Proceedings of the Standing Senate Committee on
National Finance
Issue 1 - Evidence - November 19, 2013 (Afternoon meeting)
OTTAWA, Tuesday, November 19, 2013
The Standing Senate Committee on National Finance met this day at 2:16 p.m. to study the subject-matter of Bill C- 4, A second Act to implement certain provisions of the budget tabled in Parliament on March 21, 2013 and other measures.
Part 1 — Income tax measures Part 2 — Excise Tax Act
Senator Joseph A. Day (Chair) in the chair.
[Translation]
The Chair: Honourable senators, this afternoon, we are continuing our study of the subject-matter of Bill C-4, A second Act to implement certain provisions of the budget tabled in Parliament on March 21, 2013 and other measures.
[English]
We have a number of representatives from the Department of Finance here. We welcome Mr. Ted Cook, Senior Legislative Chief; Mr. Sean Keenan, Director, Sales Tax Division; Mr. Pierre Mercille, Senior Legislative Chief, GST Legislation; and Ms. Chantal Pelletier, Chief, Financial Institutions Taxation. From Employment and Social Development Canada, we welcome Mr. Campion Carruthers, Director, Program Integrity, Temporary Foreign Workers, Skills and Employment Branch. We will bring the latter witnesses forward when we get to those particular sections. We're letting Mr. Keenan and Mr. Cook take the main carriage for us as we move along to get as much of this done as possible over the next two hours. We'll go until 4:15.
This morning, we concluded our meeting at clause 31, so this afternoon we will begin with clause 32. Mr. Cook, please proceed.
Ted Cook, Senior Legislative Chief, Department of Finance Canada: Thank you, Mr. Chair. Clause 32 actually continues with the measure we were speaking to at the end of the last meeting with respect to preproduction mine development expenses. Clause 32 is an amendment to the definition "Canadian development expense." As we were discussing this morning, there is a transition for certain expenditures being treated as Canadian exploration expense to Canadian development expense. This continues that measure.
Turning to page 56, clause 33 replaces the words "urban area" with "population centre." We have a couple of provisions that refer to Statistics Canada documents. Consequential to a change in terminology used by Statistics Canada, we've made a similar amendment to the Income Tax Act. That's clause 33.
Clause 34 on page 56 is a continuation of the life insurance measure that we also discussed this morning. It gives a valuation rule for life insurance policies that are leveraged insured annuities.
The Chair: Were you able to find out any information for me that impacted on universities' fundraising schemes?
Mr. Cook: Not over the lunch hour, no; I didn't have a chance.
Next, clause 35 introduces a new measure that relates to non-resident trusts. It is paragraph (h).
The Income Tax Act provides that if an individual contributes property to a trust and they retain what we consider effective control over that trust, we will attribute any income that's earned by the trust in respect of that property back to the individual. That long-standing provision goes back to the 1930s and is found in section 75.
In a recent decision in Sommerer, the court held that this rule would not apply if property was sold at fair market value to the trust as opposed to just being contributed to the trust. We did not think that accorded with the relevant tax policy and, as a result, in response to Sommerer, we are making certain consequential amendments.
In Sommerer, the property was sold to a trust in Austria, so it was a non-resident trust. In Bill C-48, the last big technical bill that was passed, a whole new regime with respect to the treatment of non-resident trusts was implemented into law. It provides that certain non-resident trusts will be deemed resident in Canada for particular purposes; and that the contributors to that trust in Canada may, in certain circumstances, be liable to tax or joint and severally liable for the trust tax.
In response to Sommerer, we have carved out these non-resident trusts from the application of the existing section 75 of the Income Tax Act. That's clause 35. We'll see ahead that there is another clause further on that provides that in these situations where property is transferred in similar circumstances to Sommerer, the new rules with respect to deemed non-resident trusts will apply instead. That's clause 35 on page 56.
Clauses 36 and 37, on pages 57, 58 and 59 of the bill, contain more consequential amendments to the trust measure, the introduction of the terms "taxpayer" and "lost restriction event."
The Chair: That was the earlier trust issue you talked about in the previous meeting — bringing a trust in as if they were a corporation.
Mr. Cook: That's correct. The next clause that would be of interest is on page 59. Clause 38 implements a budget 2013 measure with respect to synthetic dispositions.
Under the Income Tax Act, things are generally taxed according to their legal substance. When a taxpayer disposes of a property, they're taxed on the disposition. When we look to see whether there is a disposition, we look at whether they legally sold or otherwise disposed of the property.
As a result, some taxpayers have entered into a series of transactions where they will not be disposing of the property legally until sometime in the future; but, in the meantime, they are disposing of all of their risk with respect to the property. All their opportunity for gain or profit or all their risk of loss are being transferred to someone else. In a real sense, they're economically disposing of the property, but they're not legally disposing of it until a later date. The tax benefit of that, of course, is that the capital gain is not recognized until that later actual disposition. Certain tests under the Income Tax Act apply depending on how long you've held the property. If you dispose of the property later, then you can more easily satisfy these holding tests.
In response to these transactions, we've introduced a synthetic disposition measure. It provides that if you have disposed of all or substantially all of your risk of loss or opportunity for gain or profit for a property, you will be deemed to have disposed of it at the time that you enter into that agreement. Then, you will recognize any appropriate gain at that point. You will be considered to have reacquired it, and when the transaction finally closes out at the end, you'll have a second disposition with respect to that property.
Senator Callbeck: Thank you, Mr. Chair. I am just wondering if this occurs often?
Mr. Cook: It's certainly less prevalent than the character conversion type of transactions that we talked about earlier. Our analysis has suggested that given the current low interest rates and that kind of thing, this kind of activity has ebbed over the last couple of years. In that regard, we think now is perhaps a good time to introduce the rule because there is less disruption as there are not as many people doing it at the current time.
Senator Callbeck: It's really just a way to defer the capital gain.
Mr. Cook: Absolutely.
Senator Callbeck: Thank you.
The Chair: I know this is item (f) of your analysis and the Library of Parliament uses the same F. at page 5.
Mr. Cook: On the next page, we have clause 39, which introduces rules with respect to corporate amalgamations.
Section 87 of the Income Tax Act has a number of rules that apply where corporations are amalgamated or merged to provide that appropriate tax results continue to flow through those merged entities.
The main amendment in clause 39 is in paragraph 1 and relates to a corporate loss trading measure, which we have not discussed as yet. Perhaps I'll give an overview of that measure.
The Chair: I note that would be item O. in the analysis on page 10 of the Library of Parliament document. I beg your pardon, Senator Hervieux-Payette.
Senator Hervieux-Payette: It's page 12 in the French version; and I have a question later.
The Chair: First we'll get Mr. Cook to finish up his comments.
Mr. Cook: As we've been discussing in the context of the synthetic disposition, the act generally operates off legal consequences of a taxpayer's actions as opposed to the economic result. And as we've also talked about in the trust context, there are certain tax implications that arise when acquisition of control occurs. That is when someone acquires legal control of a corporation.
Because of these — particularly the restrictions on the uses of loss that arise on an acquisition of control — transactions have arisen where, rather than acquiring legal control of a corporation, a purchaser will acquire economic control without taking legal control. So they may have typically 80 or 90 per cent of the economic value of a corporation, but they will not have more than 50 per cent of the legal control, with the result that the loss restrictions that we've been talking about would not apply.
In response to this type of planning, the corporate loss trading measure would provide that where someone — either a person or a group of persons — acquires 75 per cent of the economic value of the shares of a corporation, that would trigger these acquisition of control rules in terms of the restrictions that apply on losses.
Senator Hervieux-Payette: I always thought that it was business as usual to buy a bankrupt company in order to use its tax liabilities and not to pay taxes on a corporation that makes money. Will that apply to every transaction? What is the limitation on that?
Mr. Cook: In terms of whether or not it's business as usual, there are a number of taxpayers who have entered into these, but the Canada Revenue Agency has been challenging these wherever possible, and it's not consistent with tax policy.
In terms of how and how often it will apply, we've talked about acquisition of control, which is when you have 50 per cent legal control. What we've done is set the bar, if you will, for economic control at 75 per cent. Typically for these loss trading transactions, the economic value that's acquired is in the range of 80 to 90 per cent.
So by setting the economic value at the 75 per cent, we feel it's self-policing in the sense that — It would be extraordinary circumstances for someone to acquire 75 per cent of a company and not want to have legal control in order to protect their investment. It's a strong indicator that there is —
Senator Hervieux-Payette: But they would not benefit from the losses of the company they are buying?
Mr. Cook: If they acquire more than 75 per cent, that's right, they would not have . . .
Senator Hervieux-Payette: So if it's less, they will still have?
Mr. Cook: If it's less than 75 per cent, they will still have.
Senator Hervieux-Payette: Why the 75 per cent?
Mr. Cook: Because 75 per cent accords with what we've observed out in the marketplace. If you will, it's a balancing act between certainty for taxpayers and what we observe.
As I said, in terms of real transactions, we see they tend to be 80 or 90 per cent. We do not anticipate that someone would acquire 70 per cent and not acquire legal control in the normal course of business.
Senator Hervieux-Payette: If the future is like the past, how much money would not be lost to CRA?
Mr. Cook: In terms of the amounts involved, CRA has identified 38 cases in which there are approximately $2.6 billion in loss pools.
Senator Bellemare: $2.6 billion?
Mr. Cook: That's right.
Senator Hervieux-Payette: Yes, I knew it was large. That is why I was asking.
Mr. Cook: With the economic downturn, there are a number of entities whose primary, if not only, asset is their loss pools.
[Translation]
Senator Bellemare: Have you done any impact studies on that to determine what effect it may have on restructuring the industrial base in countries? We know that some businesses go bankrupt, are bought up or disappear. It is assumed that value will be created out of that eventually.
Perhaps that is all very well, but have you done an impact study on the impact of that measure on restructuring in businesses that are registering losses or that have been bought up?
[English]
Mr. Cook: Typically, what we see is not the purchase of these companies with a view to recapitalize and redevelop them as a go-forward entity; we see these companies being purchased as an asset. They're buying a tax attribute — a loss — and what's being done is simply applying it against a profitable business that the acquirer may already have. It's not about restructuring.
[Translation]
Senator Bellemare: So, there might be an impact on the hedge funds that have grown significantly in recent years?
[English]
Mr. Cook: I am not sure. I think we view these as artificial transactions that are simply the acquisition of a tax asset and not useful in terms of tax policy in terms of recapitalizing businesses.
The Chair: We wouldn't want to leave the record to suggest that hedge funds are in any way an improper activity.
Senator Bellemare: No, no.
The Chair: Thank you.
[Translation]
Senator Chaput: Could this proposed definition of attribute trading restriction and the rules apply to other entities, like trusts?
[English]
Mr. Cook: We do not anticipate that it would apply to trusts in the sense that trusts do not have shareholders in the way corporations do. In fact, our trust rule that we've been talking about operates already based on the value of the interest of the beneficiaries of the trust, so it's already incorporated into the trust rule.
Senator Chaput: So it should not apply?
Mr. Cook: No.
The Chair: Okay. We are ready to go on to clause 40. It looks like an extensive one. It's referred to under "other income tax measures," which means that it wasn't in the budget?
Mr. Cook: That is correct.
Clause 40 refers to section 88 of the Income Tax Act, which applies rules on the windup of a subsidiary of a corporation in which the corporation has at least a 90 per cent interest. Clause 40 largely implements a series of comfort letters that we've already talked about to deal with impediments on the windup of a corporation into its parent corporation.
The Chair: We're looking forward to seeing one of those comfort letters. It will give us some comfort.
Mr. Cook: Yes.
[Translation]
Senator Hervieux-Payette: Are we referring to things that happened in December 2012? Did it come into force in 2012, or will it once the budget is passed?
Because often, when the minister makes a statement regarding fiscal matters, it applies that very day; you win some, you lose some. But in this case, I would like to know when this measure came into force.
[English]
Mr. Cook: In terms of when it will come into force, as we had talked about with respect to the comfort letters, very often the comfort letters indicate that we'll make a recommendation as of a particular date.
Now, in Bill C-48, which did not come before this committee but went before the Standing Senate Committee on Banking, Trade and Commerce, we had a lengthy discussion of the Department of Finance catching up on outstanding comfort letters that had been issued to taxpayers. This continues that process and, in fact, some of the amendments in this particular clause would go all the way back to 2001. There were a number of comfort letters that had been outstanding for a number of years.
In response to concerns raised by the Auditor General, the Department of Finance had released a series of technical release packages to try and catch up on those comfort letters. The December 2012 package was the third such package of technical releases. What we're proposing is that some of the comfort letters would apply to amalgamations after 2001. In fact, if this bill is passed, the law would go back.
Senator Hervieux-Payette: To 2001?
Mr. Cook: That's correct. Some of the changes will be relieving to taxpayers. They will have filed their income tax returns based on the comfort letter and CRA will have assessed based on the comfort letter. If Parliament chooses to pass the legislation, the legislative solution that supports both the CRA and the taxpayer will be passed into law.
The Chair: Other than new court cases where the judge interprets something somewhat different from Revenue Canada — so that would be comfort letters that may come in the future — will this section 40, which relates to your release back in December 20, 2012, basically clean up this bundle of outstanding comfort letters that had not been cleaned up with a technical amendment?
Mr. Cook: I believe the Auditor General suggested there were in the neighbourhood of 250 outstanding comfort letters at the time of their audit in 2009. With the current packages released in December 2012, plus additional packages of amendments released in July and August, I believe we're now down to fewer than 10 comfort letters that have not been released as draft legislation. Certainly the Department of Finance has made great strides in trying to catch up on outstanding technical amendments.
The Chair: This is December 2012, and earlier we also saw some technical amendments arising out of September or July 2012?
Mr. Cook: July.
The Chair: We are seeing all of that in here.
Mr. Cook: That's correct. With this bill, the technical releases that had been released — except for one that relates to a budget measure — would basically catch up on the draft legislation released by the Department of Finance up until the end of 2012.
The Chair: Thank you. That brings us up to speed with the Banking Committee, many of whom are at this table.
Mr. Cook: That relates to clause 40.
Clause 41 relates to the leveraged insured annuities and the 10/8 policies that we talked about earlier. We had some discussions around the role of who might use these types of arrangements, and particularly that they might be used by private corporations. Corporations have capital dividend accounts. Canadian controlled private corporations have capital dividend accounts which allow certain amounts to be paid out tax-free — the tax-free portion of the capital gain — and insurance death benefits would go into the capital dividend account. With the measure we talked about regarding 10/8 policies and linked annuities we are ensuring that there are not inappropriate increases in the capital dividend account. That is clause 41 on page 66.
The Chair: Do I have the letter H beside the clause? Does that mean H explained this?
Mr. Cook: Actually, I would say this is part of your paragraph M, leveraged life insurance arrangements.
The Chair: Okay.
Mr. Cook: Then clause 42, on page 67, is more consequential amendments to that trust tax attribute measure. And if we continue on to page 68, particularly subclause 42(8), which goes from the bottom of page 68 over to 69, I've been talking about the non-resident trust measure where we were having the new deemed trust rules apply rather than section 75.
The Chair: That was in the previous legislation. Was it not?
Mr. Cook: Previous legislation?
The Chair: In the Budget Implementation Act that we previously handled, did we not deal with non-resident trusts at that time?
Mr. Cook: It escapes me.
The Chair: Okay, forget I said that then.
[Translation]
Senator Hervieux-Payette: When we know that measures regarding trusts are in most other countries, are we aligning ourselves with what G8 or G20 countries are asking for, meaning measures that will prevent tax avoidance? Is that unique to us or is it a trend in other countries that are following the same philosophy as us?
[English]
Mr. Cook: I think you have identified correctly that there has been greater concern throughout the OECD and internationally more generally with respect to the use of offshore entities and taking income out of the particular jurisdiction that you're involved with. In terms of whether this trust measures lines up with those, many different countries have their own versions but I wouldn't say that our particular approach lines up exactly with the way they do. I believe this is a uniquely Canadian way of dealing with it.
Senator Hervieux-Payette: Could we say it is a general trend?
Mr. Cook: Yes, I would say that's right.
[Translation]
Senator Chaput: How many cases does the Canada Revenue Agency have to analyze each year that deal with non- attribution of income drawn from a non-resident trust?
[English]
Mr. Cook: I can't respond directly to how many cases. I would say the existing rule in section 75, and what we're doing in section 94, are more along the lines of "don't do it" rules. I don't think anyone would want to fall into section 75 because basically you've got a trust and you put property in it. You're not directly holding it, but you are being attributed the income to it. It is very much exceptional that there are assessments. There are some. In the Sommerer case that went to the Court of Appeal, the taxpayer had transferred shares with a market value of approximately $1.5amillion and then less than two years later they were sold for $14 million. So there was a $13 million gain that occurred offshore in the course of a couple of years.
Senator Hervieux-Payette: And no taxes?
Mr. Cook: The court held that because the shares had been sold for fair market value — and I will admit the CRA accepted they were sold at fair market value — that that meant this was property of the trust as opposed to income that should be attributed back to the original contributor.
[Translation]
Senator Chaput: Could you give an example of the Canada Revenue Agency's position before and after the Sommerer decision?
[English]
Mr. Cook: In terms of the CRA's position, it's illustrated in the case. In Sommerer, you had a family that established a trust in Austria. They had shares in Canada and those shares were sold for fair market value to the trust in Austria. Even accepting that they were sold for fair market value, CRA's position was even if they were sold for fair market value, the Canadians still had effective control and the ability to either have the property revert to them or to control who the property would go to. As a result, they were the ones in a position to have the gain on the final disposition.
The court of appeal didn't agree and said, "Well, if you've sold the property, then that's the indication of a disposition." The court did point out certain anomalous results that can arise in a trust because you could have one person who contributes property and then that property could be used to buy something else. You could end up with sort of a double attribution, but, even so, I think the CRA's position is illustrated by what they took to court in Sommerer. The court held that 75(2) would not apply in those situations, and we are trying to put in place an appropriate legislative response.
The Chair: On to the next one.
Mr. Cook: I believe the next clause is 43, on page 69.
This is another technical amendment, which is just deleting an obsolete cross-reference and correcting a cross- reference to the corporation partnership deferral rules in 34.2. It is just a cross-reference.
Clause 44, on page 70, is another piece of the non-resident trust measure that we've been talking about, and it's about the situations in which trust property can be rolled out at cost, rather than fair market value, to beneficiaries.
Then clause 45, on page 70, is another consequential amendment relating to the trust loss rule that we've been talking about. Then, on page 46, we've got a new measure that was announced in Budget 2013, and it is paragraph A — the lifetime capital gains exemption.
The Chair: You want to talk a bit more about the change?
Mr. Cook: The change does two things primarily. One is to increase the lifetime capital gains exemption from $750,000 to $800,000. The reason the legislation says $400,000 as opposed to $800,000 is because it applies to the taxable portion of the capital gain. As you know, the capital gain is one-half included in income, so the legislation only has to refer to the half — $400,000.
Subclause 2 is an ordering rule to prevent — Sorry, I'll step back. The second part of this measure is to index the lifetime capital gains exemption to inflation for years after 2014. Subclause 2 of clause 46 provides a rule to prevent taxpayers from using reserves with respect to their gains to try to effectively increase the amount of gain that can be sheltered because each year the expectation is that the capital gains exemption will increase.
The Chair: Thank you. That applies to fishers, farmers and corporations?
Mr. Cook: That's correct. It applies to qualified small business corporation shares, qualified farm property and qualified fishing property.
The Chair: Other activities or individuals that made money on the stock exchange or through the sale of a house do not fit under that?
Mr. Cook: That's correct.
Senator Callbeck: Can that capital gains exemption only be used once? It's $800,000. Can it be used in three or four transactions, or does it have to be in one?
Mr. Cook: It does not have to be in one. The overall $800,000 is all you get, but you could use $200,000, then $300,000, then $200,000.
Senator Callbeck: If you sold a business three years ago and your capital gain was $1 million, all you could get was $750,000. With this going through, would you be eligible to use the other $50,000?
Mr. Cook: You would only be eligible up to what the capital gain was at the time you entered into the transaction.
Senator Callbeck: Okay. There is no retroactivity here.
Mr. Cook: That's correct.
The only thing to clarify is that, even once you've used your capital gains exemption, the extent to which inflation creates new capital gains exemption room will be regenerated, if you will. If you sold a property for $800,000, you've used your whole capital gains exemption, and then inflation is applied to the capital gains exemption. So if that results in an extra $2,000 in limit, then that would be the limit that would potentially be available with respect to another transaction.
The Chair: Another transaction? With a $2,000 difference if you used it up. Okay.
Senator Hervieux-Payette: A small and simple question: How is it improving what we did in the past? I read your example, and I must say that it's a good thing I'm not a farmer doing that because I would have to call you to know how to put all these things in — all the clauses and all the years and everything. What was happening before?
Mr. Cook: There are two reasons it's better. The potential gain you can shelter is bigger, and it will be indexed for inflation. Those are the two improvements.
Senator Hervieux-Payette: Thank you.
Senator Buth: Financial impact?
Sean Keenan, Director, Sales Tax Division, Department of Finance Canada: It starts small, but, because of indexation, it grows over time. The budget reports that, over the five years of the fiscal period shown, it's $110 million in tax relief, and it increases by $5 million or so every year so that, over time, it will grow.
Senator Buth: Thank you.
[Translation]
Senator Bellemare: I had the same question. So it has been answered.
The Chair: Perfect. Clause 46?
[English]
Mr. Cook: That was clause 46.
The Chair: Oh, sorry, that was 46. We will go on to 47.
Mr. Cook: Clause 47 is a clause that goes for a number of pages. It starts on page 71 and goes to page 79. These are all almost exclusively consequential amendments to the trust loss rules. Section 111 of the act is where the rules that provide limitations on a taxpayer's ability to use losses are found. There are a great number of amendments made that are just consequential on the trust loss measure. That would go to page 79.
The Chair: These ineligible losses already exist for non-trusts. Is that correct?
Mr. Cook: They exist for corporations. All we're doing is —
The Chair: Bringing trusts under this.
Mr. Cook: That's correct.
The Chair: Okay.
Mr. Cook: That goes to page 79, and clause 48 is on the bottom half of page 79. We'd already talked about synthetic dispositions and how they could be used to defer taxation or to get around holding period tests in the Income Tax Act. This is just one example. There are two amendments that relate to holding period tests. One is your ability to claim a loss on a disposition of a share, and clause 48 just has a rule that provides that, if you have a synthetic disposition, you won't be satisfying the hold period test.
Clause 49 implements indexing for the lifetime capital gains exemption that we've just been talking about.
The Chair: Okay. That's pretty straightforward.
Mr. Cook: Clause 50 is a technical amendment that corrects a reference to scholarship exemptions and a dollar limit that no longer exist in the act.
The Chair: We dealt with scholarships this morning. If you didn't bring it into income tax, does this relate to that?
Mr. Cook: It's separate, actually. It essentially corrects statutory references within the act.
The Chair: Okay.
Mr. Cook: Clause 51 is on pages 81 and 82. This is the last portion of the amendments relating to — I shouldn't say that. There is one more amendment. The July 2012 amendments relating to specified investment flow-through entities, SIFTs, and stapled securities. Clause 51 makes a couple of clarifying amendments with respect to definitions that are used in the context of the specified investment flow-through rules in section 122.1.
[Translation]
Senator Bellemare: Why change these definitions? Is it to modernize them, increase the tax base, reduce it? The question is technical, but what is the impact?
[English]
Mr. Cook: In the first amendment in subsection 1, the definition of "non-portfolio property" is relevant to determine whether something is being held as a passive investment or as an active investment. We've referred to a particular entity to make sure that the definition can apply to corporations as well as trusts and partnerships. The rules, as originally put into the act, referred to partnerships and trusts only, so we're applying an even playing field for corporations, trusts and partnerships.
The second definition, "excluded subsidiary entity," is relevant for determining whether a particular trust or partnership is a SIFT. You would have been familiar with the term in the context of income trusts and the changes we made back in 2006 with respect to income trusts.
The second amendment is relieving in nature to allow greater expansion of the entities that can hold an excluded subsidiary entity so they wouldn't fall under the SIFT rules.
[Translation]
Senator Bellemare: Is the monetary impact major or minor? Has it not been calculated?
[English]
Mr. Cook: It wasn't calculated. There is no real expectation of a monetary impact with respect to these changes.
[Translation]
Senator Chaput: In 2012, the Supreme Court of Canada spoke about the residence criterion for trusts, and there was a change. Now, these criteria are based on where the central management and control are done. Will this residence criterion have an impact on the rules, because it was still modified?
[English]
Mr. Cook: You're quite right; the Supreme Court decision did expand the test for determining where a trust is resident as a matter of a factual determination of where a trust is resident. Many thought before the decision that it would be where the majority of the trustees of the trust resided. In the decision you refer to, the Supreme Court talked about the central management and control of the trust.
That has relevance in terms of the factual determination of whether a trust is resident in Canada and subject to tax on its worldwide income. With respect to the application of the rules we've been talking about at 75(2), the attribution rules, it concerns a situation where someone contributes property to a trust and still retains effective control over it. The governing issue is control of the property as opposed to the residence of the trust.
The deemed non-resident trust rules in section 94 that we've been talking about apply where a trust is not resident in Canada, so it may change at the margin how many trusts it applies to just because some trusts may actually be resident in Canada under ordinary rules.
[Translation]
Senator Chaput: With this change, might we end up with a larger number of trusts that are not resident in Canada?
[English]
Mr. Cook: I think, if anything, it depends how taxpayers react, to some extent. The expectation is that, given the broader test by the Supreme Court, it would actually result in more trusts residing in Canada rather than outside Canada. The kind of situations we're contemplating are where a trust is set up outside but significant directing activities with respect to the trust are potentially going on in Canada.
Senator Chaput: Thank you.
The Chair: Not seeing any other questions, I guess we can go on to the next clause.
Mr. Cook: Clause 52 runs from page 82 to 83. This is a technical change to delete a reference to a definition that no longer exists in the act.
Clause 53 would repeal an obsolete provision.
Clause 54 relates to the phase-out of the additional deduction for credit unions. The committee may remember that the first budget bill had a measure to phase out the additional deduction available to credit unions. It was found that the way we phased out the additional deduction interrelated with the general corporate tax and the general rate reduction.
The way the income tax works is that a corporation is subject to tax at 28 per cent nominally under the act; and then they are eligible for a deduction. We found that with the way we had crafted the phase-out period, the portion of the credit union's income that wasn't eligible for the phase-out was also not eligible for the basic deduction in the computation of the tax rate from 28 per cent to 15 per cent. Therefore, the portion of the additional deduction that wasn't eligible for the reduced rate would actually be taxed at 38 per cent, with the result that the phase-out of the credit union measure would be faster than was anticipated. This is a technical measure to ensure that the measure introduced in the first BIA accords with the budget announcement.
The Chair: There was an unintended consequence of the previous legislation passed. We sat here with you and we talked about what we were trying to achieve and we passed it. It seems that the potential consequence was brought to our attention before we passed this. When did you become aware of this and how did we become aware of this needing rectification?
Mr. Cook: If the Senate committee had heard about it, I don't think we discussed it at committee with you, so I don't know whether you had heard something from a different channel.
The Chair: I am trying to put some blame on us, not on you.
Mr. Cook: No, no. I just don't think we talked about this specific aspect of it when we were here —
The Chair: I can remember this being an issue of concern and remember it being brought to our attention before we voted on this. But now the government has recognized this and is bringing about a change to try to meet this oversight. Nobody intended this to happen the way the earlier legislation we passed in June —
Mr. Cook: Normally, we do a sort of triage after the budget to see which are the complex measures or the measures that would benefit from consultation, and then they are released for consultation prior to inclusion in the bill. All the budget measures included in this bill were released for consultation in September, and taxpayers and their advisers have had a chance to look at and review them.
In terms of the first budget bill, obviously there is no time for a specific consultation other than what's included in the notice of ways and means or the supplementary information. So we try to make our best judgment as to what we've got right, and we thought we had this one right when we drafted it and included it in the bill. That turned out not to be the case.
The Chair: There is no intent to go back to where the credit unions and the caisses populaires were prior to the first budget implementation bill?
Mr. Cook: This is not meant to unwind or affect that. This is purely to make sure that the phaseout applies as was announced in the budget and as intended.
Senator Callbeck: I am trying to understand this. Maybe the best way to ask this is: After these mistakes are corrected and this legislation goes into effect, what is the bottom line? What are credit unions going to be paying — what per cent? What are banks going to be paying?
Mr. Cook: In terms of this, they will be taxed at the general corporate rate of 15 per cent for income that doesn't qualify for the small business deduction, which is the general corporate rate that applies in Canada. The additional deduction that is being phased out was not available to other financial institutions.
Senator Callbeck: And how much was that special tax deduction that credit unions had? And did that apply to all credit unions, large and small?
Mr. Cook: It applied primarily to — I'll ask the subject matter expert, Ms. Chantal Pelletier, to come up.
What the additional deduction did was allow credit unions to take advantage of the small business deduction in respect of income above the small business deduction limit. Small credit unions would be eligible for the small business deduction, and they would continue to be eligible for that deduction going forward.
The additional deduction was primarily of benefit to larger credit unions.
The Chair: We have Ms. Pelletier, who is the subject matter expert on this. Do you have any general comments?
[Translation]
Chantal Pelletier, Chief, Financial Institutions Taxation, Department of Finance Canada: This supplementary tax credit is still available to all credit unions, larger and smaller. The tax benefit of this additional deduction goes mostly to larger credit unions. Generally speaking, most credit unions have access to the small business deduction, and they also have access to the additional deduction, but in terms of tax benefits, the vast majority of the additional deduction will go to larger credit unions.
[English]
Senator Callbeck: Did you say that was still available? I thought we were eliminating it here.
Ms. Pelletier: Do you want to answer this?
Mr. Cook: The small business deduction —
Senator Callbeck: Right. That's there.
Mr. Cook: That's right. It is available and continues to be available. For small credit unions, which encapsulates the majority of credit unions, that is sufficient to give a lower tax rate to their income.
Senator Callbeck: But the special tax deduction — that will be eliminated, right?
Mr. Cook: That is correct.
Senator Callbeck: How much was that? What does that amount to, and does it affect all credit unions?
[Translation]
Ms. Pelletier: I believe that in 2013, we estimated that the additional deduction would give a total tax benefit of $47 million. I would need to confirm that. In our projections, in 2017-18,, we thought that the tax benefit for this credit would be about $75 million.
[English]
Senator Callbeck: So it's $75 million, then, that the credit unions are going to lose? I mean, they're not going to be able to take advantage of that special tax deduction.
[Translation]
Ms. Pelletier: In fact, over a five-year period, from 2013 to 2016, they will be able to claim it partially. In other words, in the 2013 fiscal year, they will have access to 80 per cent of the credit that they would have otherwise been entitled to. In 2014, it will be 60 per cent; in 2015, 40 per cent; in 2016, 20 per cent; in 2017, it will be completely eliminated.
[English]
Senator Callbeck: The $75 million — would you go over that again? What does that represent? Is that over five years or one year?
Ms. Pelletier: This is the revenue gain for the fiscal year 2017-18. So in 2017-18, this is how much the government will raise in terms of revenue from having the additional deduction fully eliminated in that year.
Senator Callbeck: In other words, that's $75 million per year that's going to come out of the credit unions? Okay. Thank you.
[Translation]
Senator Chaput: I am sorry. I do not understand exactly what happened. A change was made to the other budget bill, and Canada's credit unions were not happy with the change that was made.
Ms. Pelletier: Yes.
Senator Chaput: Does what we are doing now correct what was done previously? Was a correction made to set things straight?
[English]
Mr. Cook: That is correct. It is a correction. Budget 2013 announced that the phaseout would be over five years. With the way we had drafted some cross-references as to how amounts go into income that's subject to tax, economically, it would have occurred for credit unions over a shorter period than the five years.
So this makes a correction to the way the various corporate tax rates apply to make sure that the phaseout is over the five years that was announced in the budget.
[Translation]
Senator Chaput: The correction that was made is based on the phase-out. It does not correct the action; it is just spreading it out over a longer period of time.
Ms. Pelletier: That is correct.
Senator Chaput: That is not at all what Canada's credit unions asked of us, if I understand correctly.
How much will these proposed changes cost credit unions in administrative fees? Do you have any idea?
Ms. Pelletier: This measure will simplify the tax act as such, so I do not think the measure will cost anything.
Senator Chaput: No additional costs? Okay. How does the current tax rate imposed on credit unions compare to the tax rate imposed on other financial institutions in Canada?
Ms. Pelletier: Credit unions will continue to have access to the small business rate until 2017, but partially, because we are eliminating the additional deduction.
There are two types of credit union: those that will continue to have access to the small business deduction — they will continue to benefit from the lower business rate of 11 per cent — and larger credit unions that will indeed benefit the most from the additional deduction. They will see their tax burden increase on the portion of their income that will no longer be eligible for the additional deduction over the five-year period, during which we will be doing the phase- out. Starting in 2017, they will be fully subject to the 15 per cent general corporate tax rate.
Senator Chaput: To summarize, smaller credit unions will be penalized, if I understand correctly.
Ms. Pelletier: Generally, the smaller credit unions will not be penalized or affected by this measure because most of them will continue to have access to the small business deduction. This measure mostly benefits the larger credit unions, so they are the ones who will be affected the most by the measure.
[English]
The Chair: Are you suggesting that the smaller credit unions didn't have a lower rate than the small business deduction rate? I thought it was still smaller before the government brought in this change. It was lower.
[Translation]
Ms. Pelletier: The rate that applied to credit unions?
[English]
The Chair: Yes.
[Translation]
Ms. Pelletier: This measure allowed, allows and will continue to allow certain credit unions to benefit from the small business rate versus the general rate.
[English]
The Chair: I understand. That's available to all small businesses, but the credit unions had a lower tax rate before Budget 2013. Is that correct? I might be wrong, but that's what I understood. It had a lower rate and the 2013 and the first attempt at changing this brought the small business enterprise rate, brought their rate up to that. So they do not get the special deduction that was intended to help the small caisses populaires and the small areas of Quebec, the Maritimes and Western Canada where the larger banks wouldn't be able to operate, anyway. They had higher administrative costs and lower profits. That's why we had the lower rate for them.
Ms. Pelletier: That's right, but I will probably repeat myself here. Most credit unions in Canada are small, so most of them already benefit from the small business deduction. They will continue to benefit from it even with the phase- out of the additional deduction because most of them do not need the additional deduction to access the small business rate because they already have access to the small business deduction.
The Chair: My understanding was incorrect that they had a deduction to the small business rate. You're saying that's incorrect?
Ms. Pelletier: Yes. I am aware of only two tax rates.
The Chair: I am pleased that you sorted me out on that. That's good.
Senator Buth: My understanding was that the deduction essentially allowed all credit unions to claim the small business rate and now that's being phased out so the small ones will still continue claiming the small business rate. Can you give me the definition of "small business?" What's a small business?
Mr. Cook: Small business is $500,000 in income per year.
Ms. Pelletier: It's generally a corporation that has taxable capital in Canada of less than $15 million. Once a corporation meets that condition, then they have access to the small business rate up to $500,000 of their income.
Senator Buth: Up to $500,000 of their income?
Ms. Pelletier: Yes.
Senator Buth: So they can have higher income. They just can't claim the lower tax rate on that income. If they have income above $500,000 they get taxed at the corporate rate.
Ms. Pelletier: At the15 per cent general corporate income tax rate.
Senator Buth: The small business rate is 11 per cent?
Ms. Pelletier: That is correct.
Senator Buth: And the corporate rate is 15 per cent?
Ms. Pelletier: Yes, at the federal level.
Senator Buth: When this gets phased out, the larger credit unions will all be paying the 15 per cent rather than the 11 per cent?
Ms. Pelletier: That's right.
Senator Callbeck: In 2017, what will be the tax rate for the large banks as compared to the large credit unions? What about the small credit unions?
Ms. Pelletier: I don't know what will be the tax rate in 2017, but the tax rate should be the same for both — all financial institutions — banks as well as credit unions.
Senator Callbeck: Regardless of size?
Ms. Pelletier: I was talking about the large credit unions. They will be subject to the same tax rate as other corporations, including financial institutions, which will be the 15 per cent rate.
Small credit unions in 2017 will continue to benefit from the small business deduction and thus from the small business rate of 11 percentage points.
Senator Callbeck: What is the net worth of, let's say, our smallest chartered bank in Canada as compared to the net worth of our largest credit union?
Ms. Pelletier: That's a good question. I would say that the smallest banks probably compare to the largest credit unions in terms of asset size. As you all know, one of the most important credit union groups in Canada is the Desjardins Group. Desjardins overall would compare to Banque Nationale in terms of assets.
Senator Callbeck: Okay. Thank you.
The Chair: Thank you. This has been a matter of some public discussion, as you might know, so the information that you've been able to give us is helpful in understanding what this legislation is trying to achieve.
I do not see any other questions, so we'll move on to the next section.
Mr. Cook: That was clause 54.
Clause 55 is another technical amendment that relates to the small business deduction for Canadian controlled private corporations. It is just to insert appropriate references to section 34.2 of the Income Tax Act, which are the corporate partnership deferral rules we talked about a little earlier.
The Chair: Nothing to do with credit unions.
Mr. Cook: No, it's got nothing to do with credit unions.
Clause 56 on page 84 is another clause relating to synthetic dispositions, and this is a rule that limits the ability of a taxpayer to claim a foreign tax credit if they've held the relevant property for less than a specific period. This makes sure that if there is a synthetic disposition arrangement entered into with respect to a property, that they will not be considered holding it for the purposes of whether or not they can claim a foreign tax credit. That's clause 56.
Clause 57 runs from pages 85 through 88 and it contains a number of consequential amendments with respect to the trust lost measure that we already discussed and the pre-production mine development expense measures that we've already discussed. For the most part, they make cross-references and update the terminology as we've discussed already.
On page 88, we've got an amendment to the definition "qualifying corporation" in subsection 127.1. The term "qualifying corporation" is relevant for determining whether a company has what's called a qualifying income limit, which in turn is relevant for whether or not they can claim an investment tax credit.
At the request of CRA, we're making a clarifying amendment so that a company can only be a qualifying corporation if in fact it has a qualifying income limit. Clause 59 is on page 89.
It relates to the Labour-Sponsored Venture Capital Corporation measure, which is paragraph D.
The Chair: D for Day?
Mr. Cook: That's correct. This measure phases out the federal Labour-Sponsored Venture Capital Corporations credit, the LSVCC credit. The credit will remain at 15 per cent when claimed for a taxation year that ends before 2015 and will be reduced to 10 per cent for the 2015 taxation year and 5 per cent for the 2016 taxation year. The credit will be eliminated for 2017 and subsequent taxation years. The measure also provides for ceasing the registration of new LSVCCs for federal purposes and the prescription of provincially registered LSVCCs for tax purposes.
[Translation]
Senator Chaput: What is the reason for this? Why phase out the federal tax credit for labour-sponsored venture capital corporations?
[English]
Mr. Keenan: The government has been pursuing a policy agenda focused on increasing productivity and innovation in the Canadian economy, and, in 2010, the government established a review of federal support for research and development, led by Mr. Tom Jenkins. One of the outcomes of that report was the introduction of the Venture Capital Action Plan that was in Economic Action Plan 2012.
The independent experts who have studied the Labour-Sponsored Venture Capital Corporations tax credit have indicated that it has not been an effective way to support venture capital development in Canada. This is a message that has been heard by the government through organizations like the OECD. To provide more focused, targeted support to venture capital, the decision was taken to gradually phase out the Labour-Sponsored Venture Capital Corporations tax credit.
[Translation]
Senator Chaput: It was a government decision?
[English]
Mr. Keenan: Absolutely.
[Translation]
Senator Chaput: How many of these labour-sponsored venture capital corporations are there in Canada? Are there many?
[English]
Mr. Keenan: There are currently 19 LSVCCs, only 12 of which are currently open to new subscriptions. So they are offering new shares.
[Translation]
Senator Chaput: Are there provinces where there are none?
[English]
Mr. Keenan: The two largest LSVCCs are in Quebec. There are 10 in Ontario, two in Saskatchewan, one in British Columbia and three that are multi-provincial. A number of provinces also offer the provincial tax credit for purchases of shares in Labour-Sponsored Venture Capital Corporations. Alberta does not. Prince Edward Island does not, and, in 2005, the Government of Ontario announced that it was eliminating its credit. That credit has been completely eliminated.
[Translation]
Senator Chaput: How are these labour-sponsored venture capital corporations reacting to this government decision?
[English]
Mr. Keenan: I think it's fair to say that they are opposed to that decision.
[Translation]
Senator Chaput: Yes, obviously.
Senator Bellemare: I would like to know a little more about the monetary impact by region. We know that the largest labour-sponsored funds are in Quebec: the Fonds d'actions, the Fonds de solidarité, those are large funds. What will the financial impact of these measures be for the funds by province, or at least for Quebec?
[English]
Mr. Keenan: It's a federal income tax credit that is available to individuals who purchase shares in Labour- Sponsored Venture Capital Corporations, so, according to the latest public data, the largest number of people — 90 per cent — who claim the credit are in Quebec. In terms of value of the credit, it is about 85 per cent. Their purchases are not necessarily at the maximum, which is $5,000 of purchases. The situation of the funds in Quebec is quite different from other funds in that they are large, well-capitalized funds. Their infrastructure and ways of getting contributions are totally different from other provinces.
[Translation]
Senator Bellemare: I have $300 million in mind as the fiscal impact. I do not know if that number is correct, but I think I saw it somewhere and I wanted to check. It might be more, it might be less.
Mr. Keenan: $300 million?
Senator Bellemare: Yes, the fiscal loss for Quebec, the financial impact. I just wanted to check that.
Second, that capital is generally invested in the local economy. We are talking about venture capital, which has more to do with job creation. Have you conducted an impact study? I am asking because, in Quebec, we are being told that this is a very bad measure. Do you have anything to say about what we are being told?
[English]
Mr. Keenan: The number is what you are saying.
[Translation]
Senator Bellemare: Yes. That is what I was looking for earlier, and I could not find it.
[English]
Mr. Keenan: In the budget, it was indicated that, through the phase-out period — for the five years in the fiscal forecast — the savings to the government in terms of eliminating the tax expenditure are $355 million. That is for the country as a whole, with a large share coming from Quebec.
Senator Bellemare: About 80 per cent?
Mr. Keenan: Eighty-five per cent.
Senator Bellemare: So it is about 250, 260 million.
Mr. Keenan: As I said to Senator Chaput, the government has looked at the best way to support venture capital development in the country. That report from Mr. Tom Jenkins suggests that the Venture Capital Action Plan and the targeted support toward private sector venture capital is going to lead to better development of venture capital in Canada and be a better way to support it. The evidence from international commentators and people who have looked at the credit is that it is not an effective way to support venture capital. Introducing the Venture Capital Action Plan and eliminating the LSVCC tax credit will lead to better outcomes for venture capital.
[Translation]
Senator Bellemare: So if members of our community ask us about this, we should refer them to the Jenkins report and tell them that the document suggests eliminating the tax credit. Is that how I should interpret your answer?
[English]
Mr. Keenan: The adoption of the Venture Capital Action Plan will lead to better venture capital outcomes than we had previously, yes.
Senator Callbeck: You say that there is a report showing that these labour-sponsored venture capitals are not the best way to support venture capital. The government is doing a venture capital action plan. Can you describe that? Is it in effect now, or is it coming?
Mr. Keenan: I'm not the expert on the venture capital action plan but I can say that four main criticisms of LSVCCs come through in the academic literature: a high level of upfront tax assistance provided; a link between individuals who make a contribution primarily to receive the tax support and then lose interest in the performance of the fund, so from the venture capital outcome side, you do not get the ongoing interest from shareholders; a small proportion of the investments received are directed through venture capital; and generally, there is a different governing structure in those funds than in other types of funds where owners actually have money invested so there is poor market performance. The venture capital action plan is spelled out in some detail in budget 2013 and 2012 when it was introduced. The government is investing $400 million in various venture capital investment funds. I am not the expert but it will leverage private sector money upwards of $1 billion to support venture capital development in Canada.
Senator Callbeck: You said that on labour sponsored venture capital a small per cent went into venture capital?
Mr. Keenan: According to the analysis done internationally and looking at the funds, not a huge share of the money that is invested in LSVCCs finds its way into what is considered traditional venture capital activities.
Senator Callbeck: I thought that was what it was all about. I am surprised to hear that.
Mr. Keenan: Rules apply to them and provincial funds are registered provincially. Those are recognized by the federal legislation. They have rules very similar to federal rules but 60 per cent of the funds from an LSVCC need to be directed to eligible investments. Those are certain types of small businesses that have fewer than 500 employees. I think it's been understood that the largest funds in Canada are in Quebec. Those funds are large and well capitalized, but they have a history that goes back further than the federal LSVCC. They serve a regional development purpose that is not necessarily venture capital. They are governed by the legislation in Quebec that authorizes them and puts them into existence; so those rules are different from the federal rules. In terms of how much of the investment going into the funds is truly traditional venture capital, it's a small share.
Senator Callbeck: Did you or the government have any discussions with the provinces or any of these venture capital corporations before they decided to cancel this program? I know you had a report but did anybody actually talk to the people involved?
Mr. Keenan: On a measure like this that is essentially improving the neutrality of the tax system and eliminating an ineffective measure, it would be uncommon for us to do consultations in advance of announcing the measure.
The government announced as part of the budget that a period of consultations was to take place to look at changes to the tax rules that could help LSVCCs in the transition period and whether rules need to be changed inside the Income Tax Act to assist them. Those consultations ran from May to July. The government is still reviewing the rules to see whether changes to the Income Tax Act could be introduced to help the funds manage in the phase-out period.
Senator Callbeck: What percentage of the $400 million capital action plan will go to small business?
Mr. Keenan: I'm not the person who has all the details about the venture capital action plan, but I could endeavour to find that out.
Senator Callbeck: Right. I would think that the cancellation of this program would make it much harder for a lot of small businesses to get funds. That's why I'm asking about this new program. When you're sending information to the committee, could you send information on that program to tell us exactly what it is?
The Chair: That's all the questions I have from senators on clause 59. We'll go on to 60.
Mr. Cook: Clause 60 starts on page 90 and goes to page 91. This technical amendment was released in December 2012 and relates to the computation of the alternative minimum tax for individuals. That tax is calculated without respect to certain deductions to ensure that a certain baseline income tax is paid by individuals with income over a certain amount. Under the existing rules, if a person was a member of a limited partnership and that limited partnership had losses, they could not use those losses in computing their income for alternative minimum tax purposes. All they could do is off set them against taxable capital gains from the same partnership. This has been found, in some cases, to have an overly onerous impact where the income of the partnership goes up and down can as they could end up having liability for alternative minimum tax in one year and not be able to take advantage of the losses they have. This is a relieving change that would allow losses from limited partnerships to be used for AMT purposes unless the limited partnership is a tax shelter.
Clause 61 is on page 91. It's a comfort letter issued in respect of cooperative corporations. Cooperative corporations are deemed to be private corporations for certain purposes. This amendment would allow them to be private corporations for purposes of the eligible dividend regime. That means if they otherwise qualify, dividends paid by them are eligible for the higher dividend tax credit rate.
Clause 62 relates to credit unions. It is a comfort letter that has nothing to do with the budget measure we've been talking about. The way it generally works, dividends paid on credit union shares are treated as interest for tax purposes. This comfort letter will allow the same treatment where the share is issued not by the credit union that the person is a member but by another credit union that the credit union is a member of. It recognizes the role of credit union centrals, which are more prevalent in Quebec, and their structures.
[Translation]
Senator Bellemare: Do those measures have a financial impact, whether large or small?
[English]
Mr. Cook: It is not an important impact, so we haven't booked any fiscal impact for this particular change.
[Translation]
Senator Bellemare: So you have not received any negative comments?
[English]
Mr. Cook: We have not received any negative comments on this. This is purely relieving for taxpayers.
The Chair: You indicated that this is to correct a comfort letter, so you were operating as if this was the law.
Mr. Cook: We were. This is one of our newer comfort letters as it was just issued in March 2012.
The Chair: From the point of view of impact, if you were operating as if this were the law, then there would not be a financial impact by making this the law — you were operating as if it was the law.
Mr. Cook: You're quite right.
Normally for comfort letters, they are not of enough significance in terms of impact that we would book an impact one way or the other.
The Chair: That's what I would have thought.
Mr. Cook: But you're quite right. When we announce something, we consider the fiscal impact at the time of the announcement as opposed to the time of final enactment.
Senator Callbeck: I'm just wondering: A comfort letter — how long does it take to get that?
Mr. Cook: It will depend on the particular situation and the particular transactions. Sometimes they can be done in fairly short order in terms of weeks if it's necessary for a transaction and we're comfortable with respect to the policy. Otherwise, it can take months.
The Chair: Is Justice involved in comfort letters being generated? Is Finance involved, or is it all CRA?
Mr. Cook: Actually, it's all Finance and not the Canada Revenue Agency. We might consult them on a particular aspect if we feel the need to.
The way it generally works is the Canada Revenue Agency, as administrator of the Income Tax Act, will do its own technical interpretations or advance income tax rulings where, in respect of a transaction a taxpayer is planning to make, the CRA will say, "We will assess it in this manner, provided these facts are correct." What normally happens is the taxpayer may go to the CRA and come to a point where the CRA will say, "We cannot issue a positive income tax ruling because no matter when you do, you will fall afoul of this rule. If you want to do anything, go the Department of Finance and make your case to them that, in fact, the rule should be changed."
So it is all Department of Finance that does the analysis.
The Chair: In terms of process, that's good to know in case we want some comfort sometime.
Mr. Cook: Clause 63 is also a technical amendment that just deletes some cross-references that are no longer necessary in the act.
Clause 64 is an amendment to section 147.1, and this is the second part of the amendment related to registered pension plans, correcting contribution errors — paragraph (b). This is the amendment that actually allows the administrator to refund the over-contributions.
The Chair: Without penalty?
Mr. Cook: That's correct.
[Translation]
Senator Chaput: How would you define a "reasonable error"?
[English]
Mr. Cook: In terms of what constitutes a "reasonable error" — people can have different views as to what is "reasonable" — the administrator of the act — the CRA — will develop their administrative guidelines as to what is reasonable.
We are trying to get at things that might happen inadvertently in the normal course. For example, someone has gone off payroll because they've left their job, but it has not been correctly reported yet. As a result, there has been a contribution made. Those kinds of things. What we're really concerned about is that we don't want people wilfully entering into over-contribution transactions and then taking it out later as a way to sort of play with the registered pension plan regime.
Senator Chaput: So guidelines will be developed?
Mr. Cook: As necessary between the CRA and —
Senator Chaput: And it is case by case, more or less?
Mr. Cook: At the end of the day.
The Chair: Next is 65.
Mr. Cook: Clause 65 relates to the 10/8 arrangements that we had talked about earlier. This is a transitional rule that actually gives taxpayers an opportunity to extract themselves from a 10/8 arrangement without undue tax consequences.
The main thing we want is to stop these 10/8 arrangements. So there is a limited period within which people can unwind their 10/8 arrangements without undue tax consequences.
The Chair: Without penalty again?
Mr. Cook: That's right.
The Chair: Okay.
Mr. Cook: In the sense they will be allowed — If they would have had an income inclusion, they can take an offsetting deduction so they are kind of net.
Clause 66 is on pages 94 and 95. Again, this is just a consequential amendment relating to the trust loss measure. This particular clause puts in rules around when a trust becomes or ceases to be potentially in a tax-exempt entity.
Clause 67, on pages 95 through 97, introduces another measure — Paragraph C of your briefing — with respect to a reassessment period for reportable transactions and tax shelters, and also Paragraph P reassessment period for reporting foreign-specified property. This section of the act provides the rules around when CRA may reassess a taxpayer.
The two measures that are involved are with respect to tax shelters and reportable transactions. In both cases, tax shelters and reportable transactions have independent reporting requirements — information returns that must be filed by the promoter of the tax shelter or the participant in the reportable transaction. This measure would give the CRA the ability to assess in respect of the tax shelter or reportable transaction up to three years after the information return is filed. The notion behind it is that these information returns are to help the CRA police these types of transactions, and if they are aren't being filed as appropriate, then the CRA should have additional time to appropriately audit and reassess taxpayers.
The Chair: It gives CRA three more years on top of what?
Mr. Cook: The normal reassessment period for an individual taxpayer is three years.
The Chair: So it is three plus three, so it can go up to six years?
Mr. Cook: If they don't file at all — Let us say they do not file for five years, it would be three years after when the information return is filed. It's only in respect of that particular tax shelter or reportable transaction, though.
The Chair: Okay.
[Translation]
Senator Chaput: Do you have an idea of how much taxpayers will be affected by this change?
[English]
Mr. Cook: I'm afraid I don't have any particular figures. I don't know whether my colleague knows the number of people involved in tax shelters. I'm sorry. There is a fair number, but I do not have any specific information.
The Chair: Is that something that, when you go back to your office, you could easily locate for us? We don't want you to go to all the files and count them, but —
Mr. Cook: It is essentially the number — On the reportable transaction side, I do know that the implementation of that was just in the recent technical bill. And the number of people who have filed in respect of reportable transactions is very, very low; it's well under 100. That's a very small cohort.
[Translation]
The Chair: Senator Chaput, is that enough for you?
Senator Chaput: Yes, thank you.
[English]
The Chair: Thank you. We will go on to the next section.
Mr. Cook: There is actually one other measure that is embedded in this. The second part of this is an extended reassessment period with respect to what is called form T1135. That requires taxpayers to report assets outside Canada and income from those assets if certain assets are worth more than $100,000. In instances where the form is not filed or not correctly filed and foreign income is not proper reported, then the CRA will have an additional three years to reassess the particular year of the taxpayer.
So in that case, in contrast to the measure we've just been talking about, this is just an additional three years. It's from three years to six and it's in respect of the taxpayer's entire return as opposed to one aspect that's reported on the form.
The Chair: Thank you.
Mr. Cook: Clause 68 relates to specified investment flow-through entities, and what it provides is for these SIFT entities, specifically trusts. Trusts for purposes of the act are generally considered to be an individual's, which meant that SIFT trusts would pay installments for tax, as individuals would on a quarterly basis. Given the size of SIFTs and the way they're operated, they're closer to corporate businesses. This change would require SIFTs to pay installments on a monthly basis, as corporations do, as opposed to individuals.
The Chair: Can you refresh our memory on SIFTs?
Mr. Cook: They are flow-through entities. They're basically the income trusts, where trusts were used to hold corporate entities and there were concerns that debt was used to reduce the corporate level tax that was paid. A comprehensive regime with respect to SIFTs, and an additional SIFT tax, was originally introduced in 2006-07 and implemented in 2012, I believe.
Clause 69 on page 98 corrects some typographical errors in the act, adding an "s" to parts. In subsection 2, it corrects a reference to a defined term.
Clause 70 relates to Scientific Research and Experimental Development penalty, which would be paragraph J of your briefing note.
Basically, this is to ensure that billing arrangements are correctly reported to the CRA to facilitate auditing of SR&ED claims. Where billing or preparer information is missing, incomplete or inaccurate, there will be a penalty of $1,000. If there was a preparer involved, then the preparer would be joint and severally liable with the corporation making the claim.
The Chair: Is it common that you have joint and several liability for someone who does your income tax return for you?
Mr. Cook: This is specific to —
The Chair: This is pretty special.
Mr. Cook: This is special.
[Translation]
Senator Bellemare: Were there any specific reasons for proposing this measure for a given sector? Were there any cases of abuse or any complaints?
[English]
Mr. Cook: The SR&ED is a very specialized area of income tax, and there are specialized preparers that assist taxpayers in preparing their SR&ED claims. There is more widespread use of contingency fees, so my fee would be related to the extent to which you can successfully claim. There has been a consultation with respect to that.
This is to provide CRA with basic information so that if they start to see a pattern with respect to claims where specific preparers are involved, it will help the CRA to direct their efforts towards auditing those types of claims.
The Chair: I am reading from proposed subsection (5.2), at the top of page 99. I think this is quite extraordinary that someone who prepares your income tax return for you could be jointly and severally liable with you. I see where there is a chance to get out of it. The claim preparer is not liable for a penalty in respect of a false statement or an omission — it could be an inadvertent omission, not an intended omission — if the claim preparer has exercised a degree of care, diligence and skill. And then it says "to prevent the making of the false statement or omission." What does that mean? In effect, you're saying there would be no penalty if the claim preparer was able to find the omission and corrected it, so there is no penalty at all.
Mr. Cook: In terms of how we drafted the specific legislation, the penalty is predicated on making, participating, assenting to or acquiescing in the making of a false statement or omission in respect of that. So the predicate is that the false statement or omission has been made. All this is trying to do is give a due diligence to the preparer.
The Chair: But the degree of diligence and skill has to have prevented the making of the omission, so if it prevented the making of the omission, there isn't any omission and there is no penalty. There must be something wrong with that wording, or maybe it's late in the afternoon and I am misreading it.
Mr. Cook: I think the way that we would interpret it is that you've undertaken steps that a reasonably prudent person would have done to try to prevent the making of the omission.
The Chair: To try and prevent, yes, absolutely. I understand that, but it's not saying to try and prevent; it says to prevent the omission. So the person who prepares the claim has to have been so diligent that he or she would have prevented the error from occurring and therefore there is no error because a form would have been filed without an error and there is no penalty to undo.
Mr. Cook: I think it just refers to exercising a degree of care, diligence and skill to prevent. It's not that the end result is necessarily to prevent, but that you've exercised the skill to try and —
I've used the word "try" again.
The Chair: I've made my point. You may want to think about that.
Senator Callbeck: I was wondering how many claims there might be in a year where information is missing or incomplete or inaccurate?
Mr. Cook: Well, this is a new form, so we've got no experience, and this is just with respect to the billing information. It's not speaking to the claim writ large. It's with respect to the billing information.
In terms of the number, there are approximately 23,000 SR&ED claims per year, but we do not have experience yet as to how many would actually be subject to this penalty.
Senator Chaput: And this does not apply to an employee filling the claims? It just applies to others who would be doing the work, but it says here "does not include an employee who prepares or assists."
Mr. Cook: That is correct. It would be the employer, not the employee.
The Chair: Any other questions? No? That was an interesting one.
Mr. Cook: Clause 71 runs from page 99 to 102 and it relates to electronic suppression of sales software, which I believe is paragraph R of your briefing material.
This measure introduces both administrative and criminal offences with respect to the use, possession or sale of electronic suppression of sales software. This is software used to essentially selectively delete sales, for example.
The Chair: Oh, so they do not get counted as part of income?
Mr. Cook: That is correct.
The Chair: Can you imagine there would be something like that?
Mr. Cook: There are parallel amendments in both Part 1 and Part 2 — Part 2 dealing with the sales tax and Part 1 dealing with the income tax.
In terms of the administrative penalties which are in the clause we're specifically looking at, for the use of this software it's a penalty of $5,000 on the first infraction and $50,000 on subsequent infractions. For the possession of this software, there is a penalty of $5,000 and $50,000 for subsequent infractions. For the manufacture, development or sale, possession for sale, offer for sale or making available this software there is a penalty of $10,000 on the first infraction and $100,000 on subsequent infractions.
For possession or acquisition and possession for sale, offer for sale, those types of —
The Chair: Is this all a new clause in the Income Tax Act?
Mr. Cook: That's correct.
The Chair: Prior to that you would have to prove fraud.
Mr. Cook: This is very much more direct in terms of dealing with this particular software.
The Chair: Yes, we are somewhat familiar with dealing with administrative versus criminal sanctions.
Mr. Cook: There would be administrative and potentially criminal sanctions.
[Translation]
Senator Bellemare: Have you estimated the value of the missing revenue, the value of sales taxes that are not reported owing to this software? This has been mentioned in the newspapers over the past few years. Consumers were being told to be careful, to ask for their receipt and make sure that is really their receipt, as it was possible for there to be hidden software and that they might be paying the tax, but the tax would not be collected by the government. Do you have a ball-park figure of how much revenue is lost?
Pierre Mercille, Senoir Legislative Chief, GST Legislation, Department of Finance Canada: I will answer the question because, as Mr. Cook mentioned, the same amendments are found in Part 2, which concerns the GST. The same offences and penalties are implemented in this bill regarding the GST.
The Department of Finance does not have any figures on that. That data is more or less reliable because this is not something people report, and they usually do not talk about it too much. So it is difficult to obtain the real numbers. The Department of Finance has no data on this, but other entities have published some figures. According to a Canadian restaurant association, some $2.4 billion is undeclared in the restaurant sector.
Senator Bellemare: Was that figure $2.4 billion?
Mr. Mercille: Yes. The government of Quebec has also implemented certain measures. The government thinks that perhaps over $400 million in sales taxes is undeclared in Quebec.
Senator Mockler: Given the answer I just received, what would be the estimated figures for other sectors?
Mr. Mercille: I do not really have any figures for other sectors. Analyses have been done in the past to determine what sectors had the most moonlighting and undeclared sales. The restaurant sector would probably be among the leaders. Statistics Canada, which has done a study in the past, estimated the value of the underground economy in Canada at $35 billion. However, that was not the value of taxes; that was the value in terms of the gross domestic product.
Senator Mockler: Overall?
Mr. Mercille: Yes, but these are just estimates. Statistics Canada carried out the study at the request of the Canada Revenue Agency. We do not really have a consensus on the best way to obtain the correct data on moonlighting. The figures are much higher than what we have because moonlighting and the whole underground economy go beyond the use of electronic suppression of sales software.
[English]
The Chair: This seems like a good time to adjourn, which is the time indicated. We are ready to start at clause 73 tomorrow. Our meeting will be in room 160-S tomorrow and we begin at two o'clock.
I'm told that the motion has now been adopted in the chamber, so the chamber goes in at 1:30 tomorrow and Thursday, so that will give you a chance to be there for any statements or Question Period. Then we'll go downstairs to 160 and see if we can finish up Part 1 and then, tomorrow evening, we'll definitely get into Part 2. It would be very nice if we can start on Thursday with Part 3 and the many different portions of that.
Thank you very much for being here, and we will now adjourn.
(The committee adjourned.)