Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce
Issue 19 - Evidence - Meeting of May 15, 2008
OTTAWA, Thursday, May 15, 2008
The Standing Senate Committee on Banking, Trade and Commerce, to which was referred Bill C-10, An Act to amend the Income Tax Act, including amendments in relation to foreign investment entities and non-resident trusts, and to provide for the bijural expression of the provisions of that act, met this day at 10:50 a.m. to give consideration to the bill.
Senator W. David Angus (Chair) in the chair.
[English]
The Chair: Good morning, ladies and gentlemen. We are continuing our ongoing consideration of Bill C-10, an omnibus bill dealing with numerous proposed amendments to amend the Income Tax Act.
Recently, we have focused on certain provisions that deal with tax credits for film and video production. Today, we have a refreshing break from that part of the action. I am pleased to welcome our witness, Patrick Marley from the Toronto office of the well-known national law firm, Osler, Hoskin & Harcourt LLP. I believe, Mr. Marley, that you have been following our deliberations that began in November 2007.
I am Senator David Angus, from Montreal. Members of the committee are Senator Goldstein, deputy chair of the committee, also from Montreal; Senator Francis Fox, from Quebec; Senator Bert Brown, from Alberta; Senator Trevor Eyton, from Ontario; Senator David Tkachuk, from Saskatchewan; Senator Mac Harb, from Ontario; Senator Wilfred Moore, from Nova Scotia; Senator Pierrette Ringuette, from New Brunswick; and Senator Michel Biron, from Quebec. The clerk of the committee is Line Gravel.
The clerk advises me that the witness' document is in English only and, therefore, has not been distributed. If honourable senators are agreed, it can be distributed. What is the wish of the committee?
Senator Fox: It should be distributed.
Senator Harb: I oppose.
Senator Goldstein: Everything that comes to this committee should be in both official languages.
Senator Fox: I agree. The Government of Canada must deal with the citizens of this country in the language of choice of the public. However, when citizens come to the Government of Canada, I do not see why they must file material in both official languages.
The Chair: Do you withdraw your objection, Senator Harb?
Senator Harb: Yes.
The Chair: Mr. Marley, a new senator has arrived: Senator Paul Massicotte, from Quebec. Senator Massicotte, the issue before us is that the witness' document is in English only and has been given to the translators. If senators agree, we will distribute the document.
Senator Goldstein: I am opposed. I am a member of the Standing Senate Committee on Official Languages. We are fiercely committed to maintaining the principle that material for distribution be in both official languages. That having been said, if I am outvoted, so be it.
Senator Fox: In other words, we could accept it but it does not set a precedent.
Senator Goldstein: It is not a precedent and, as far as I am concerned, it is not filed.
The Chair: It is an aide-mémoire to facilitate the hearing. Your objection is noted and on the record, Senator Goldstein.
Honourable senators, shall we proceed?
Senator Goldstein: I would like to have it and we can proceed.
The Chair: Mr. Marley, please proceed.
Patrick Marley, Partner, Osler, Hoskin & Harcourt LLP: Thank you for the opportunity to speak today. As background, I am a tax partner with Osler, Hoskin & Harcourt LLP in Toronto. My practice is focused on international corporate tax planning, and mergers and acquisitions. Prior to joining Osler in 1998, I was a tax policy officer with the Department of Finance, where I assisted in drafting tax laws in the international area. I speak today in my personal capacity, so my views are my own and may not necessarily reflect those of our firm or our clients. I realize that not everyone shares my enthusiasm for technical tax matters, so I will try to avoid the technical details of Bill C-10. If senators want further explanation on any matters, please let me know.
Bill C-10 contains a variety of technical tax amendments in addition to those discussed to date by this committee. Many of these amendments are important and helpful to taxpayers. However, as I am sure you have heard from others, there are provisions in Bill C-10 that raise concerns, not so much with respect to the underlying tax policy objectives, but rather that they may extend beyond their intended scope.
I will begin by referring to one of the favourable tax changes so that senators will have a sense as to what is there. An example of a helpful change in Bill C-10 is a provision that corrects a technical problem that otherwise can arise on many combinations of two corporations, whether it is a domestic amalgamation or a foreign merger. The Income Tax Act, ITA, contemplates that certain domestic amalgamations or foreign mergers should occur on a rollover basis, where no gains or losses are recognized. However, Bill C-10 corrects an anomaly in the ITA that could otherwise trigger gains on these kinds of transactions. Specifically, gains could arise where a parent company holds shares of a subsidiary and those shares are cancelled upon amalgamation. Bill C-10 ensures that no gains would arise on those shares.
We first discussed that problem in the ITA with the Department of Finance Canada in 2002, and the Department of Finance Canada officials were very helpful and issued a comfort letter to us indicating that they agreed that an amendment was desirable. However, like most comfort letters, there was no guarantee that an amendment would ever become law or that Parliament would agree with it.
As an aside, I note briefly the importance of comfort letters and their role in the administration of the tax system. Questions were raised by this committee in previous proceedings as to the legality of comfort letters and where they fit in.
Comfort letters are not agreements, per se, but merely an indication that the relevant officials of the Department of Finance agree that a potential amendment is desirable.
The Chair: If I may interrupt, given your experience in the fiscal world, are you aware of any cases when the comfort letter has been raised by the taxpayer and has not been adhered to by the authorities?
Mr. Marley: There are some occasions where they are not followed but the experience is that on technical tax matters where the amendment is to address an anomaly in the ITA and does not relate to a change in tax policy, the Minister of Finance and Parliament tend to agree with such technical tax changes, to give effect to the tax policy. However, there is no guarantee that Parliament will agree and decide to amend it into law.
Comfort letters are helpful to practitioners, in particular because they often arise in the context of specific transactions where the words of the ITA do not appear to support the underlying objectives. It is helpful to practitioners to know that the relevant Department of Finance officials agree that a specific amendment to the act is desirable.
The Chair: Some senators here are members of bar associations but none of us hold ourselves out as experts in tax. However, we have heard about tax rulings and obtaining an advance ruling. I had always understood that if the circumstance you have described were to arise, one could approach the Canada Revenue Agency and the Department of Finance Canada to obtain a ruling. Are you mixing rulings and comfort letters in this case?
Mr. Marley: They are two different processes and they achieve two different objectives. The tax ruling, as you said, is from the Canada Revenue Agency. It allows someone to know that the Canada Revenue Agency agrees with their interpretation of the law. A comfort letter suggests that the Department of Finance Canada agrees that a change to the law is desirable.
The Chair: Can one act as though the change has happened?
Mr. Marley: Yes, but it is potentially at one's peril if the change does not eventually become law because it is only an indication of the likelihood that a change will be made, as opposed to an actual change to the law.
Senator Goldstein: It does not bind the government in any way.
Mr. Marley: No, because Department of Finance Canada officials cannot promise what Parliament eventually will do. The Canada Revenue Agency simply interprets the law. The ruling process is binding but it is an interpretation of the existing law, not changes that might be made to the law.
A final point on comfort letters is that they generally cannot be relied upon by public companies for financial accounting purposes, which is an important aspect for public companies that can rely only on amendments to the tax law that are substantively enacted. Incidentally, Bill C-10 is considered to be substantially enacted because it has passed third reading in the House, even though it is not a certainty that it will become law.
Bill C-10 is not perfect: In my view, the three most significant issues relate to the application of the non-resident trust rules to commercial trusts generally; the broad application of a new rule that applies to restrictive covenants; and the uncertainty surrounding certain provisions of the foreign investment entity rules. I will touch on each of those issues briefly.
First, the non-resident trust rules were designed to prevent the inappropriate deferral of Canadian taxes, most commonly associated with personal trusts and tax havens. This tax policy objective is an important one and the proposed rules seem to achieve that objective. The concern with this area of Bill C-10 relates to non-resident commercial trusts, in particular when they are located in a tax treaty country. Unlike personal trusts, commercial trusts more closely resemble corporations. Recent domestic amendments treat commercial income trusts in Canada like corporations, and the current rules of the Income Tax Act treat non-resident commercial trusts like corporations.
However, subject to narrow exceptions, Bill C-10 treats non-resident commercial trusts like personal trusts rather than like corporations. This difference can result in significant adverse Canadian tax consequences. I will illustrate that by way of an example. Assume that a taxpayer makes a small $100 investment as a minority interest in a large, non-resident commercial trust. Under Bill C-10, if the narrow exception does not apply, all the income of that large non-resident commercial trust is liable to tax in Canada. If that trust earns $100 million in income, the entire amount is taxable in Canada, even though the only Canadian involvement is a small $100 investment by a Canadian.
Senator Goldstein: Who pays that tax?
Mr. Marley: The Canadian investor and the trust itself would be jointly and severally liable for the tax.
Senator Goldstein: If the trust is way out there, who does the CRA look to for payment of the tax?
Mr. Marley: Enforcement of the tax liability is an issue.
Senator Goldstein: Is the small $100 investor liable for the taxes on the $100 million in earnings?
Mr. Marley: The liability of that investor is limited to the total amount of the investment. In that example, the investor could lose the entire $100. Technically, the trust is liable to tax on the $100 million in that example.
In contrast, if the trust were treated as a corporation, then with respect to the trust's income, either none of it would be taxed in Canada or only the portion related to the $100 investment by the Canadian would be taxable in Canada. This is obviously a big difference, and that is why various groups have expressed concerns with respect to this tax: including for tax-exempt entities that are not normally subject to tax; with respect to the potential for being jointly and severally liable for the non-resident trusts tax; and ordinary investors taking on a potentially large tax liability.
We understand that the Department of Finance intended for non-resident commercial trusts to be treated generally in a similar way to corporations. However, the applicable rule for this treatment, paragraph (h) of the definition of "exempt foreign trust," is extremely complicated and confusing. In many cases, it is not possible for tax advisers to provide opinions to our clients that these rules will apply. That confusion causes investors to take on a risk of a potentially huge tax liability, albeit limited to the amount of their total investment. As a result of this uncertainty, we believe that many Canadians will avoid investing in non-resident commercial trusts, and we have seen some non-resident trusts simply prohibiting Canadians from investing.
As senators know, the Department of Finance has issued comfort letters to address the concerns raised by certain pension funds and others. We believe that those comfort letters adequately address those concerns. However, they do nothing with respect to other investors, whether they be tax-exempt or other taxable investors.
Many of Canada's income tax treaties allow tax authorities in Canada and the other country to provide relief from the application of these rules. However, that process is cumbersome. In any event, statements from the Canada Revenue Agency suggest that Canada may simply refuse to grant that relief in all cases, even if the trust is located in a high-tax treaty country such as the United States.
Second, the rules on restrictive covenants were intended to reverse certain court decisions that held that payments made for certain agreements or covenants not to compete could be received tax-free. For example, if an individual is selling shares of a company, it is common for the seller to agree with the purchaser not to start up a competing business. The issue in those cases arises if a portion of the proceeds were allocated to that agreement not to compete. The tax cases held that those payments could be received by the individual tax-free.
Bill C-10 reverses those court decisions and ensures that those amounts are taxable, which is an understandable tax policy objective. However, the proposed rules go much further in that they are not limited to non-compete agreements and may apply to a variety of ordinary covenants or agreements granted in virtually all purchase and sale transactions, such as an agreement not to sell off the assets of the business before closing or an agreement not to pay significant dividends prior to closing.
It is often difficult to determine whether those rules would apply to a particular covenant in an agreement in ordinary commercial transactions. As a practical matter, we believe that taxpayers and the Canada Revenue Agency will not apply those rules generally outside the non-compete context. Obviously, for taxpayers the strategy is risky, in particular where large amounts are involved.
Third, the foreign investment entity rules are designed to prevent inappropriate tax deferral of Canadian tax on certain foreign investments. The proposed rules seem to achieve this important tax policy objective. However, similar to the other two areas that I discussed, a portion of those rules are extremely complicated and, in many cases, will be difficult for taxpayers and the Canada Revenue Agency to interpret. That difficulty creates uncertainty for many ordinary investments.
Separate from the tax amendments in Bill C-10, many other draft tax amendments are outstanding and have been for many years. Many of these amendments will apply retrospectively. For example, significant amendments to Canada's outbound tax rules have been in draft form since 2004 and are expected to apply generally back to 2004, or earlier in some cases. Many additional changes to those draft rules are expected before they are introduced in bill form.
Clients and advisers, in particular those in other countries, are often disappointed that frequently we must provide three answers to all their tax questions: describing the results under the current rules, under the draft rules and under anticipated amendments to the draft rules. This necessity is true even for basic questions such as, what are the consequences of a foreign merger, or whether one can deduct interest expense on borrowed money to acquire shares. The strong preference is to remove this uncertainty by enacting proposed tax changes rather than leaving them for long periods of time in draft form. It is possible that a delay in passing Bill C-10 could cause further delays in all these other tax amendments.
What should we do with Bill C-10? The need to make favourable changes to Bill C-10, such as the amalgamation-merger provision I discussed earlier, and the desire to clean up the extensive amount of draft legislation needs to be balanced with the serious concerns that others have raised with respect to Bill C-10. While I do not think draft legislation needs to be perfect before it is enacted, since further amendments are always possible, serious concerns or issues should be addressed.
Many in the tax community would prefer that the non-resident trust rules, the restrictive covenant rules and the foreign investment entity rules be scrapped and that the government should start over from the beginning. I do not think that is needed but I believe that these rules can be improved within the current framework through targeted changes rather than through whole-scale revisions.
It is my opinion that the issues I have discussed today are serious enough to warrant fixing Bill C-10 before it is enacted. If fixing it is not possible, the next best alternative would be for further amendments to be made at the earliest opportunity, and for the Canada Revenue Agency to provide administrative guidance confirming a reasonable interpretation of the rules.
Thank you for your time and consideration of these important issues. I am happy to answer any questions.
The Chair: Thank you, Mr. Marley. You have touched on a number of issues and points that are already before the committee and that have caused other witnesses and members of the committee to be concerned.
You have described the bill in many ways. Did you use the phrase "omnibus bill?" We have become accustomed to the phrase. Do you have any views on this kind of proposed legislation?
Mr. Marley: In terms of having a number of tax amendments all together in one bill?
The Chair: Yes, and these ones go back many years.
Mr. Marley: It is preferable if we do not have huge tax bills going back so many years. Part of the problem is that the tax rules constantly change and proposed amendments are made on a regular basis. It seems that the proposed amendments happen faster than the legislation is enacted. We seem to amass more and more draft tax legislation without enacting those draft portions.
Senator Massicotte: Obviously, this proposed legislation is complicated. We are trying to hear from people like you to help us to better understand the issues in simple English or French.
I will begin with comfort letters. Your summary noted that some comfort letters issued seem to satisfy the needs of certain investors. We discussed and you answered a question on the legality of comfort letters, which are not legally binding documents.
In the case of the three letters that have been issued, how can the Canada Revenue Agency interpret or apply a treatment to somebody that is inconsistent with the law?
Mr. Marley: On your first point about the accessibility of comfort letters, I should note that they are published and included in the commercial copies of the Income Tax Act so that people have access to them.
In terms of the application of the law, as you correctly pointed out, the Canada Revenue Agency applies the law as it stands, without taking into account draft legislation or, in this case, a comfort letter, which is one step removed from draft legislation.
The way in which it is treated typically is to leave that tax year open by having the taxpayer file a waiver allowing a late reassessment of the tax year. If the draft legislation does not become law in the year, the CRA assesses on the basis of the existing law.
Obviously, if taxes are not paid when they are due and the tax legislation is not amended retrospectively, then the taxpayer must pay interest on the unpaid amounts as the case would be normally.
Senator Massicotte: It does not resolve the issue. If the draft legislation is enacted, it does not resolve the problem. Rather, it simply says we would like to resolve the problem in the future if given a chance. It means that they will take a look at it in the future.
Mr. Marley: That is right. However, it assists in resolving the issue in terms of not having to pay the tax and to keep the tax year open for assessment so that the taxpayer is not out of pocket as long as the draft legislation remains not enacted.
Senator Massicotte: The taxpayer is allowed not to pay. If the investor owes $1 million in taxes, the taxpayer, the pension fund or the corporation is allowed not to pay the $1 million despite the fact that the law deems it to be owing.
Mr. Marley: In the ordinary course, if taxpayers do not pay their taxes when due, then they must pay them eventually, plus interest on the amount. The investor has a choice: either pay the tax and apply for a refund when it becomes law or not pay the taxes and run the risk that if it does not become law, they will owe both the taxes and the interest accrued on the unpaid amounts.
Senator Massicotte: Having said that, you described the issue in your summary and verbally. It looks like the intention of this government is to amend the proposed tax further to exempt those institutions that received comfort letters. Still, many investors could invest $100 in a U.S. commercial trust or other foreign trust and find themselves liable for significant tax amounts. Your example referred to a tax liability on $1 million in revenue.
Mr. Marley: The trust could be liable to tax on $1 million in revenue. The investor's liability is capped at the amount invested.
A provision in the definition of "exempt foreign trust" is intended to exempt certain commercial trusts. If you take a look through it, no matter how many times you read it, you are still left wondering whether this provision applies to a particular investment.
Senator Massicotte: Joe Blow could invest all his savings, buy into a foreign trust and find himself at risk of losing his whole $20,000 because of some lack of clarity in the legislation?
Mr. Marley: Right; by way of example, to look at the situation in reverse, it would be as if a U.S. or a U.K. investor invested in a Canadian income trust. If they had a similar rule, then the Canadian income trust could be liable for tax on its worldwide income in either the United States or the U.K. simply because one person invested in that trust, unless they fit the specific narrow exception.
Senator Massicotte: Is there recourse to the individual investor?
Mr. Marley: Yes, it is capped at the amount of its investment. The question asked earlier was: How does Canada enforce that tax? It is obviously difficult to enforce if there are no assets in the country.
Senator Massicotte: The investor has recourse to the asset of the Canadian investor to the extent that the investor invested?
Mr. Marley: Right.
Senator Massicotte: Is that normal, in your mind? Is that fair?
Mr. Marley: In my mind, it is appropriate for personal trusts where the government is not able to determine who the ultimate beneficiaries will be or how much income they will be allocated.
For commercial trusts, where their interest is fixed at a particular amount, it is not appropriate for the trust to be taxed on its worldwide income.
Senator Massicotte: Is that the case as you read it in the proposed legislation?
Mr. Marley: That is correct, subject to the narrow exception in the definition "exempt trust."
Senator Massicotte: To repeat that answer, Canadian investors who are passive and intelligent but not tax experts can invest $100,000 in life savings in a foreign trust that is kosher, legal, and so on, and find that they have exposed all their capital investment?
Mr. Marley: That is right. Because it is difficult for the Canada Revenue Agency to go after the foreign trust, they would be more likely to go after that Canadian investor for its entire investment in respect of the trust's tax.
Senator Massicotte: That is dangerous. Canadian investors sometimes are not insured. Canadian investors do not wake up every morning and read the tax act.
Mr. Marley: I think that is why, for foreign commercial trusts, their simplest route is to prohibit Canadians from investing so that they do not take on any risk of becoming taxable in Canada.
Senator Massicotte: I am not sure this perception is accurate about the revision to the act. A year and a half ago, an income trust would be disadvantaged compared to taxation of a corporation. Obviously, there is a lot of planning for those income trusts to convert to corporation. I have heard that some amendments proposed would hinder that rollover to a corporation, and that delaying this act would affect a rollover. Is that the case? Is there any effect to those rollovers in this act?
Mr. Marley: Would a delay in Bill C-10 defer the ability of an income trust to convert back to a corporation? I think that goes back to the point that we have a significant amount of draft tax legislation. The rule that you refer to has not yet been introduced. It is not yet in bill form. Given all these draft rules that are outstanding, presumably delay in passing Bill C-10 will also delay passing further tax amendments.
Senator Massicotte: But it is not in this omnibus bill?
Mr. Marley: It is not in this bill.
Senator Harb: Thank you very much for your excellent presentation. I appreciate the fact that you came with a proposed solution, which is interesting.
You said there is a comfort letter and you spoke about the pros and the cons. Have you had a chance to see that letter?
Mr. Marley: The one on the non-resident trust rules for the pension funds and others?
Senator Harb: Yes.
Mr. Marley: Yes, I have.
Senator Harb: Do you feel comfortable with that letter?
Mr. Marley: I think it adequately addresses the concerns of those investors. Obviously, it does not do anything for other tax exempts or taxable investors.
Senator Harb: A pension fund like the Ontario Municipal Employees Retirement System, OMERS, the teachers' fund, and others who appeared before the committee had serious problems with that letter. As a result, the Department of Finance decided to sit down with them to talk about it.
In the absence of some sort of an agreement from all these funds or their representatives, it would be imprudent to proceed with a comfort letter. It was stated that the loss to these funds would be in the hundreds of millions. One group indicated that close to $1 billion in loss will be the result of something like this if it goes forward as it is now.
If the bill cannot be sliced up because of the nature of the bill, and we either take it as it is or send it back to the House, what would you do?
Mr. Marley: What would I do? Again, I think that is a difficult question. As I tried to say, there are pros and cons to both. If it were up to me, I would make further changes before enacting it into law.
Senator Harb: You would not pass it as it is now?
Senator Moore: That is what he said.
Senator Goldstein: Thank you for coming today, Mr. Marley, and for your clear and forthright exposé.
There is a part that I do not understand. I understand the desire of government, as a matter of tax policy, to arrange for taxation of restrictive covenant payments on the theory that, as frequently as not, these restrictive covenant payments are a disguised part of the purchase price in some measure. In either event, they find themselves with a favourable tax treatment in the hands of the payer and a marvellous tax treatment, because it is no tax, in the hands of the recipient. As a layman, I accept that approach as an appropriate tax policy one, although I have absolutely no experience in tax policy.
What I do not understand is the next paragraph in your written presentation, which deals with the new rules applying not only to non-competes — and, this is found in the middle of page 2 — but also to a variety of other covenants or agreements that happen to virtually all mergers and acquisitions and sales transactions. I understand that as well. What kind of monetary effects do those things have, for example, an undertaking not to pay a dividend until closing; an undertaking not to make any changes; an undertaking not to dismiss certain key employees in the intervening period; an undertaking not to increase one's own salary; and so on. Those agreements that you draft — and others expert in this field — are replete with those kinds of things.
How would those things be taxed under this statute?
Mr. Marley: That is an excellent question. Two points are important to note. First is the manner they are taxed under Bill C-10. They can be taxed one of three ways. There is the capital gains treatment, which would mirror a sale of shares. That is, they would have similar treatment and therefore no adverse tax effect, but they could have income treatment. Even if they are selling shares that are capital property, payments allocated to these types of covenants could receive income treatments. They would pay more tax on that portion than if it was all proceeds of disposition. They could also have withholding tax, if a non-resident is involved.
Otherwise, the simple solution could be not to allocate any amounts to those covenants.
Senator Goldstein: That was my next question.
Mr. Marley: The problem in Bill C-10 is that another rule can force an allocation to these covenants. It is in section 68. It says that a reasonable amount must be allocated to each of these covenants. It is hard to place a value on a covenant such as, I will not pay dividends before closing. However, every purchaser will insist on it. Therefore taxpayers are forced into a dilemma of whether to allocate an amount to that agreement not to pay dividends and have it separately treated under these rules, potentially receiving a different tax treatment, or do they say these rules were not meant to apply to that so they do not think they should apply.
Senator Goldstein: Then I have difficulty. I have difficulty understanding why the allocation, if made under section 68, will result in an income treatment as opposed to a capital gains treatment. If I sell my controlling shares of a corporation for a million dollars and I agree not to pay dividends in the intervening period until closing and all the things I have told you about, what kind of value is there to that? Is that not part of the million dollars taxed on the difference between the adjusted cost base, ACB, and the proceeds of realization, to use the technical terminology?
Mr. Marley: It is, except the default rule is to deem it to be on income account instead of capital gains.
Senator Goldstein: Where is that rule?
Mr. Marley: In section 56.4. A number of rules within section 56.4 could allow capital gains treatment, but they will not apply in all cases.
The reason I say that the rule could apply to other types of covenants is that the definition of restrictive covenant in section 56.4 does not require it to be restrictive or even to be a covenant. The definition is extremely broad. I think we can interpret it, together with the context and the purpose of the rule, to say it should be narrowly interpreted to apply to non-competition agreements. However, the words themselves are not restricted to non-competition agreements and are much broader.
Senator Goldstein: How would you fix that situation? What kind of amendment would fix it?
Mr. Marley: I think, two things; one is to narrow the definition of restrictive covenant to apply more clearly to non-competes and not other types of covenants and, second, if you remove the rule that forces an allocation to the covenants, then taxpayers can allocate everything to the proceeds of disposition. That would all be taxed in the normal manner on a sale of shares and they would not need to worry about trying to value separately different covenants or agreements granted as part of a transaction.
Senator Goldstein: A narrower definition of section 56.4 and a small tinkering with section 68 will do it?
Mr. Marley: In my view, that would do it.
The Chair: It is at times like this I resist the temptation to remind senators that free legal advice is worth the paper it is written on, but anyway, over to you, Senator Tkachuk.
Senator Tkachuk: I will try to keep away from the technical stuff and return to the bill.
These amendments were announced by governments in budgets or in some way. Is the tax department acting on these amendments as if they were the law presently?
Mr. Marley: Do you mean the Canada Revenue Agency?
Senator Tkachuk: Yes.
Mr. Marley: No; my understanding of how they apply the law is they apply the law as it exists now and not as it may exist once Bill C-10 is passed. However, where taxpayers have filed their returns on the basis of the proposed amendments, the Canada Revenue Agency, I believe, takes a reasonable approach, rather than to assess the taxes and force taxpayers to pay taxes that may never be owing, to allow the issue essentially to remain open until it is known whether the amendments are passed. Then the agency either assesses the tax plus the interest, because the taxes were not paid timely, or does not assess the taxes if the legislation is passed.
Senator Tkachuk: It is like the announcement of a GST tax in a budget but the actual law implementing that GST announcement, or income tax announcement, does not become law until the bill is passed, right? However, everyone acts as if the bill was law.
Mr. Marley: Right; in the GST context, what I believe has been done in the past is that they set the coming-into-force date far enough in advance to try to ensure that the legislation is passed, because particularly in the GST context where it is not only people filing tax returns but it applies on ordinary commercial transactions on a daily basis, it is more important to have the actual legislation in place.
The Chair: I have always been confused in this area. What is a ways-and-means motion? Are those budget provisions brought into force other than through a big act like this one, for these very reasons, at the time? I do not know.
Mr. Marley: My understanding is that it is only an indication on a global basis of all the changes, say, in a budget, but then the specific amendments are introduced as a bill to amend the act in the ordinary manner.
Senator Tkachuk: This act has taken a number of outstanding issues that have been around, in one case, since the 1999 budget, and tries to put them into law. That is why this bill is a comprehensive bill.
Are the two or three problems that you think should be fixed addressed by the comfort letters?
Mr. Marley: The problems that I mentioned are not addressed by the comfort letters. That is why, at least in my view, those changes should still be made.
Senator Tkachuk: Do the comfort letters expire at any time? How long are they there for? Can they be in place for 20 years if nothing happens? This bill is 1999. There could have been comfort letters from that bill.
Mr. Marley: The situation is similar to draft amendments to the tax act. There were draft amendments on interest deductibility released in 1991 that are still floating out there but no one expects that those amendments will be enacted.
In answer to the question, a comfort letter remains outstanding forever, but as time passes the likelihood of it ever becoming law decreases.
Senator Tkachuk: How does the commercial trust report it? Is it a tax liability? You said that they must think that at some future time, if nothing happens, they may need to pay the income tax or they can pay the tax and at some time, ask for a return of that tax. How do they report it financially? How do they deal with that potential tax liability?
Mr. Marley: Using the non-resident trust example, most non-resident trusts would ignore it on the basis that they are not in Canada, their assets are not in Canada, and I suspect most non-resident commercial trusts would not file tax returns in Canada. They would file tax returns in their home country. I suspect, as a practical matter, that would be what happens. With respect to the tax exempts such as the pension funds, they are tax exempt so they would not pay Canadian tax or file Canadian tax returns.
Senator Goldstein: We have heard a number of people with respect to some amendments, and you are the first one who has raised the issue of the taxation of restrictive covenants. Speaking for myself, I was not aware of that issue as being a problem.
Have you, or has anyone to your knowledge, explored that issue with the department?
Mr. Marley: Yes; when draft tax amendments are released, the way tax practitioners typically filter comments back to the Department of Finance Canada is through a joint committee of members of the Canadian Bar Association, CBA, representing the lawyers, and the Canadian Institute of Chartered Accountants, CICA, representing the accountants. That joint committee makes detailed submissions to the Department of Finance Canada on draft legislation. Particularly, these rules we are talking about today, like the non-resident trust rules and the foreign investment entity, FIE, rules, which have undergone six or seven amendments along the way since 1999, numerous submissions have been made by that joint committee and others on these rules, such as the section 56.4 rule and the non-resident trust rules.
Senator Goldstein: Dealing again with the section 56.4 and section 68 issues, has the department given any response to the concerns that I presume the joint committee has raised?
Mr. Marley: The Department of Finance Canada has amended the rules two or three times on the section 56.4 rules, so the department has added various exceptions that more narrowly focus the rules.
In my experience, those exceptions do not always apply and do not go far enough to limit the rule to ensuring that non-compete agreements are taxed.
Senator Goldstein: Do you still consider the bill as drafted inadequate for the reasons you have indicated?
Mr. Marley: In my view, it is, but again what is there now is much better than what was there before.
Senator Goldstein: That is good. Is your view shared by a majority of tax practitioners, to your knowledge?
Mr. Marley: To my knowledge, yes, but I cannot say for certain.
Senator Goldstein: You did not do a formal survey, but I know tax practitioners are an intercommunicative bunch of nice people. You communicate with each other significantly and constantly. Do you know from your communications whether the majority of tax practitioners, both as lawyers and as chartered accountants, continue to have concerns about section 68 and section 56?
Mr. Marley: That is a fair statement. Working on transactions, we see the issue frequently come up. Virtually every transaction has various covenants, and many transactions have non-compete covenants, so it is a difficult process trying to ensure that in all cases, someone fits into one of the exceptions to try to have the same tax treatment that they have on the sale of the business or the shares.
Senator Goldstein: The effective date of this bill as it is now drafted is for the taxation year commencing 2007, which means that de facto when you draft a merger and acquisition agreement or an outright purchase, then you are already de facto subject to these rules.
Mr. Marley: That is right. My only comment was, the coming-into-force date for different provisions in the rules is different.
Senator Goldstein: Yes, I know.
Mr. Marley: I could not recall off the top if it was 2007. I thought it might be even earlier.
Senator Goldstein: It is 2007.
Mr. Marley: You are right. Once the rule is passed, it will apply retrospectively.
Senator Goldstein: You have that problem right now when you prepare a merger and acquisition agreement?
Mr. Marley: Absolutely.
Senator Eyton: Thank you for coming here. I apologize; I had to be out of the room so I missed part of your submission. I was intrigued that, in spite of your young years, you have been tilling this particular field for a long time. In particular, I note your experience as a tax policy adviser, presumably in Ottawa with the tax department.
Were you concerned with, and did you work on, some or all the issues we talked about here today? I think you left in 1998.
Mr. Marley: That is correct. I left before any of these changes that we have talked about today were introduced.
Senator Eyton: Since then, I presume, they have been of concern to you?
Mr. Marley: Absolutely; our firm and others, as I said, primarily working through the joint committee, filtered comments to Department of Finance Canada on each of the drafts over the years as they have come out.
Senator Eyton: Looking at the notes, you start off by saying that, ideally, we would proceed with Bill C-10 and, in fact, proceed separately, I suppose, with the amendments you think are needed to the overall tax picture?
Mr. Marley: That is a difficult question. Obviously, I defer to all of you in terms of whether the bill should be passed and concerns addressed at the next available opportunity, or whether they should be addressed upfront.
Senator Eyton: You threw out three possibilities. The first was addressing all the issues with new legislation, and you expressed the view that you did not necessarily need that approach. The second was to address the issues through targeted amendments. The third possibility you talked about, which you describe as the next best alternative, would be for further amendments to be made at the earliest opportunity and for the CRA to issue administrative guidance confirming a reasonable interpretation of the rules. That position is your fallback one.
Mr. Marley: That is right. Again, from my personal perspective, using the non-resident trust rules as an example, rather than starting from scratch and starting with a blank piece of paper after almost nine years of work on the existing rules, I would leave the framework in place, particularly as it applies to personal trusts, but for commercial trusts, I would significantly rewrite paragraph (h) relating to exempt foreign trust to make it clearly applicable that if someone acquires an interest in a foreign commercial trust, they are not in these non-resident trust rules. We have other sets of rules that prevent inappropriate deferral of foreign tax, such as the foreign investment entity rules, or if they have a controlling interest in a corporation, for example, our foreign accrual property income rules. That is the main anti-deferral rule we have in our system.
In most cases, people are investing outside of Canada in corporate form rather than trust form.
Senator Eyton: That response to the question is rather complicated. I was trying to focus on the alternative you have tabled here, which was for further amendments to be made at the earliest opportunity, and for the CRA to issue administrative guidelines confirming a reasonable interpretation. Essentially, my question is, can you live with that alternative? It may not be perfect but it is something you could live with?
Mr. Marley: I think that is right.
Senator Ringuette: I am happily surprised by your comments and the light that you shed on this issue, at least from my perspective, in regard to comfort letters. You have mentioned amending these drafts many times before they become proposed legislation.
From your experience, how long does that process take in the Department of Finance; to draft and amend a draft before it comes to us and it is still in non-acceptable format with discrepancies as in your presentation today? I am somewhat amazed. From your experience in the department and now in the private sector, how long does this process last; a draft and amending the same draft, before it comes before parliamentarians?
Mr. Marley: It depends, in part, on the nature of the change and its complexity. I think I mentioned briefly the changes to our foreign affiliate rules, our outbound tax rules. Significant amendments to those rules were proposed in 2004. They remain in draft form. However, since 2004, the Department of Finance Canada has been consulting with the Canada Revenue Agency and with taxpayers, and they have realized that significant changes to the 2004 legislation are needed. Over the past several years, the department has mentioned various ways that they would likely amend the legislation once amendments are reintroduced again in draft form for comment before then becoming a bill.
That is an exception to the norm, but in that case, we are optimistically expecting those changes to come out in draft form maybe sometime later this year, and then potentially being introduced as a bill either late this year or maybe next year. Those rules will remain in draft form for probably five years or more, and in many cases longer.
Obviously, that situation is not the ideal one. What we need to be doing — and not what every parliamentarian wants to hear — is passing more tax laws and passing the draft laws into law quicker.
Senator Ringuette: I understand what you are saying. You must bear in mind that our committee received Bill C-10 in November. Parliamentarians do not hesitate to look at legislation; however, it is not forthcoming.
Meanwhile, from your private sector experience, if you have delays of five or six years where a client may defer payment of taxes with the provision that they will file a return when the bill is passed, that time frame is five to six years of investment uncertainty, which probably costs Canadian investors and the Canadian government a lot of money.
Mr. Marley: It is an issue. As I mentioned, we often must give three answers to the questions and tell our clients what will happen under the current rules, the draft rules and where we think the draft rules will go before they are enacted. Whenever possible, we try to structure transactions to meet all three of those situations. It is not always possible, but essentially, that is where we are.
Senator Ringuette: Regarding the issue of comfort letters, from your knowledge and experience, how many of these comfort letters, that are not that comfortable, exist right now in the Department of Finance Canada?
Mr. Marley: I am not sure exactly how many there are. I think I mentioned that in the commercial versions of the tax act, the government typically prints both the comfort letters and any draft amendments to the law in a shaded form. They cannot be pulled out of the Income Tax Act, but if you flip through, you can see all the shaded parts are draft amendments that have not been passed yet. Included with that section are all the changes in Bill C-10, which are obviously quite a few, but many other changes are still needed. Many of them are helpful to the taxpayers, which taxpayers have requested. Others are changes that the Canada Revenue Agency has requested to try to administer the rules better.
Senator Goldstein: I want to ask one last question if I may, Mr. Chair. The Income Tax Act, without these amendments, covered about 2,000 pages in the past. I am not talking about the regulations; I am talking about the act itself. This bill covers 560 pages. In your experience, has there ever been so large an amendment introduced in one fell swoop this way?
Mr. Marley: I am not sure in terms of page count. In the past, there have been other large technical amendments.
Senator Goldstein: Certainly, there have been other large ones, but have there been any as large as this bill, in your recollection?
Mr. Marley: Not that I am aware of.
Senator Goldstein: I am not being critical; I only ask the question. I am curious.
Mr. Marley: There may have been; I am not sure.
Senator Goldstein: Would it be fair to say that amending or suggesting the amendment of one or several pieces of the act, targeted areas, almost all of which you have identified, might jeopardize the rest of this legislation, which is largely remedial and appropriate for Canadians? Would that be of concern to you?
Mr. Marley: That is a good question and it is a concern. If we separate all the technical tax changes into numerous bills, the problem is that it makes the process more cumbersome to enact the legislation, particularly when there is significant additional draft legislation coming, and will continue to come as new budgets are introduced and new changes are required.
In my mind, the issue is not enough of these amendments are passed on an annual basis. They build up and build up until we have omnibus tax bills.
Senator Goldstein: With respect to the foreign investment enterprise vehicle entities, some of these rules are not dissimilar in their effect from the foreign accrual property income, FAPI, rules, entered into the Income Tax Act some years ago, probably a decade ago by now and maybe more.
My recollection of the practitioners' reaction to the FAPI rules is that they thought the rules were extremely complicated, difficult for taxpayers to interpret and difficult for the CRA to interpret. The rules are nevertheless there, they have been enforced and applied, and Canadians generally know what the rules of the game are in terms of foreign accrual property income.
Is that not the case as well for the FIE rules? They will take some getting used to but people will get used to them and deal with them?
Mr. Marley: Each of these rules has the same objective, and that is to prevent inappropriate deferral of Canadian tax. The foreign accrual property income rules are the main set of rules, then the FIE rules and, to an extent, the non-resident trust rules backstop.
Senator Goldstein: That is correct.
Mr. Marley: The act currently has FIE rules and non-resident trust rules, but CRA's view is that the current rules are not adequate to protect the system properly.
In terms of the complexity of the rules, you are right. Complexity, in and of itself, is what we, as tax advisers, are paid to address on a daily basis. Complexity, in and of itself, can be addressed and worked with. The problem is that if it is to the point where looking at and studying the provision does result in an answer at the end of the day and leaves advisers still wondering whether or not the provision applies, then the complexity turns into uncertainty that cannot be reconciled through additional work or study.
The Chair: Sir, thank you very much. You have shed interesting light on thorny issues for us. You have given good directions to our people involved in the generation of this legislation, this type of legislation. We will ensure it is well circulated.
Mr. Marley: Thank you again for the opportunity to come today.
The Chair: Honourable senators, that concludes the appearance of this witness. We have before us a matter of Senator Goldstein's point from yesterday. I am advised that matters such as this one are generally dealt with in camera. Is it your wish to go in camera?
Senator Goldstein: I am prepared to go in camera briefly with the proviso that if one or more people decide to go back on the record, we will have a vote and do so.
The Chair: I will adjourn the meeting.
Senator Goldstein: No, you suspend the meeting.
The Chair: Excuse me; whatever.
The committee continued in camera.