THE STANDING SENATE COMMITTEE ON NATIONAL FINANCE
EVIDENCE
OTTAWA, Tuesday, October 17, 2017
The Standing Senate Committee on National Finance met this day at 9:30 a.m. to continue its study on the Minister of Finance’s proposed changes to the Income Tax Act respecting the taxation of private corporations and the tax planning strategies involved.
Senator Percy Mockler (Chair) in the chair.
[Translation]
The Chair: Honourable senators, welcome to this meeting of the Standing Senate Committee on National Finance.
[English]
My name is Percy Mockler, a senator from New Brunswick and the chair of the committee. I wish to welcome all those who are with us in the room and viewers across the country who may be watching on television or online. As a reminder to those watching, the committee hearings are open to the public and also available online on the Senate website at sencanada.ca.
I would like to ask the senators to introduce themselves, starting on my left.
Senator Oh: Victor Oh, Ontario.
[Translation]
Senator Pratte: André Pratte from Quebec.
Senator Moncion: Lucie Moncion from Ontario.
[English]
Senator Neufeld: Richard Neufeld, British Columbia.
Senator Marshall: Elizabeth Marshall, Newfoundland and Labrador.
[Translation]
Senator Eaton: Nicole Eaton from Ontario.
Senator Forest: Éric Forest from the Gulf region of Quebec.
[English]
The Chair: Now I would like to recognize the clerk of the committee, Gaëtane Lemay, and our two analysts, Sylvain Fleury and Alex Smith, who team up to support the work of this committee.
This morning, our committee continues its special study on the proposed changes to the Income Tax Act respecting the taxation of private corporations and the tax planning strategies involved, changes that the Minister of Finance proposed during the summer.
Today, honourable senators, we have before us three witnesses we’ve asked to give their opinions on the impacts of the proposed changes.
[Translation]
We are pleased to welcome Michel P. Coderre, lawyer-director of De Jure Lawyers. Mr. Coderre is a member in good standing of both Quebec and Ontario bars. He is also a chartered accountant and submitted a detailed brief to the committee.
[English]
We also have from the Canadian Centre for Policy Alternatives, the CCPA, David Macdonald, Senior Economist. The CCPA has its national office here in Ottawa but also has offices in five other provinces. Finally, from the Canadian Taxpayers Federation, we welcome Aaron Wudrick, Federal Director.
Witnesses, thank you for accepting our invitation. We will now proceed with your presentations.
[Translation]
Michel P. Coderre, Lawyer-Director, De Jure, Lawyers, As an individual: Thank you, Mr. Chair. My speech this morning will be in English, but I will obviously answer any questions in French or English.
[English]
On a personal note, it’s good to be back in the Senate after 40 years. While in university, I worked as a page in the Senate under the command of Major Guy Vandelac, then Usher of the Black Rod and a Dieppe war hero. His conditioning was so effective that if any of you today asks me for a glass of water, I might just spring to my feet and get you one.
Enough about me; on to the proposals. My presentation today is based on the July 18 proposals. The government yesterday announced that changes would be made this week, but we don’t yet have any details. The comments I will be making today are in the nature of framework comments and so will be useful to assess the upcoming changes this week.
The government has characterized the proposals as, one, plugging tax loopholes; two, taxing rich Canadians who use private corporations to avoid taxes; and three, making the middle class work better.
These three characterizations are unfortunate. The proposals are not about closing loopholes; they are mostly foundational. As I will show today, private corporation owners are not all rich Canadians, and the proposed changes are not about building a better middle class. Not a single dollar is added by the proposals to the pockets of the Canadian middle class.
The government is on a self-imposed neutrality binge, between entrepreneurs and employees, and between successful entrepreneurs and other Canadians. I would suggest that good tax policy is not about neutrality. It’s about good choices. This committee can play a vital role in validating the assumptions underlying the tax proposals and assisting the government to make good policy choices.
Instead of buying into this neutrality thing, this committee might consider the following questions: Is our tax system aligned with Canada’s industrial policies? As the Prime Minister tours the country to declare support for innovation, artificial intelligence and small business, are Canada’s tax policies supporting this? Do we wish to idealize a system that, first and foremost, seeks tax neutrality between entrepreneurs and employees? Do we wish to foster a business climate where Canadians are encouraged to become wealthy and take risks? Do we wish to ratchet down the incomes of our successful business class for the simple purpose of preaching equality?
The proposals are directed to three areas: passive capital, income shifting and income conversions. I will comment briefly on each of these three areas.
Passive capital is first. Over my career, I have worked extensively with small and medium-sized businesses. One of the most important lessons that entrepreneurs learn over and over again is that cash is king. In particular, there is never enough cash. Whenever you have cash, you need to protect it. There is always a rainy day. Banks and venture capital may not be there for you exactly when you need them — or ever, for that matter.
In July, the minister justified the proposals by concerns over the fact that the number of private corporations had risen to 1.8 million. But the minister did not provide supporting data on the makeup of these 1.8 million corporations, and the minister has been using this figure of 1.8 million to argue that rich Canadians are not paying their fair share.
Is this called for? Is this justified? I submit that it is not.
Yesterday, the government finally released data on this. The analysis of this data is very troubling, as it can legitimately serve to question why the minister chose to address the tax proposals by firing a bazooka across the entire Canadian small-business sector. In so doing the government has created havoc for the past three months in the small-business communities and it has hijacked the business of Parliament.
The data released yesterday pertains to the year 2015. It indicates that out of the 1.8 million corporations, more than 1.5 million of them had no passive income at all. Another 143,000 had passive income of less than $10,000.
Out of the 1.8 million private corporations, only 20,000 corporations had passive income over $100,000. This represents 1.6 per cent of the 1.8 million corporations.
As to passive investments, 85 per cent of the 1.8 million corporations had no passive investments at all, while 1.6 per cent of the 1.8 million corporations held 80 per cent of all passive investments.
In fact, I would say, dear senators, that the data suggests that what Canadian small business needs is a capital injection. Small business has no cash. They are undercapitalized.
This being said, what can we do with these 20,000 corporations who earn most of the passive income and hold 80 per cent of passive investments? Well, we have two options. One option is to throw them under the bus and tax them. A second option is to thank them profusely for supporting Canadian financial markets and Canadian businesses and for making venture capital investments.
Before we can make any decision on which option to take, I submit that we still need additional information. We’re not ready yet.
What will the impact be on Canadian financial and stock markets if the government appropriates billions in investment assets to redirect the funds into the Consolidated Revenue Fund? Information suggested today is that Canadian passive investments stand at $400 billion and that they presently generate $28 billion of annual income.
Another question: What will the impact be on banking loan ratios, debt-to-equity ratios, once a sizeable portion of the asset value of our corporations disappears into government coffers? Who will cover the borrowing shortfall?
Also, has the government discussed its proposals with the banking sector? Will the proposals trigger defaults under existing loan arrangements? What will the government do with the money? After withdrawing it from the economy, will the government reinvest it in the economy to replace the lost capital?
I will now turn to income sprinkling. I would suggest that for a tax measure to be defensible it should meet two tests. First, it should be justified on grounds of policy. Second, it should be capable of sound administration.
It’s debatable whether the proposed measures on income sprinkling meet the first test on policy. Small business is a family affair. The family shares the stress and the burdens. Why would the family, particularly the spouse, not share the income? This is not like employment income.
But the income sprinkling rules fail the second test on tax administration. My specific comments are that the reasonable test is unenforceable and the rules are horribly subjective. Subjectivity has no place in tax administration. As they are drafted, the CRA will have a field day with these rules.
While the proposed rules are earmarked to raise $250 million, this has to be offset by the government enforcement costs and the dispute resolution costs. The proposed income-sprinkling rules will seriously penalize any taxpayer who becomes the subject of an audit. Any small-business owner knows that any tax dispute is crippling to small-business life. It occupies time, it costs money, and it distracts to the detriment of the business. Moreover, any tax dispute can jeopardize business banking arrangements, as we all know that banks get very nervous and uncomfortable with tax assessments.
I would suggest that the CRA in fact already has the existing tools to control undue family income sprinkling. Rather than introducing new rules, it would be best to address issues of concern by using existing rules.
Income sprinkling is often conducted to finance the education of children of university age. Has the government considered that removing the corporate financing of education will ricochet into provincial coffers through increased student loan applications?
Finally, does the government really think that this is a worthwhile exercise, to occupy so much of the national agenda for $250 million of revenues?
For these reasons, the proposed income-sprinkling rules make no objective sense. They should be withdrawn.
Thirdly, and briefly, the income conversions. The income conversion rules were introduced by the government as a response to perceived tax abuse in converting dividends into capital gains. They are very technical. In response, the government released rules which looked deceivingly simple but which after a full consideration can be construed as a rampant virus into routine Canadian corporate transactions.
On October 2, the Joint Committee on Taxation of the Canadian Bar Association and the Chartered Professional Accountants of Canada released a 60-page brief showing how these rules permeate small-business transactions such as business sales, business financing and estate planning.
In the corporate world not everything is a dividend, nor should it be. There are capital transactions which should not attract tax, particularly on the return of capital. In short, the proposed rules stand to convert anything that moves into a dividend. For these reasons, they should be withdrawn.
Thus, in conclusion and summary, on passive capital we have a bazooka approach that is based on unfounded assumptions and on incomplete analysis. On income sprinkling we have rules with a debatable policy justification and rules that fail the administration test. On income conversion we have technical rules that overflow into a host of unintended consequences on Main Street corporate transactions.
I thank the committee for this opportunity to be heard. These are my opening remarks.
The Chair: Thank you, sir. Now we will recognize Mr. Macdonald.
David Macdonald, Senior Economist, Canadian Centre for Policy Alternatives: I’d like to thank the committee today for their invitation to attend this session.
Of the three measures proposed, and given the time, I’d like to constrain my time primarily to the income-sprinkling proposal, although I’m happy to respond to questions on the other two issues.
I will refer senators to my recent report, “Splitting the Difference: Who Really Benefits from Small Business Income Sprinkling?” That report contains more detailed analysis that I will summarize today verbally.
Data in the report and presented here today utilizes Statistics Canada’s tax modelling software to determine statistically valid impacts of income sprinkling.
What is immediately clear upon studying this issue is how concentrated the benefits of income sprinkling are among Canada’s richest families. The top 20 per cent of families receive 91 per cent of the benefit of income sprinkling. The top 5 per cent of families making over $216,000 receive half of the benefits of income sprinkling. The bottom 70 per cent of families — including all middle-class families, incidentally — making less than $100,000 share 3 per cent of the benefit of income sprinkling. Those families benefiting from income sprinkling are almost exclusively male-headed.
Despite all the fuss, the benefits are incredibly narrow, even for families receiving CCPC dividends. Of the 904,000 economic families receiving private corporation dividends, 13 per cent could be using income sprinkling, although assuming that all dividends do not pass the reasonableness test, clearly representing an upper bound of impact. Put another way, at least 87 per cent of small-business families cannot benefit from income sprinkling.
Further refinements reveal that only about 5 per cent of small-business families are actively using income splitting as a tax strategy and would likely fail the proposed reasonableness test. This represents 0.3 per cent of all Canadian families.
The estimated 2017 federal cost of income sprinkling is $280 million, with a provincial additional cost of $110 million spread across the provinces.
Interestingly, the average tax benefit is lower than recent rhetoric might suggest, even for families in the top 1 per cent making over $416,000. The average benefit from income sprinkling is only $10,000 for those receiving that benefit.
Professionals are far more likely to be using this tax strategy, most likely our families with a household head in the health care sector. This is going to be folks that work as doctors, dentists, chiropractors, physiotherapists, that sort of thing, where 26 per cent of families are likely benefiting over $10,000 from income sprinkling. Second most likely is the broad professionals category, which would include professions like lawyers and accountants. The third most likely to benefit is the real estate and insurance sales industry.
These are not generally what is thought of as a traditional small business. In fact, if we look at the agriculture sector, which would contain family farms, or the accommodation and food services sector, which would include things like family restaurants, they are 2.5 times less likely to benefit over $1,000, compared to families in the health care field, from income sprinkling.
In terms of the passive income proposal, it’s similarly heavily focused, as we saw with new data yesterday, with about 3 per cent of private corporations holding over $1 million and gaining about 88 per cent of all of the benefits from passive income; therefore, any tax changes would affect a very limited number of private corporations. This is a very concentrated group, just as the group is very concentrated for income sprinkling. Similar to income sprinkling, 85 per cent of private corporations hold no passive income at all. Any changes in terms of passive income would not affect the vast majority of small-business corporations.
Interestingly, it appears that the federal government is considering reducing the small-business tax rate in compensation, to some degree, for the changes. We don’t know in detail what the passive income changes are. Upon full implementation, the cost of the reduction in the small-business tax rate will be about $855 million in 2020. Income sprinkling cancellation would raise about $280 million. The net cost of closing tax loopholes, oddly, is $575 million. Of course, closing tax loopholes is supposed to raise money, although, in this case, it’s costing us two or three times more than we’re saving.
With that in mind, and given the concentrated nature of the benefits among Canada’s richest families, I do encourage the committee to back the proposals, particularly on income sprinkling, and something on passive income, although again the details aren’t clear at this point.
I would also encourage the committee to consider bigger fish when it comes to tax expenditures, including the stock option deduction, which would be effective for CEOs and those making far more than most small-business owners. And larger issues like the capital gains inclusion rate.
I would encourage the committee to seek a broader public review of tax expenditures. Certainly, the parliamentary Finance Committee has conducted an internal academic review whose report has not been made public. I think a broader public review of tax expenditures is in order.
Thank you for your time. I look forward to your questions.
The Chair: Thank you.
Aaron Wudrick, Federal Director, Canadian Taxpayers Federation: Good morning. Today happens to be my birthday. There’s no better way for a tax advocate to spend their birthday than talking about taxes. Thank you very much for the invitation.
Obviously, with the announcement by the government yesterday and additional details to come this week, the context of the discussion around these changes has changed somewhat. I am pleased to see that the government has recognized many of the problems with its proposals, and I certainly look forward to analyzing the details as they are made public this week.
With respect to the one measure that has already been announced, the resurrection of the government’s pledge to reduce the small-business tax rate to 9 per cent, far be it for a group that advocates for low taxes to complain about a tax cut, but we also believe that not all tax cuts are created equal. As with the previous government, we would have preferred to see lower, broad-based tax deductions rather than the panoply of boutique measures introduced. So, too, we have concerns with the opportunity cost and the unintended consequences of further widening the gap between personal and small-business tax rates.
Recall, senators, that by the government’s own argument, the main catalyst for embarking on these reforms in the first place was the rapid rise in the number of Canadian-controlled private corporations, or CCPCs, over the last 15 years.
The cause of the rise in the number of CCPCs was the widening gap between personal and small-business rates. At higher income levels, the personal income tax marginal rate can be around 50 per cent, whereas the small-business rate combined with the provincial rates is much lower, usually around 15 per cent. This, of course, provides a very strong incentive for people to try to structure their affairs to access the lower rate.
Against this backdrop, the Trudeau government has widened the gap by introducing a new 33 per cent tax bracket, a personal rate on high-income earners, and now reducing the small-business tax reduction to 9 per cent. In a sense, they are exacerbating the very problem they identified in the first place.
It should also be said that the number of CCPCs increasing is not a problem; it is only a problem, from the government’s point of view, if the increase is primarily a result of people doing the same work in the same way but paying less tax.
I will be very interested to see if the government brings any measures forward to address specific ways in which CCPCs are being used, and I think my friend David said it well when he said it was mainly professionals, and professionals are accessing CCPCs primarily for the purpose of reducing an individual’s tax burden.
On income sprinkling, the government has suggested that it will put forward a simpler test to determine whether an individual can be paid income from the business. I think it is fair to say that few people defend the position that someone with absolutely no connection to a business should be allowed to be paid purely for the purpose of lowering the business tax burden. The tricky part is where the contribution to the business is subjective or not obvious.
A contentious point, for example, has been whether or not spouses who do not work directly for the business but who may have taken a financial risk, such as assuming joint liability on a personal line of credit with their other spouse who is actively running the business, are those people eligible to receive income. Because they, of course, have taken a risk by taking out the loan.
On the passive investments issue, I am also encouraged by the fact the government seems to have observed the fact that many small-business owners use them to fund such things as maternity leaves and retirement, and that taking an aggressive approach to restricting them can have serious negative, unintended consequences.
Overall, senators, I’d like to be clear that we agree with the government’s broad objective of tax reform. Our concerns have been with the specific proposals put on the table. Our tax code is too complicated. It is a million words long and 3,000 pages. It does not have to be this way.
I know my friend David and I would disagree vehemently about how much revenue we would like to see the government take in, but I suspect we would agree that we’d want them to generate it in the most efficient, simple and fair way possible.
The mistake this government has made, in spite of commissioning a study of federal tax expenditures last year, the results of which they have not made public, is that they have taken too narrow an approach to tax reform, not too broad. It is as if they decided to clean out the attic but simply focused on one box in the corner marked “CCPCs.”
The federal government provides no estimates for more than 90 tax credits and expenditures, and, by the OECD’s estimate, this could be in the range of up to $140 billion a year, including everything from large things like pension plans and RRSPs to GST exemptions on groceries to union dues, to political donations, to film and TV tax credits.
Accordingly, rather than abandon tax reform, our group has called for a royal commission on tax reform to mirror the process that was undertaken by the Carter commission in the 1960s. Our view is that the problem here is not too much tax reform but too little. As this government has quickly come to learn, picking on some while ignoring the rest can be very politically problematic.
I am happy to take questions.
The Chair: Thank you.
I’d like to ask the deputy chair to introduce herself.
Senator Cools: Good morning. My name is Anne Cools, and I am a senator, as you can see. In particular, I’m from Toronto, just like my buddy over here. I must tell you that I’m very pleased to hear your testimony.
Your testimony raises very important issues, the largest of which is the right of governments. Do governments have an absolute right to tax and to go into the taxpayers’ pockets whenever they feel like it?
It’s a very deep political, moral and economic question, but it has been debated among members of Parliament for centuries. That’s why we have the expression, “No taxation without representation.” The whole House of Commons concept was born on the issue of these principles — the limits of government to raise taxes.
Senator Eaton: My question is addressed to Michel Coderre. My colleague Senator Marshall asked Minister Morneau last year if he could give her the parameters of what constituted a middle-class income. He would not say.
Could you give me what you think the parameters are, something we could work from, of what a middle-class income in Canada is today? What is it considered to be?
Mr. Coderre: I don’t know, senator. We know we have different tax brackets. What is middle-class income? I don’t know. But I would suggest that the apparent focus of the proposals, the premise to make the middle class better, is flawed. There is nothing in there about who is the middle class. Who are we targeting? How does the minister define the middle class? Is it composed of tax people as well as non-tax people?
Senator Eaton: Are we talking about people who earn $30,000 to $90,000 a year?
Mr. Coderre: No. I would say that the middle class is between the $50,000 to $60,000 range, on an individual basis, with family income, combined, of somewhere between $50,000 and $100,000. That’s what I think the middle class is.
Senator Eaton: That’s important to define, because then we know who they are talking about, as this government — well, all governments, I guess, are happy to talk about the middle class.
Mr. Wudrick, happy birthday to you. Could you elaborate a little bit more on something that Mr. Coderre referred to, which is the sprinkling of income that the government is keen to clamp down on — this idea that it is a very subjective thing in the sense that a wife can be a receptionist in a medical office, a farm wife can be helping by driving a tractor? It’s very subjective. As you say, people take out joint loans on a family house.
Could you elaborate a bit more on that, on your thoughts?
Mr. Wudrick: Sure. There are two important points. The first is that the picture the government tried to paint was a situation where there is an individual, in many cases an adult child, who has no connection whatsoever to the business — so they are perhaps off in another city — and they were being paid a salary. That is very hard to defend. That is paying someone who has no connection to the business purely for the purposes of reducing a tax burden. That’s a black-and-white case.
But there are many other cases that are greyer. The example that was raised frequently was a spouse who does not work day to day in the business but is liable on a personal line of credit to fund that business. Other instances are where they do part-time work in the business while juggling other duties, either other full-time work or staying at home.
The question became not only “How is the government going to draw clear lines around this?” but also “What is the compliance burden for business in terms of tracking how much contribution a spouse makes in order to make them eligible?” Then it’s about what the correct amount is. Is part-time bookkeeping worth $20,000? Is $25,000 too much? These questions raise a lot of uncertainties.
The other thing speaks to a broader inconsistency in the tax code: What is the unit we want to tax? Do we want to tax the individual or do we want to tax the family? Generally, we tax the individual in our system, but as we have seen, there are some instances — the previous government did this with income splitting. Income splitting is still allowed for seniors; there is pension splitting for seniors. Of course, programs such as the government’s old child care tax, the Canada Child Benefit, which we support, was based on household income, not individual income.
The point there is that the government needs to get it straight -- Will they tax individuals or families? -- and then be consistent with that across the tax code.
Senator Eaton: I will go on the next round.
Senator Pratte: I have two questions.
[Translation]
My first question is for Mr. Coderre about passive investments. You quoted the figures released by the government yesterday that indicate that large passive investments are made by a very small minority of private corporations. Straight away, this indicates a possibility that is opening up for the government and that may be announced this week, which is to limit the new tax to 1.6 per cent, or even less, to companies that make substantial investments. Is this a proposal that you prefer?
Mr. Coderre: First of all, we should see before taxing anything if it is economically justified. There should be some justification for taxing this private capital.
I would propose a simple rule that would be a precedent for other pieces of legislation. For example, a threshold was set for the provincial corporate capital taxes and the federal large corporations tax. The large corporations tax in section 181.1 of the act provides a deduction of $50 million to the affected corporations. So we could set some kind of threshold and, in the case of private companies that meet certain conditions, we could take their so-called passive capital and establish a presumption. We could offer them a basic deduction, be it $1 million, $5 million, $10 million or $50 million. The deduction should then be calculated, whether or not it is a percentage of assets. In the interests of social or fiscal peace, we could offer a basic deduction like this one that would bring a little tax back to the government.
[English]
Senator Pratte: My second question takes from Mr. Wudrick’s testimony. You talk about a royal commission. I don’t know if that’s the right formula, because royal commissions are quite big things, but since this debate started, a lot of people have mentioned the idea of having a thorough study of the Income Tax Act, saying it’s become extremely complex. We haven’t had that kind of thorough examination since the Carter commission.
Could you elaborate on what that royal commission or expert committee could study exactly? Maybe other witnesses could also briefly tell us whether they would be in favour of that kind of examination of the Income Tax Act.
Mr. Wudrick: Thank you, senator. The government commissioned a group of experts to review tax expenditures in the 2016 Budget. That review has been completed. It has not been made public. That would be a very simple first step.
I say that because the difficulty here, as I referred to in my remarks, is that people are feeling picked on. If we were going to clean out the tax code, because it is too complicated — and it is an important point that for too long, the debate about taxation has been just “higher or lower.” We all have views on that, but it is also too complicated. It shouldn’t matter whether you want higher or lower tax. Clearly, we all have an interest in acquiring those revenues in the most efficient and simplest way possible.
There are compliance burdens, and there is uncertainty in business. You create what is essentially a cottage industry of attempts to avoid tax when you create these tax code loopholes.
There is a lot of talk about abuse of tax vehicles —and to call them loopholes is derogatory — both domestically and abroad. When you make a simple tax code, you reduce the possibility of that happening.
It’s a very important thing. Even though we are displeased with many of the things the government has put forward, we don’t want to discourage them from tax reform. If they walk away from this now, we are left with a tax code that is 3,000 pages and a million words long. There is no reason it needs to be that complicated.
Mr. Macdonald: I would agree with Aaron about examining tax expenditures, in particular, which is really what is complicating the personal tax code, at least. The corporate tax code is a different thing entirely.
With the personal tax code and its list of tax expenditures every year, we give away as much in tax expenditures as we collect in actual tax. That is to say that if we closed all tax expenditures, we would double the amount of personal income tax we collected. It’s a substantial expenditure from the federal government’s perspective.
Tax expenditures are usually created and then put in a dusty report and left forever. They are never re-examined to see whether they are accomplishing whatever goals they were presumed to accomplish in the future, unlike programs, which are reviewed every five to ten years, to see whether they are accomplishing what they were supposed to accomplish.
Certainly, a thorough review of tax expenditures and a commitment to eliminate some set of tax expenditures, say five or ten a year, would go a long way in terms of limiting the capacity, particularly of high-income individuals, to use tax loopholes to pay lower taxes than the middle class that doesn’t have the right accountants and doesn’t have the right types of income to take advantage of them.
[Translation]
The Chair: Mr. Coderre, would you like to add anything?
Mr. Coderre: No, thank you.
[English]
Senator Marshall: I wanted to talk about the overall cost of the 9 per cent small-business rate and the additional revenues the government will raise as a result of the proposed tax changes.
The 9 per cent small-business rate is going to cost the government. It looks like the income sprinkling, from what we have been told, is going to raise around $250 million.
I’ve asked previous witnesses for an estimate for what they think the government will raise as a result of the changes to the passive income. I haven’t been able to get a number out of it, but given the financial position of the government, they can’t continue to decrease taxes, like the 9 per cent. The reduction to 9 per cent is going to cost the government, so I would think that revenues will have to come from somewhere.
I would like to have your opinion on where you think they're going to come from. I know there is going to be a tax on marijuana and the carbon tax, but I have sort of put that aside. I’m trying to look at these changes that they are proposing now. Will they be self-balancing? Will the government take in additional revenues from some of the changes, but others are going to cost them money?
It seems, looking at where we are today, that taxes will have to go up. I’m looking at the passive income proposal, and I know, Mr. Coderre, you did allude to it in earlier testimony. The transitional changes for the passive income, I haven’t seen anything specifically announced yet, but it seems like that would be a place where they could raise additional revenues. It looks like there are about 20,000 corporations that would be the target.
I’m just thinking ahead and thinking, okay, this is where they are going to raise their revenues to help pay for the 9 per cent small-business rate. But then I look at what happened last year, when they raised the income tax rate on the top earners to 33 per cent and they forecast what they thought they would raise in additional revenues. It didn’t materialize.
I’m looking at where we’re at now, and I’m wondering where exactly the government is going with this. Are we looking for bigger deficits, or do you think that the passive income proposal is going to raise a whole lot of money, because there are billions of dollars sitting in those passive investment accounts?
I would like to hear your opinions on that.
Mr. Coderre: Senator Marshall, I don’t think I have the data to provide any precise numbers to you. I can just formulate general observations.
On passive capital, I have not seen the ugly word “retroactive” yet, so I would hope that we are not proposing to tax the opening capital balance. If that opening capital balance stands at $400 billion, I would hope that if we tax that capital, it’s on a going-forward basis.
Senator Marshall: But the government hasn’t made that commitment. It’s left open, so it’s possible it will be retroactive.
Mr. Coderre: Possibly. I do not know the growth of that $400 billion annually. Notionally, if the $400 billion grows at, whatever example, $20 billion a year, the tax would apply on the $20 billion base and not on the $400 billion. This is just conjecture on my part, and I don’t know how that would work.
On the small-business tax rate, not everything meets the eye. The government is giving an additional point and a half tax reduction. If we flush that through, all right, where is that money going to go? Some businesses, hopefully, will be able to use that money for corporate growth and investment in assets and so forth, which would be the desirable thing economically.
Others, who are not so profitable, or who are cash-strapped, might just take the money and distribute it to shareholders, in which case the government gets the money back, gets more back, through increased salaries or dividends, and then the net tax cost is zero.
In other cases, if the company has cash, and that 1.5 points is a bonus, I suppose it will get added to passive capital, and the government will get tax on that. I suspect that the government has figured that out quite well.
Senator Marshall: But we seem to be going around in a circle, because Minister Morneau was very concerned about the increase in the number of these private corporations. By lowering now the small-business rate, I would think that would encourage other people to incorporate. Seems like we’re going around in a circle, you know? The objective yesterday is not being met by the actions of today.
Mr. Coderre: In a way, yes. I would suspect that certain of these corporations in the 1.8 million are rejoicing because they do not need the money and are quite happy to have it and contribute it to their holding company for investment purposes, hoping that the passive capital rules will not come into play. But yes, for sure.
Senator Marshall: Right now those 20,000 people who had the big passive income accounts must be very nervous.
Mr. Coderre: They must be. I don’t know. Again, we do not know where that money is. If that money is supporting the Canadian stock market, why would we touch it?
Senator Marshall: It will ripple.
Mr. Coderre: Why would we touch it?
Mr. Macdonald: It appears that all of the passive income that is presently there would be grandfathered, so the net gain to the federal government in the first couple of years would be zero, in essence. It would be very small. Of course, we don’t have a concrete proposal, so it’s difficult to say what that would hypothetically be.
The taxable passive income that’s generated from private corporations in Canada is worth about $20 billion a year. The main goal of the passive income proposal is to make up the difference in the first year between the 15 per cent, roughly, small-business tax rate and the 50ish per cent personal rate that’s applied in the second year on passive income.
If we hypothetically apply that difference, which is about 30 per cent or so, to the passive income and we had already done it, so none of this was grandfathered and it was applied on a go-forward basis, it would be worth a lot of money. It would be worth in the neighbourhood of $5 billion to $6 billion a year in additional taxation of passive income. That would be very focused on 3 per cent.
That would give you some rough idea of, hypothetically, 20 years from now how much this might be worth. I think next year, or the next couple of years, it’s worth zero, in essence.
What that means is that if we contain just the small-business tax changes, we net negative for the government, creating about a $5 million additional expense once fully implemented several years from now.
Senator Marshall: Thank you.
Mr. Wudrick: I think it’s clear that of the three proposals, this is the big-ticket item. There is no question that this one is billions. It’s very hard to say given we don’t have a clear amount of the stock of existing passive investments, we don’t know about the go-forward basis, and we don’t know what the rules will say. It is obvious both from the response from stakeholders and from the government’s credit that they are being more careful around passive investments. They have been much clearer and have not put it in as concrete terms as in the other two. A hard number is hard to give you, but billions is probably safe to say.
[Translation]
Senator Forest: In fact, passive investments are one of the very important issues of this reform. The vast majority — over 85 per cent of passive investment capitalization — is in the hands of 6 per cent of the 1.8 million of the company.
This is a very worrying situation. I would like to think a little about what you said, Mr. Coderre, in terms of setting thresholds. How is it possible to define thresholds? There is significant relevance in passive investing, and there is a problem of imbalance in the current concentration. How can we define the threshold of a type of business regarding the renewal of the technology park or the liquidity needed for less prosperous days? What options do SME owners who don’t have a retirement fund have aside from this passive investment?
In your experience, how could we define guidelines that would allow us to be more equitable with respect to the tax burden and not subtract 85 to 86 per cent of passive investments by Canadian companies in the hands of 1.5 to 1.6 per cent of the companies? What would allow these companies to have adequate passive investment capitalization at the same time, given their type of operations?
Mr. Coderre: Senator Forest, you have asked an excellent question that doesn’t have an easy answer. If there was one, I think the government would already have proposed it. However, I can tell you that the threshold is a possible solution. Of course, it’s a simplistic solution that isn’t perfect.
Another approach that might be considered, alone or with a basic threshold, would be to allow corporations with this passive portfolio to deduct investments in the economic sectors identified. It is a little like the approach adopted in 1972 following the Carter commission, where deductions were allowed for eligible investments.
For example, we could say that any investment in a Canadian SME is not counted or is deducted from the tax target. We could also say that any venture capital investment is excluded, that any venture capital fund is excluded and that any company active in lending is also excluded.
This may end in a net result corresponding to investments in liquid securities on stock exchanges or on other items, investments that could benefit from the deduction of capital. In this way, at least, we would have a little better cut of the deduction to allow a concentration of capital in favoured sectors of the economy.
Senator Forest: It is clear that the idea of a threshold —
The Chair: Mr. Macdonald would also like to answer the question.
[English]
Mr. Macdonald: It’s a great question of how do you separate out folks that are using private corporations as a means to reduce their taxation on their retirement savings, which other Canadians don’t have access to. I have to put money in an RRSP or a TFSA. I don’t get the right to get my money taxed at 15 per cent and then have it saved for the rest of my life, but people with private corporations can absolutely do that.
How do you separate corporations that are legitimately saving money for investment or a rainy day, which you want to encourage, from corporations that are simply being used as a tax structure to build their own private retirement system that doesn’t abide by the rules that everybody else has to abide by?
There are two ways you could do it, broadly speaking. One is you could limit withdrawals from corporations that come from the passive income side to some amount, say $50,000 a year. If you withdrew more than that from the passive income side, an additional surtax would be supplied, the result of which would be that companies would be free to build up capital within the company. But if their goal is retirement savings, then they would be surtaxed at the point of withdrawal, and that would be a disincentive for them to use CCPCs as a retirement structure, and hopefully they would use RRSPs and TFSAs just like everyone else.
The other approach is to limit additions to private capital above a certain amount. Once you accumulate a certain amount of private capital in your corporation, say $1 million, or something like that, then when additional money is added, you pay a surtax on the active income, 15 per cent that you pay, so that every year you’re bumped up to the 50 per cent rate, which is roughly what you would pay on passive income after the first year.
I’m not sure which one is better in terms of encouraging and allowing corporations to save for a rainy-day investment, but those are two broad options you could use to discourage folks from using CCPCs as a retirement savings vehicle.
[Translation]
Senator Forest: I have two simplistic ideas, despite the fact that simplicity isn’t the number one attribute of taxation. We all know that it’s a rather complex area. In fact, let’s say that a threshold for passive capitalization and a cap on the potential withdrawal of companies would be interesting guidelines to explore.
[English]
Senator Oh: Mr. Coderre, can you tell the committee about your clients’ reaction to the consultation document released by the Minister of Finance on July 18?
My second question is for the panel. This government has been in office for two years, and there has been no concrete economic policy imposed. All the money the government has spent is elsewhere and not in this country. Do you believe that many shareholders of Canadian-controlled private corporations are preparing to reduce their investments in Canada in response to the amendment proposed by the minister on July 18?
Mr. Coderre: Senator Oh, my clientele is more of the small to medium-sized companies. I don’t deal as much with very large investment funds.
My clientele are stunned. They are insulted. They don’t understand. They are working hard. They are trying to make ends meet. The way the package was presented to them, and every time they have turned on the news for the past three months, they have heard that rich Canadians are using private corporations to defeat the tax system. It’s unbelievable. The message from the government has been disastrous. The reaction is very unfavourable.
What is particularly troubling is that they have frozen a lot of business decisions. There has been a wait-and-see approach for three months for the small-business community. Tax planning is part of everyday life, and the tax planning has stopped at the small-business level. This is bad.
My clientele is not leaving Canada; they are here to stay. They are not part of that clientele that would leave Canada, but I think we have a very serious problem with that client base.
Senator Oh: Thank you.
Mr. Macdonald: I don’t think it’s particularly surprising that small businesses, given the lack of clarity on several of these measures and the communications challenges of the introduction of these measures, are unsure about whether they want to invest and expand their businesses in the short term. That’s a Catch-22 for the government in the sense that you do want to consult on the potential implications of items you are proposing, particularly on the passive income side where it’s not nearly as well defined as income sprinkling. But at the same time, you don’t want to drag it out over a long period of time and not provide some clarity to small businesses in terms of how they want to invest.
I don’t see changes in the small-business tax rate as an incentive, per se, for businesses to move. If businesses were to move, there are places in the country, like Manitoba, that have no small-business tax rate. The tax rate is zero for the provincial level. If all small businesses were driven purely by the tax rate, they would already have moved to Manitoba. The small-business tax rate can play a role in encouraging companies to reinvest profits back into the business as opposed to merely using it as a flow-through for income.
In that sense, I hope the government comes rapidly to some conclusion on these measures and moves on to other tax expenditures unrelated to small businesses, like the stock option deduction.
Mr. Wudrick: Further to Mr. Coderre’s point, the paralysis is perhaps the most troubling thing that has happened here. I take David’s point about you want to consult, but what the government did was put out these half-formulated ideas and allow every tax lawyer and accountant in the country to come up with scenarios in which, if these ideas crystallize in a certain way, it could be damaging. They got the worst of both worlds. Had they simply put out a paper saying that they were going to look at this long list of things and consult on them, I don’t think they would have created that paralysis.
Senator Moncion: I’m a little surprised by the last comment you made because I have read the document that was proposed by the government, and, in all aspects of the document, you have the information on what the government is looking for and was asking for. They were proposing different things, and they were asking for information on how to make this better or how to fix it. I’m a little surprised by your last comment about the fact that the government has brought upon itself a lot of mayhem by having a document that is not well prepared. I didn’t look at it that way. That’s not my question, but I would like for you to comment.
Mr. Wudrick: I’m not suggesting the government didn’t prepare anything. It’s a 60-page document. There is stuff in there. The problem is that there are many things that perhaps they did not consider. There are unintended consequences. This is where we have seen the conflict in the public debate between the economists and the departmental officials and the accountants and the tax lawyers.It is a question of the theory colliding with the practice. That is where a lot of uncertainty has arisen.
Senator Moncion: I agree with you about the uncertainty. I’m just not necessarily in agreement with all the comments that have been provided. This is a consultation document. What I’ve read so far and from what I’ve received, we haven’t received a lot of things to correct or propositions to make this better. We’ve had people writing about not liking what is proposed but not proposing any changes or any tweaks. I’ve heard two to four things that could easily be tweaked and that the government could work with.
My question is about one other tweak around the income sprinkling or the income splitting. Could you give me some information about what you think of what they do in the United States, where they look at income splitting on a family basis, as opposed to in Canada, where we look at it on an individual basis?
Mr. Macdonald, you wrote a whole paper on this. I’ve read your paper. I liked your paper. It was just on one of the three things.
Mr. Macdonald: The situation in the U.S. is very different in the sense that you are required to file as a family. Therefore, income splitting as we think of it in Canada is simply the way the tax law exists. Income splitting is just the way things are across all types of income.
In Canada, we have income splitting presently on pension income. You can income-split within a private corporation. Until 2015, we had income splitting if you had families with children, at which point that was ended.
In some cases you can income-split, and in others you can’t.
The U.S. situation is different. The U.S. situation for corporations is very different as well. The U.S. is much more likely to have sole proprietorships that don’t retain earnings in the same way that Canadian corporations do. Therefore, because you’re not retaining earnings, passive income is not really an issue in the U.S. because that’s not the way the corporate structure works.
The question in Canada is should the owners of private corporations have benefits that non-private corporation owners in Canada don’t have? And income splitting is a good example of that. We decided in 2015 that income splitting is not something individuals who don’t receive small-business dividends can do.
I’d argue that in terms of horizontal equity, you’re trying to make similar families the same. But this is something that should be extended to small-business corporations as well.
Senator Moncion: You also talked about this issue?
Mr. Wudrick: The important thing is to be consistent. We need to apply this rule across the board.
The points that have been raised by some business owners around limiting income sprinkling, which they view as a form of income splitting, are these: Why do seniors get to split pensions? Why are certain entitlements from the government based on household income rather than individual?
The government just needs to decide whether they’re going to treat the economic unit as individuals or households, and be consistent across the tax code.
Senator Moncion: Thank you.
Mr. Coderre: Income splitting is a very narrow issue and more of a spousal issue. By definition, there is no income splitting if your child is already earning a salary. Income splitting seeks to fill a vacuum when there’s zero tax on one side and 50 per cent tax on the other. There’s no benefit of income splitting if somebody else has income. So income splitting is more a spousal issue.
At the children level, it’s more of an issue when the children are in university. Once they start earning, there is no income splitting.
Really, we have income splitting. We have had income splitting forever. At the small-business level, CRA is tolerant of someone paying a salary to the other one within the business context. It’s not available to employees, but a business owner could pay a reasonable salary to a spouse or to children. We need to be reasonable about it, but this has happened for years.
The question is this: Is it more effective to pay a salary or more effective to pay a dividend? We’re not talking about that much tax. We’re talking about very narrow situations. In response to that, the government put out something that just doesn’t work.
Senator Cools: I would like to thank the witnesses again for appearing before us. By way of expressing my concerns, I would like to say that I have been in the Senate for 33 years. In that time, I have voted on quite a few of these “tax reform” questions. The one that stands out largest in my recollection is the GST, Bill C-62. I can still remember the number. It was a long time ago. I can tell you, at the time, the Senate had tremendous public support. The Liberal senators at the time, then in opposition, were bent, bound and determined to defeat that bill because of the mood that was in the public.
Whenever there will be predictable changes in systems, one expects some unhappiness. But my concern is that I’m not hearing unhappiness. I’m hearing a mood of deep-seated uneasiness and uncertainty, which is quite different from unhappiness.
I wonder if you have been sensing this mood. As a committee, we will soon be travelling east and west, and I look forward to it; I think the whole committee is looking forward to it. Do you have any idea as to why such a mood would have settled on so many Canadians?
Mr. Coderre: The mood has been set by the message, Senator Cools, which was very insulting to some owners of small businesses. The communications message has failed. It failed from the very beginning. It was released in the middle of the summer when nobody was noticing. Frankly, once you looked at them, the proposals are extremely complex and very hard to understand. We’re still trying to figure them out. That’s how complicated they are.
There’s a problem in mood, there’s a problem in breach trust and there’s a problem of the feeling that the government just doesn’t understand what it is that people are living. “You do not understand the daily stress in which we’re living, and you’re telling us that we’re using companies to deprive you of tax dollars? Come on. Give me a break.” That is the essence of the problem.
If the government had said, “Listen, from the very get-go, we’re here to support small business. We’re going to do everything we can for small business. We have two or three very targeted concerns, and we’d like to engage on those concerns to see whether there are vast pools of capital that are just not productive to the economy and that we want to be taxed, and wether income sprinkling is something that we can fine-tune, and whether there’s income conversion.” If that had been the object of the exercise, nobody would have complained.
Senator Cools: Thank you for your insights.
Mr. Macdonald: Part of the anxiety, particularly on the passive income side, is that there isn’t actually a concrete proposal; they are looking for input on a particular issue. Therefore, it’s unclear how it’s going to affect businesses.
On the income sprinkling side, the impact is presumed to be much larger than it will actually be. The folks who are actively using income sprinkling as a means of reducing their taxes are a very small subset of people who own private corporations. It’s probably about 5 per cent, about 45,000 families that are actively using income sprinkling as a means of reducing their tax bill.
The reasonableness test already applies to salaries. You can’t pay someone a salary unless they are doing work for your business. You can’t do that at present. The reasonableness test has already been litigated. It is used by CRA, but you’ve got to be pretty egregious in terms of your violation of the reasonableness test on the salary side.
The transportation of the reasonableness test from the salary side to the dividend side, where it does not presently apply, can rely on a history of its application on the salary side in the same way. If you’re receiving a dividend but you have nothing to do with the business, that would be a problem with CRA going forward, as it is with the salary side.
There are definitely complications when it comes to the capital contribution, which obviously does not apply on the salary side, as Aaron mentioned previously. Those are things that would have to be worked out in the details.
That being said, the reasonableness test was blown out of proportion in the idea that CRA is going to come down and check businesses to see whether folks are working, the idea that the salaries or dividend payments to spouses and children who are actively working in the business are somehow going to be forced up to one earner, and therefore the tax rate is going to go up. That certainly hasn’t happened on the salary side where those rules already apply, so there’s no reason to think it’s going to happen on the dividend side.
I think because there was some lack of understanding of the reasonableness test, everyone thinks that it applies to them and that CRA is going come down and charge them more tax, which is clearly not going to be the case.
I hope that as more details emerge, it will become clearer that the impact will in fact be fairly limited to a very small group of corporations that are really actively using these measures as a means to create their own tax system on the retirement side or as a means of simply income splitting, which isn’t legal for the rest of us.
Mr. Wudrick: I wanted to speak to the point about the unease around the country. I would go further than that. I would say in some cases it’s outright anger.
We’re an advocacy organization that spends a lot of time trying to get our — we have 130,000 supporters. We try to get them worked up about taxes; we didn’t have to do that here. This was a role reversal where I was responding to almost, if you want to call it that, a tax revolt. It’s something I’ve never seen. I wish our supporters got that worked up about all taxes all the time, but they don’t.
Now you could also say that some of this is an overreaction and a panic and a misunderstanding. That’s a fair point. But the reaction is still there.
You compound that with the communication around the issue, and it has reached a point now where I don’t even know if a full abandonment of the proposals would repair the damage that has been done. That is troubling.
I hope that the government, the rest of this week, when it’s clear what they are going to do, and we have all the details — because, remember, they are saying don’t worry, this is only going to impact a handful of people. That’s what they said the last few months. They told people who kept raising concerns, “Don’t worry, it won’t affect you,” and then yesterday the Prime Minister announced, “Well, this time we’ve got it right.”
We’re going to wait to see the details before we declare that things are better now.
Senator Cools: Thank you very much.
Senator Eaton: You threw out an interesting line in your presentation: Our tax code should align with our industrial policies. Could you elaborate a bit on that? Give us a few examples, perhaps?
Mr. Coderre: I suppose we’re getting into my personal belief system and getting away from tax technicalities.
Senator Eaton: That’s fine. We all have a personal belief system here.
Mr. Coderre: I do think that tax policy is never on a stand-alone basis. Tax policy is part of an ecosystem that includes industrial policy, economic policy, financial markets policy, social policy. I looked yesterday, and my taxation act has over 3,000 pages and two columns, so it’s much more than a collection device.I think that tax has to be viewed as any time you make a change to tax, it causes a ripple effect in the economy.
To be more precise to your question, I personally have trouble with statements such as “We want to design a tax system for the middle class.” That is not a very lofty objective, in my mind. I would think if we say that, we want to design a tax system to drive entrepreneurs, to create innovation.
Senator Eaton: Or productivity.
Mr. Coderre: To build world-class companies, to enable the assembly of capital pools, as we see businesses are seriously lacking in, to become more competitive and so forth. This is what I call industrial policy. It’s something that we use the tax system for, to arrive at the type of country that we want to live in, and not simply make what I respectfully feel is an empty comment to say — and the minister has been repeating this over and over again — that when the tax system works for the middle class, the whole country --
I don’t know what this means, and I don’t think we should strive to have a middle-class mentality as opposed to having a growth mentality.
Senator Eaton: You talked about they said “releasing passive income,” but aren’t we trying to encourage companies to innovate, to invest in new equipment, to expand? If we start taxing passive income, aren’t we removing some of that incentive? Aren’t we making it harder for people to invest in innovation and new machinery? I think one of our problems in Canada is our low productivity.
Mr. Coderre: Definitely, Senator Eaton.
I will use an example. If I have a company — let’s use a large company that has $100 million on hand. Once you look at the company’s balance sheet, you say that $20 million is invested in a venture capital fund, another $20 million is invested directly into small businesses, and then another tranche of the money is loaned out, and another tranche of the money is invested, yes, in marketable securities and Canadian equity and debt markets.
This is why I legitimately asked the question: Okay, let’s admit that this money has been funded in large part with the 35 per cent tax deferral. That’s fine. Let’s concede. Does that mean we need to take that 35 per cent and bring it back into the government coffers, or are we happy to leave it out there to work as it’s presently working?
It’s really a specific identification of how the money is used, and maybe we just have a general deduction that everybody gets no matter what they’re using the money for. This would be a basic study.
Senator Eaton: Or maybe companies could say — what about if a company said, okay, $20 million is invested in this, we’re putting $20 million towards innovation, $30 million is going to new equipment, and $30 million is staying in a pension fund?
Mr. Coderre: Exactly. But instead the government message says there’s all this money out there and these are the personal savings accounts of rich Canadians. It’s a vast generalization and oversimplification.
Senator Eaton: Thank you.
Senator Pratte: There’s been a lot of talk about the reasonableness test problem, and Mr. Macdonald, you alluded to that. Tax practitioners have been saying all along that this test would be inapplicable.
[Translation]
Mr. Coderre, I think it’s a little like what you said as well.
Mr. Coderre: Yes.
[English]
Senator Pratte: Yesterday the government discussed that, and in its press release the government committed to, and I quote:
. . . simplify the proposed measures with the aim of providing greater certainty for family members who contribute to a family business. Specifically, the Government will work to reduce the compliance burden with respect to establishing the contributions of spouses . . . .
It looks to me like the government has heard the message and wants to simplify the test so that the burden, the compliance burden, is not too heavy.
Are you satisfied with this? I’m addressing the question to all witnesses, especially Mr. Coderre and Mr. Wudrick. Do you think they have heard the message and they can make it simpler?
Mr. Coderre: They’ve heard the message. We’ll have to see what the rule says.
The trouble with drafting tax rules — and this is what we are living with right now — is that federal finance officials draft these rules. They think they work. Then when it filters down into all the transactions, we find out they don’t. We’ll have to see what the rule says.
Senator Pratte: To Mr. Macdonald’spoint — I don’t want to start a debate here — the reasonableness test is applied for labour now, so it could just be transferred to dividends. Isn’t that true?
Mr. Coderre: It could not, in my view. It is not the same thing. Holding a share is not an employment contract. Holding a share is not a contract for services. Holding a share is an investment. The rules cannot be the same.
As a shareholder, I’m entitled to hold my share even if I do zero work. That’s the nature of a shareholder, and it results from hundreds of years of corporate law.
We cannot do that. We cannot mix the concepts. That is the problem.
Mr. Wudrick: That’s actually an important point that’s been raised several times. You’re attempting to graft on rules that apply to income to property, which is what holding a share is. If you try and apply those same rules, you’re going to have all kinds of unintended consequences. I think that is the difficulty.
Mr. Macdonald: Generally, shares in public corporations are not worth $1 or $5. There’s actual risk undertaken on behalf of the stock shareholder. In the case of private corporations, it’s not uncommon to buy a share for $5, some nominal value, so there’s no real capital on the line there.
It’s certainly true that we’re mixing concepts, although the small business itself is in some ways a mix of concepts between public corporation and private self-employment.
I think there are certainly complications on the capital contribution side. If you’ve made a capital contribution to CCPC, for instance you put up your house as capital for a small business — which is very common, one of the more common ways of funding a small business — how do you account for that in terms of a reasonableness test on the capital side?
On the labour side, I think you could absolutely go with the same reasonableness test that already applies on the salaries part of small businesses, and it’s well understood by tax accountants. The tax accountants probably wouldn’t run afoul of the reasonableness test on the salary side, so they could apply those same rules of thumb to the dividend side.
Senator Marshall: Thank you very much. I’m back to talking about the passive income. In the brief that’s on the Department of Finance website, and even when the officials came before us and spoke about it, they were arguing that if you had an individual who had $100,000 to invest and then somebody had the same $100,000 in a private corporation, the private corporation yielded all these benefits. They gave examples in dollar amounts.
But the briefs we’re receiving now from tax experts are disputing that. Some of them are saying that the benefit is negligible and that in some cases there is no benefit, that instead of holding the money as passive income in a private corporation, you’d be better off investing it as an individual.
Of course, as committee members, we’re now left to decide who has the facts right: Is it the Department of Finance officials or is it the tax experts?
Have either of you had any experience in this area? Is there some insight you could provide into this?
Mr. Macdonald: The benefit on the passive income side is that in the first year, the income is taxed at the small-business rate and not at the personal rate. The small-business rate is going to be roughly 15 per cent, and the personal rate would be 55 per cent. So you start with more money the first year. After that, you’re taxed at the personal rate, even if you’re in a corporation. So there’s no benefit to be inside or outside. It’s only the first year and the starting capital.
In terms of comparing a small business, for instance, to an RRSP or TFSA, which are the options for everyone else, it depends on the types of investments you’re investing in, whether you’re going to incur more capital gains or more dividend payments on those investments over the long term, and whether you’d be better off in an RRSP versus a private corporation. In that sense, it’s not clear where you’d be better off, but it depends on your assumptions, and sometimes the market doesn’t go the way you’d want.
In general, you’re better off in some structure rather than no structure. If you are just holding income on your own outside of an RRSP or TFSA or small business, you’re going to be worse off than all of those other options. I think that if you were to keep that money within a small business, you’d be better off than keeping it just unsheltered on the personal side. In that sense, there is a benefit for the person with the private corporation over holding that money outside — although if they had it in an RRSP or a TFSA, it’s not clear they would get the benefit.
The additional benefits, of course, of holding money in a private corporation are that you have more flexibility in terms of taking that money out versus an RRSP. For a TFSA, you can take the money out, but with an RRSP you would incur taxes by taking the money out.
The other big benefit is that there’s no limit. There’s no upper limit to how much money you can put into a private corporation in order to save for retirement in the same way that there is for RRSPs and TFSAs. If I want to put $50,000 into a TFSA, I can’t; I only have $5,000 a year.
So those additional benefits may play into the calculation. If you have $50,000 a year to put away, that’s well above the RRSP and TFSA limit, even at the maximum, which would be about $31,000 this year. In that case, yes, the private corporation would be a better option for you than RRSPs and TFSAs, and it’s certainly a better option for you than outside. But it depends on the circumstances. So the real question is, are you providing benefits to small-business owners that all other Canadians do not have access to on the retirement savings part?
It’s certainly important to differentiate between who is using private corporations to save, to invest, to get them through hard times, to keep people employed. You want to continue to encourage that, but you want to separate that off from people who are using them as a retirement savings account. That’s one of the challenges for writing up the specifics on the passive income side.
Senator Marshall: But the money eventually comes out and the government gets its share?
Mr. Macdonald: Yes, potentially. The issue is that if you’re putting in more money upfront on the small-business side, you start with a bigger pool of capital that isn’t taxed that first year. You may end up being better off, depending on your assumptions about how much capital gains and dividends. You’ve got to put together a spreadsheet. Sometimes it will work in your favour, and sometimes it will not.
Senator Marshall: In which case, the government gets a bigger share?
Mr. Macdonald: They may or may not. In the end, if you’re taxing passive income, the point is that you’ve allowed people to put in more money upfront and therefore pay less in tax over the long-term investment of this; and you want to curtail that, because most Canadians don’t have that ability. As a result, obviously, yes, the government would, over the long run, make more in tax revenue. That is part of the point, yes.
Mr. Wudrick: Senator, you make an important point. From a government standpoint, it’s not about whether they get their revenue; it’s when they get the revenue. Do they get it now or later?
It’s difficult to argue that, on the one hand, the people who get this benefit that no one else gets are going to make off like bandits. If they are, then the government is also going to do well; and if they don’t, then the government won’t either. Your fortunes are tied in that sense.
When we talk about whether there’s a benefit to using passive investments versus other vehicles, it’s not just about the monetary benefit; I think it’s also about flexibility. This is something that a lot of small-business owners have pointed out. When it first came up that they have to save for retirement, and then other people were saying, “Well, why can’t you save through RRSPs and TFSAs like everyone else?” I put that question to them, and they said, “It’s a question of predictability. I don’t have the ability to borrow against my RRSP or to take money out of my RRSP. It’s not as liquid as some of my other —”
An. Hon. Senator: Nobody can.
Mr. Wudrick: I recognize that. That’s why business owners say if you are a salaried employee and you have a predictable income stream, it’s easier for you to plan how much of it you can set aside and put into an RRSP, whereas if you’re in a business and you can’t pay yourself one year, you create no RRSP room.
So I think the circumstance is different. David is correct when he says that not everyone has access to this savings vehicle. But the point is also that small-business owners are facing circumstances that other people are not facing, and therefore they argue that they need the flexibility that other people don’t need.
Mr. Coderre: It’s a complicated issue, as obviously you’ve heard.
Let me take it this way. Say I have a client, a small business, and I say, “It’s tax time. Why don’t you put your money, your contribution, into your RRSP?” Very often the client will say, “I’m sorry; I don’t have any cash. I want to keep my cash inside the business. If I take $26,000 out — I really need that for my business. I think I’ll wait.”
What the client is saying indirectly is that “My life is my business. My pension is my business. Whether I make it or I don’t make it in my life, this will be based on my business. My business is, in fact, my retirement fund, my estate, my everything.”
The government is saying, “Well, look, you’re using that private company as a retirement vehicle -- bad, bad, bad.”
But say the government were saying, “Listen, let’s have a consultation. If we want to talk about savings, let’s look at savings everywhere. There are private company savings. We’re often comparing the situation to employees. Let’s look at employees. Let’s look at life insurance. Life insurance is something available to employees, available to all Canadians.”
There are huge tax deferrals in life insurance, RRSPs, TFSAs and Registered Education Savings Plans. Canadians right now have all these instruments that they can go to in order to plan for their retirement, their savings, and the government is funding all the instruments. But instead of looking at all of them and saying, “Is there really such an inequity between the private company person and the employed individual who uses the other instruments,” the government is simply targeting the private corporations. It’s an incomplete analysis.
[Translation]
Senator Moncion: I would like to continue with passive income. Not all corporations make a lot of money. I agree with some aspects of your comment, but less so with others, because these are very isolated examples.
However, when we look at all the figures presented, we can see that, of the 1.8 million private corporations, about 40,000 truly benefit from the system in terms of patient capital. I really liked the different measures you proposed when companies buy or invest in share capital, capital to grow other businesses, and so on. However, we also know that some companies don’t do this and that they use private corporations to put money aside to avoid investing in anything other than their personal wealth. This group is the government’s target. The government wants to recover the tax portion of this group.
As I said, I really like your proposals, and I hope you have submitted them to the government so that it can at least study and analyze them. However, we must pay attention to the examples; we will isolate one or two examples, given that the majority of SMEs do not even have the means to invest in RRSPs, education funds, and so on. There are limits everywhere with this.
In the end, we are studying — I’ll say it in English, because Mr. Wudrick mentioned it:
[English]
Taxation issue versus fairness issue.
[Translation]
This is where we are trying to find out what we can deal with in terms of tax and fairness for Canadians in general.
Do you have anything else to propose for people who don’t invest, who don’t make investments anywhere but in their personal wealth?
Mr. Coderre: First, we need to define what an “investment for personal wealth” is, assuming that we can define it because it isn’t easy. If you asked me to write this rule of law today, I would have a lot of trouble.
We know that we can already work with the structures that exist in the legislation to target what we allow and what we do not allow. A fundamental concept in tax law is well-defined in the legislation and has been well commented on by the case law for decades. It is the concept of active business. It is defined in the act. This concept already exists in several legislative structures under the act. The capital gain exemption of $800,000 is permitted only in active business. If it was determined at the outset that the amount a holding company invests in the active business is not subject to the additional tax, we could very well control the impact.
What I recommended a little earlier is that if, by exclusion, we arrived at an outcome, saying that there are so many millions of dollars invested passively, we could then reach a conclusion that would surely not be perfect or fully clear, assuming that the amount is fundamentally a personal pension fund. Again, it should be compared to other instruments that are available to everyone to see if imposing it is fair and equitable.
This matter will be settled. The definitions exist, as do the concepts, and this is not the first time we are thinking about it. We are quite familiar with the concepts, and we could very well come up with a solution that should be custom-designed. It could be established.
Senator Moncion: I will go a little further. Companies and corporations that are able to invest in pension funds also have access to hidden corporate returns, because they receive returns on these investments that are put under the seal of corporate income, which makes the tax rate much lower.
Mr. Coderre: No. You know, when you earn investment income within a corporation, you are taxed at 50 per cent today. There is no benefit. If I personally invest $100 today, I will pay 50 per cent tax on the amount. If I invest the same $100 in a corporation, I will pay 50 per cent on the income.
Senator Moncion: And the individual?
Mr. Coderre: It is 50 per cent for the individual, and 50 per cent for the company. The tax rate is basically the same. That is why we say that there is no significant advantage to investing in a publicly held company in relation to a personal investment.
[English]
The Chair: Are there any other questions? If not, honourable senators, I will remind you that we will be meeting at 2:15 this afternoon until 4:15 here in the same room.
To the witnesses, as this rolls out and until we table our report in the Senate before Christmas, if you feel that you would like to add additional information, please do not hesitate to contact us.
Senator Pratte: After the government unveils its last changes, it would be nice if witnesses could provide their comments to the clerk once we have the final details.
Mr. Coderre: Sure.
The Chair: We would appreciate that. Thank you, Senator Pratte. On this, honourable senators, I now declare the meeting adjourned.
(The committee adjourned.)