon. Senators: Agreed.

The Chairman: Senators, that finishes our work probably until September. I want to thank you all for your astuteness and great questions.

The committee adjourned.

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