THE STANDING SENATE COMMITTEE ON NATIONAL FINANCE
EVIDENCE
ST. JOHN'S, Newfoundland and Labrador, Monday, November 20, 2017
The Standing Senate Committee on National Finance met this day at 9:03 a.m. to study the Minister of Finance’s proposed changes to the Income Tax Act respecting the taxation of private corporations and the tax planning strategies involved; and election of the chair.
[English]
Gaëtane Lemay, Clerk of the Committee: Good morning, honourable senators. As a result of the motion adopted by the Senate on November 7, the membership of the Standing Senate Committee on National Finance has been returned to 12 members as of today and the new membership has been identified.
Therefore, here is the current list of members in alphabetical order: the Honourable Senators Andreychuk, Black, Campbell, Cools, Day, Eaton, Forest, Jaffer, Marshall, Mockler, Neufeld and Pratte.
Honourable senators, as clerk of the committee, it is my duty to preside over the election of a chair. I’m ready to receive a motion to that effect.
Are there any nominations?
Senator Cools: Yes, I have a nomination.
Colleagues, guests and audience, I have the honour and the pleasure to nominate a distinguished and beloved senator, Percy Mockler, to be the chair of Standing Senate Committee on National Finance.
We know, we love and we have great affection for Senator Mockler because we have worked with him in the past and he has served in that capacity and in that role most nobly for the longest time.
I can assure senators that Senator Mockler will serve the Senate and Canada with distinction.
Ms. Lemay: Are there any other nominations?
Senator Andreychuk: I move that nominations cease.
Ms. Lemay: It is moved by the Honourable Senator Cools that the Honourable Senator Mockler do take the chair of this committee.
Is it your pleasure, Honourable Senators, to adopt the motion?
Hon. Senators: Agreed.
Ms. Lemay: I would invite you, Senator Mockler, to take the chair.
Senator Percy Mockler (Chair) in the chair.
The Chair: If you permit me, honourable senators and colleagues, even with a few years of experience, I am still nervous about the process.
Senator Cools: It will pass with time.
The Chair: Thank you, colleagues, for your renewed confidence. I pledge to continue to serve the committee to the best of my ability. I know I can count on all of you, and together we make a great team. You have shown in the past your passion, interest, commitment and support in a spirit of collaboration with the mandate we have received from the Senate of Canada.
Honourable senators, I would like you to consider that we not proceed with the election of deputy chairs. However, with your permission, I would make a suggestion that the committee is on the road, far from Ottawa, and some members are not with us today. Therefore, if we agree, I would like to propose that the election of the two deputy chairs be on the agenda of our first meeting when we return to Ottawa. In all likelihood this would happen on Tuesday, November 28, at 9:30 a.m.
Honourable senators, do we have agreement to move and accept that the deputy chairs be elected when we return to Ottawa?
Hon. Senators: Agreed.
The Chair: There is unanimity and agreement. Therefore the election of deputy chairs will be the first item of business at our first meeting back in Ottawa.
Now that the committee has been duly constituted, honourable senators, as chair I would like to propose that we observe a minute of silence in remembrance of our colleague and friend the Honourable Tobias Enverga Jr., who passed away last Thursday, November 16, while participating in a parliamentary delegation in Colombia. Let us please rise for a moment of silence.
[Minute of silence.]
Thank you very much, honourable senators
Through the clerk, I will now ask the first witness to please come forward to the table. I will be making a formal introduction shortly.
I ask senators to introduce themselves, following which I will ask Senator Marshall to welcome us to St. John’s, Newfoundland and Labrador. Let’s start from my left, please.
Senator Marshall: Elizabeth Marshall, Newfoundland and Labrador.
Senator Oh: Senator Oh, Ontario.
Senator Andreychuk: Raynell Andreychuk, Saskatchewan.
Senator Cools: Anne Cools, Toronto. That is in Ontario, in case somebody doesn’t know.
The Chair: I am Percy Mockler, chair and a senator from New Brunswick.
I would like to ask our senator from Newfoundland and Labrador, Senator Marshall, to welcome the committee.
Senator Marshall: I would like to welcome all my Senate colleagues here, as well as the staff and the officials who are accompanying us and making this hearing possible. A special welcome to our guests. I see some in the audience also. We’re looking very forward to hearing what you have to say.
I would also like to welcome you to our community. Newfoundlanders are very proud of their province. I understand some of you arrived last night in time to go to Signal Hill.
Senator Cools: Yes.
Senator Marshall: I’m sure you experienced our warm hospitality. The fog that you see outside is something that is not unfamiliar to us. We feel very much at home. We will have a wonderful hearing today, and we hope that our flight is able to depart for Halifax this evening.
Senator Cools: Otherwise you’ll have us for another day.
Senator Marshall: In the meantime, I’m sure that the weather is much warmer than what we experienced out West. It’s six degrees here today.
Again, welcome. It’s wonderful to have everybody here.
The Chair: Thank you, Senator Marshall.
Also at the head table our analyst, Sylvain Fleury, and our clerk, Gaëtane Lemay.
The committee received a mandate on September 26, 2017. With the permission of senators, I would like to register the fact that the mandate of the Senate of Canada given to the Standing Senate Committee on National Finance was that the committee be authorized to examine and report 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, in particular income sprinkling, holding passive investment inside a private corporation and converting income into capital gains; over and above, that the committee take particular note of the impact of the committee’s proposed changes on incorporated small businesses and professionals, economic growth and government finances, the fairness of the taxation of different types of income and other related matters; and that the committee will submit its final report to the Senate no later than December 15, 2017, and retain all powers necessary to publicize its findings for 180 days after presenting the final report.
For your information, this marks the twenty-second public meeting dealing with this subject. In Ottawa, earlier this fall, we held 13 public meetings in which we heard from close to 60 witnesses. Two weeks ago, we were in Western Canada where our hearings generated a lot of interest from the business community. We heard from witnesses from the health sector, the agricultural sector, and in general from concerned Canadians.
On our first panel this morning, we have Dr. Leonard Wade Locke from Memorial University of Newfoundland. Dr. Locke is a full professor of economics at Memorial University. He specializes in the Newfoundland and Labrador economy, resource economics, public finance, public policy, innovation indicators, productivity, economic impact assessment, cost benefit analysis, and has published extensively.
Dr. Locke, thank you very much for accepting our invitation.
I would also like introduce another witness with Dr. Locke this morning, Professor Doug May. Thank you for being here with us.
Dr. Locke, I will ask you to make your presentation. It will be followed by questions from the senators. You can rest assured that the first question will come from Senator Marshall.
Wade Locke, Professor of Economics and Department Head, Department of Economics, Memorial University of Newfoundland, as an individual: I acknowledge that this presentation was done with the help of Dr. May. As well, I want to welcome your committee to the province. You have a big task to deal with in terms of the amount of information you have to process.
We thank you for allowing us to present our ideas on this important topic. We will do it from the perspective of Newfoundland and Labrador. I can imagine you hear a lot of similar things in different places. There are a couple of other witnesses today who will help you understand those, but rather than focus on those kinds of aspects we decided to look at specific Newfoundland data to help you understand the issues being addressed today from the Newfoundland perspective.
We apologize for the presentation. We assumed we would be doing a PowerPoint presentation. It is designed for that. You have a copy of it and we will refer to the slides as we go through.
We are on the second slide right now. We understand that you are attempting to address issues around the sprinkling of income, holding passive investment portfolios and converting private corporation regular income into capital gains as per the discussion paper from Finance Canada.
We will move on to slide 3. We understand part of the rationale for making these changes is to protect and to make more fair issues pertaining to the middle class. We thought you might find interesting this slide titled “Hollowing Out.” It is a diagrammatic depiction of how the middle class has changed in Newfoundland, in Canada, and in the U.S. from 2000 to 2014. This is based upon the IMF definition of middle class, which is the population between 50 and 150 per cent of the median equivalized family income.
Based on that definition, it doesn’t appear that the middle class is shrinking in Canada. You can see that by the height of our little stick people. Our little stick people haven’t shrunk in size. The red one is 2014. The blue one is 2000. They’re basically the same size in 2000 and 2014. By that definition, the middle class in Canada has not shrunk.
If you look closely at Newfoundland, it is slightly below Canada in terms of the size of the middle class as a per cent of the population. It has shrunk slightly from 2000 to 2014. To compare that for the U.S., you can see the U.S. shrunk quite a bit and is substantially below the size of middle class in Canada.
You can see why these issues might have got press. It’s not clear why there was this small change or no change in the size of the middle class, and why this would have precipitated the changes being put forward now as a rationalization for protecting the middle class or being more fair to the middle class.
Slide 4 is a graph which shows a polarization index and a Gini coefficient. If you look carefully, it shows the U.S., Canada and Newfoundland. Based on the simulation exercise we went through here using 2016 data, we have lower polarization indexes and lower Gini coefficient in Canada and in Newfoundland. They indicate that the middle class are growing.
If we are making these changes to protect the middle class, all of these indicators point to the fact that the middle class is not shrinking. In fact, these two particular indices indicate that they are growing, both in Newfoundland and in Canada.
We can now turn to slide 5. We went back to Stats Canada to try to get access to the data that Wolfson et al put out in their Canadian Tax Journal study, which was the basis for the changes you see in the Income Tax Act being considered now.
We asked for and received access to the Canadian-controlled private corporation data for Canada. Slide 5 shows you that for the 11 years for which we have data from 2001 to 2011, the number of tax filers in Newfoundland who have a 10 per cent ownership or more of a Canadian-controlled private corporation. Hereafter I’ll call it CCPC, if you don’t mind. It’s a mouthful to say. That has grown from 2.85 per cent to 3.85 per cent. There has been a one percentage point change in the number of Newfoundland tax filers who have a 10 per cent or more ownership share in CCPC. Whatever is happening in terms of the impact of CCPC ownership, it doesn’t appear to have had a big impact on this particular province. You can see that there is a noticeable up tick after 2006 in Newfoundland, but that’s due to the change in the economy. The economy started to grow at that point in time, so more people had more income. That is what we would attribute that to.
We can now turn to slide 6. It is meant to visually demonstrate to you that when you look at the number of tax filers who access CCPC versus the total number of tax filers, what you will see is that it’s not a large component. If you look at the graph on the left, the blue one with a little red line, the little red line is pretty close to horizontal axis. It’s the same picture that you’ve gone from 2 point something to 3 point something per cent of Newfoundland tax filers.
The numbers are not large as well. We can see that the number of tax filers has increased from 12,000-13,000 to 17,600. There are about 5,200 additional tax filers while the number of tax filers has increased by 23,400. Of the bottom 90 per cent of all Newfoundland tax filers, only 1.9 per cent owned 10 per cent or more of a CCPC in 2001. That increased to 2.45 per cent in 2011. We would point out to you that number is significantly lower than reported by Wolfson et al. In the overall picture, the use of CCPCs does not appear to be an overwhelming problem in Newfoundland at this time.
We can turn now to slide 7. It shows you how CCPC ownership changes by grouping by decile income groups or in this case after tax income groupings. The slide on the left is the share of total taxpayers in 2001 and 2011. We have these for every year, but just to illustrate the point it is 2001 versus 2011. You can see a couple of points. For every income category the red bars are above the green bars. This means that for every income category CCPC ownership in Newfoundland has increased. It’s not just the rich as has been alluded to. It is the case that the top decile, the top income group makes more use of it here. For the top decile we see that it’s gone from 7.2 per cent to 10.1 per cent. That’s higher than any of the other deciles by a lot. In other words, if you’re more affluent and you’re a higher taxpayer, you are more likely to make use of this particular option.
What we’re doing in the next slide is basically taking the tenth decile, the top two graphs. Now we’re on slide 8. Wolfson et al broke out the top decile into the top 90 to 95 per cent, the top 95 to 99 per cent, the top 0.9 per cent and the top .01 per cent to show you that as you go from less affluent to more affluent and extremely more affluent there’s a higher proportion of tax filers that take advantage of this particular option.
For example, for the top .01 of 1 per cent of tax filers, 47.6 per cent of those people own a CCPC. While 46 per cent or 47 per cent of these people own one, it’s important to recognize that these are 200 tax filers in Newfoundland of 450 some odd.
Senator Cools: Wow, not many.
Mr. Locke: It’s a high percentage, but it’s a low number, just so we get a sense of that.
If we could turn now quickly to slide 9, it shows by income group and by decile how the usage of CCPCs has changed over time. Rather than go through each of these slides, what you see is that for the low income groups it’s about 1 per cent. It changes slightly. It has gone up a little over time by 1 per cent. As you go up, it goes up a bit more but not a lot more.
For the second decile it’s about 1 per cent. For the third decile it’s about a little more than 1 per cent. For the fourth decile it’s again about 1 per cent. If you’re a low income person, a low income taxpayer, you don’t make a lot of use of CCPCs.
If we turn to slide 10, this goes from decile five to decile eight. What you’re starting to see is that the numbers are getting a bit higher. For decile five we see that it goes from 1.3 per cent to 2.0 per cent of taxpayers in that group. For the eighth decile it goes from 3.6 to 4.3 per cent. As you go up each of these go up one step in terms of one decile for taxpayers, and as you go up the numbers shift up.
If we go to slide 11 you will see the tenth decile in the top left-hand corner. Then you see the top 1 per cent in the top right-hand corner and then the top 0.1 per cent in the bottom left-hand corner. You will see that the primary users of CCPCs are the top 0.1 of 1 per cent or about 200 tax filers in 2011. The finer you make the top of the income group, the higher is the usage of the CCPC option. These are lower than what you’ll observe for Canada, without a doubt. There has been a growth in the use of CCPCs from 2001 to 2011. It has gone from 32.9 to 47.6 per cent of that group of taxpayers. Again, it’s important to recognize that there were only 200 tax filers in Newfoundland in 2011 in that category.
We also wanted to draw your attention on slide 12 to the issue of progressivity because part of this is tied to fairness and fairness is tied to something called vertical equity or horizontal equity. Vertical equity means that it’s typically tied to a progressive tax structure. The more progressive it is, the more it is attempting to address some degree of vertical inequity. Basically vertical equity implies that people with a greater ability to pay do pay relatively more in taxes.
It’s important for your committee to understand that while we throw out the term vertical equity, the extent of vertical equity is a value judgment. It’s an opinion. It’s not right or wrong. It’s a matter of what we believe to be right or wrong. It’s a matter of fairness and fairness a lot of times is where you sit.
We decided to do a simulation on using SPSDM for 2016 data to look at how the tax rates change by income class. We took all the Newfoundland families, the 257,228 families in Newfoundland, and then we ranked them by the amount of taxes they paid relative to the amount of transfers you see. When we say taxes, we mean income taxes and commodity taxes.
What you see on the left-hand side is a graph for those families which have a low amount of taxes relative to transfers paid and for those which have a high amount of taxes relative to transfers paid. What you see is that as income goes up, which is the blue line, the amount of taxes they pay is more negative. We report tax as negative, so that is more taxes they pay. We’ve taken that and we translate that into a tax rate for you. That’s the right-hand diagram. That’s the dashed red line.
What you see is a relatively steep and progressive structure as the income goes up. We have a degree of progressivity. Horizontal equity, on the other hand, is that people who are the same should be treated the same. How you define equal is open to interpretation, but if they’re equal by some definition they should be treated the same.
Senator Andreychuk: When you say “taxes,” is that provincial and federal?
Mr. Locke: Yes, that would be. They are commodity taxes and income tax as well.
Senator Oh: The HST and the federal and provincial income taxes.
The Chair: Can we please conclude and we’ll go directly to questions?
Mr. Locke: Sure. We only have two slides left.
Slide 13 is meant to show you what happens when we incorporate transfers? How does that change progressivity? The left graph puts transfers on the previous graph and then the dashed green line on the right-hand side shows you progressivity net of transfers, taxes net of transfers. That should be compared to the red dashed line because the red dashed line was the line you saw on the previous diagram. What that shows you is that when you take transfers into account, the taxes become much more progressive.
We would point out to you that half of families in Newfoundland under this simulation are not net contributors. Half are and half are not. Some 76 per cent of the transfers are received by those who are not contributors, and 23.47 per cent are those received by those who are contributors. The share of taxes is 42 per cent for non-contributors and 86 per cent for contributors. Only half of the households are net contributors.
Taxes are significantly more progressive in Newfoundland when transfers are considered. This may have implications for vertical and horizontal equities. It may have implications for whether changes to the CCPC are warranted. It is important to think of changes to taxes in a holistic framework rather than piecemeal.
Let me just finish with our conclusions at slide 14. We thank you for your indulgence and giving us the time to present. The use of CCPCs in Newfoundland follows a similar pattern to Canada but is relatively lower. We’re similar. It looks the same on a diagram but we’re lower.
Newfoundland is similar to Canada in that the use of CCPCs increases with income. It is most heavily utilized by the one-tenth of 1 per cent income group which is smaller in Newfoundland. For example, 200 tax filers.
The Newfoundland tax system is already progressive. Whether it should be more so, as would be implied by the changes in the CCPCs is a matter of opinion or value judgment.
The ability of transfers accentuates the degree of progressivity in the Newfoundland tax system and the presence of transfers can have implications for horizontal equity. While the middle class has not been hollowed out in Canada and only slightly in Newfoundland, our simulation in 2016 suggests a growth in the middle class in both jurisdictions.
The problem with income sprinkling is that the individual is the tax paying unit. Income sprinkling could be dealt with by having family as a tax paying unit as we appear to do for other policies. For example, the equivalized family income is used to develop a poverty reduction strategy in Canada.
Passive investment and capital gains exemptions seem to violate horizontal equity. They need to be dealt with in some form or another, either inside or outside of the CCPCs.
It might be time to reconsider a somewhat broader examination of our personal tax system since it has been over 50 years since the appointment of the Carter commission. Thank you very much.
Senator Marshall: Thank you very much. I was going to say this was interesting, but it is almost fascinating. I think it is because this is my province. They say that the devil is in the details. Where the numbers are smaller, you can really see what is happening.
I don’t know if you looked at this aspect, but why don’t we fit on the same track as the rest of Canada? Why do we have fewer? Is it because of our economy? Why are our numbers lower? We are not as representative in CCPCs per population. It would seem that we’re lower. Why are we? Is it because of the business economy?
Mr. Locke: Yes, senator, it is because Newfoundland’s economy is not as well developed as other economies. Prior to 2006 our economy was doing relatively poorly. Prior to 2009 we received equalization, one of the highest equalization per capita in the country for a long period of time. When the fishery collapsed in 1992 we had an outmigration of population in the range of 12 per cent. Nowhere in this country or any other country had we seen that kind of outmigration of population.
We have very few opportunities for employment outside of government and outside of the direct resource sectors. As a result some people have done okay and have accumulated wealth, but most people have not. As a consequence of that, you don’t see as many people taking advantage of the situation in terms of the CCPC numbers. They’re low numbers and we’re an aging population now, which is going to create some other issues for us.
Senator Marshall: Where you’re talking about the 0.1 per cent and the number 200, were you able to tell which professions? I don’t know if targeted is the right word, but one of the professions is that of doctors. Are you able to tell who is in the 200, which professions?
Mr. Locke: The answer is you could. We didn’t have the data to do that, and that is something we will be looking at.
Senator Marshall: Is that something we could get?
Mr. Locke: Yes. For example, we can get doctors or people working in doctors’ offices. We can get construction. All those kinds of things you would be interested in, you can have access to.
Senator Marshall: The very high income earners are the 0.1 per cent making the most use of it. It would be interesting to know whether these are doctors or whether they are other types of small businesses. That would be very interesting to know.
Do you think the proposed tax changes that are coming now will have an impact on small businesses, regardless of whether they’re doctors or other types of small businesses? Do you think these tax changes will impact the CCPCs in Newfoundland and Labrador? We don’t have many as it is. We’re below the national average. Do you think that this will have a negative impact on them?
Mr. Locke: Let me say the following to you, senator. Unambiguously these changes will impact small business in this province in a negative way and in every province as well, not just here. They’re designed to take more tax away from them, to remove their ability to save with inside the corporation, and generally to reduce the amount of income they have for investments. There is no ambiguity. That is what the impact will be. If people believe that will not be an impact, I think they’re mistaken.
Senator Marshall: It would be interesting to know what types of businesses because then you could tell whether they’re mobile and whether they could move to other provinces or other countries. If it’s primarily doctors, it would be interesting to know.
Mr. Locke: The impact of these changes will raise the progressivity of the tax on this particular group. It will raise the federal rate to them. It will exacerbate the difference in provincial rates. That in itself will cause some reallocation of incomes and people between provinces that otherwise might not be anticipated by this legislation.
Senator Marshall: Looking at your slide 11, the one on the lower left where it says Newfoundland tax filers own more than 10 per cent of the CCPC. Do you see where the numbers are changing? Why are there dips and peaks? Would you have any insight into that?
Mr. Locke: Those are years of recession.
Senator Marshall: Oh, that is what it is, yes. Then it started to come back up, and it is starting to go back down in 2011.
Mr. Locke: Yes.
Senator Marshall: We’re in recession.
Mr. Locke: In 2011 we were not in a recession, but prices were starting to come back down.
Doug May, Professor of Economics, Collaborative Allied Research in Economics (CARE) initiative, Memorial University of Newfoundland, as an individual: I want to confirm what Dr. Locke said. When you file a T2, a tax form, your BRN or business registry number is with Statistics Canada. You can identify the industry. You can’t get the occupation but generally with many industries there are associated occupations such as in the medical profession, the dental profession, or something like that. You in fact could easily trace that out.
I thank the people at Statistics Canada because they knew we were appearing here on Monday morning. They rushed to do this analysis, but they could carry on with it too.
Senator Marshall: I would just like to make one other comment. I was really surprised on slide 6 at the number of tax filers in Newfoundland and Labrador. We only have a population of 500,000 and we have over 450,000 tax filers. Is that an indication of our low youth? That’s what that is, is it?
Mr. Locke: Yes. It’s often the case that in order to collect certain kinds of benefits you have to apply.
Senator Marshall: You have to file, okay.
Senator Andreychuk: Thank you. You made some statements at the start on slide 3 about the middle class. One of the problems we’re having is defining the middle class. In your case you said it was to protect the middle class. Somewhere in there you thought that was the reason for these changes.
How do you figure out the middle class for your graphs and charts and come to some of the conclusions that you have made?
Mr. Locke: I’ll let Dr. May answer that one.
Mr. May: First of all, clearly there is no strict definition of the middle class. I mean various groups use different definitions. With the paper we have here we’re trying to compare our province and Canada to what was happening internationally.
In particular a lot of the discussion surrounded the growing income inequality in the United States. A paper was prepared by the International Monetary Fund, referred to as the IMF. We just followed the definition used by the IMF and presumably the OECD and others. In coming up with our definition, I discussed the matter with people in the Income Statistics Division of Statistics Canada. They were the people who released the new numbers last week. That is how we came up with the definition to make these international comparisons.
It’s 50 per cent of the median and that actually corresponds to what you might hear elsewhere as the low income measure, the measure that’s sometimes used for poverty. Then it goes up to 150 per cent. It could change slightly on the higher end, but that’s the definition that international organizations use.
Senator Andreychuk: We hear politically a lot of comments about growing the middle class, the middle class being in danger, et cetera. In your paper you seem to agree that it’s a difficulty but not a difficulty in Newfoundland or Canada as much as it has been made out to be, if I understand your slide three.
Mr. Locke: That’s correct, senator. We don’t see it. If that’s the primary motivation for these changes then it’s not a strong motivation.
Senator Andreychuk: Mr. Morneau came before our committee and certainly made public that one of the motivations was the middle class. Separate and apart from that, the point was made that someone who makes $50,000 as a salary shouldn’t have to pay the same tax as someone who is a private incorporated business.
What is your thinking on that? Is that a fair assessment to make? Someone who is salaried and an entrepreneur are taking different risks. Employees take risks but entirely different types of risk. Is it a fair comparison to say they should pay the same tax?
Mr. Locke: If the person making that comparison takes into account all the transfers, the income and amount of tax they pay and then make the statement you just made, that would be fair. People who are identical in regard to what we think are important would be on equivalized family basis. They ought to pay the same tax. That is correct. That part would be fair but there are a number of qualifiers we would put into that as well, especially in terms of looking at transfers and having it as the basis of family size and family as a unit.
Mr. May: You have to be careful here too, senator, in making statements like that because the Income Tax Act becomes terribly complex. For instance, if you had wage income of $50,000, and forget about anything else, what becomes taxable income depends upon the composition of your family. For instance, if you got $50,000 but were an unattached young individual that would be one thing. However, if you’re a senior with 10 children, all dependent upon you, that would be another thing.
You have those different definitions. What the deduction should be would be yet again something else. What a deduction should be is a matter of opinion, but I think we don’t want to try to tax people into poverty.
Senator Andreychuk: We’ve heard compelling stories in other provinces beyond what you’re saying that an entrepreneur takes a risk and does not have a defined pension or other kind of pension as an employee may have.
Risk should be equally valued and, therefore, retained earnings are used for a lot of purposes to expand a business, to grow a business. You have to take your personal assets off as mortgages and as collateral for loans. All of that has to be taken in so that the comparison between a salaried worker and a risk taker entrepreneurially should not be a value judgment for fairness.
Mr. Locke: It would always be a value judgment for fairness, but the issue with respect to compensation of risk and taking account of risk in the tax system is important. If you don’t compensate for risk, there will be less risk taking. There will be less investment. With less investment there will be less growth and less growth means there will be a lower standard of living.
We’re not arguing that risk ought not to be incorporated into an appropriate tax system. I guess what we’re suggesting is that your ability to save passively within the CCPCs provides a large benefit to the people who participate that way. You might change the other systems outside so that individuals who have money that’s not in a CCPC can invest in their future as well.
If the issue is risk taking, that’s one thing. If the issue is saving for retirement, that’s something entirely different that can be dealt with outside of the CCPCs. It is a tremendous advantage right now as far as we understand it, but that’s an accounting issue. The accountants will have an answer for you, senator.
Senator Andreychuk: I’ve forgotten on which page it was, but graph shows that as you go up in private corporations you’re paying more tax and that some of the prime users are at the top end. Is that correct?
The case we have found elsewhere is that you start out small and you grow your business and you grow your business. If you’re targeting now with this amendment that the minister has made the top 3 per cent of that group, is that a disincentive then to grow your business? You’ll simply stay where you are. You’re not going to reach out to grow the business. Perhaps you might not go internationally.
Mr. Locke: I don’t feel comfortable trying to provide a response to that question. You’re going to be interviewing Mrs. Keating shortly from the St. John’s Board of Trade. She will be able to tell you from a business perspective whether or not they feel that is an impediment that may reduce the incentive for businesses to grow from small to big.
Anything you do to take away at the top end will have a dampening effect on incentives. That we can agree on.
Senator Cools: I thank you very much, professors, for sharing this information with us. I must tell you that I have great respect for modelers and simulation models. My husband taught me great respect for that because he used to do a lot of those things.
I was very impressed by the information you put before us and pleased that Newfoundland is doing as well as is reflected in your findings. I’m just wondering if it is possible that this is more than a Newfoundland result that you presented to us.
Is it possible that this could be a Maritimes and Atlantic trend? Maybe these provinces are beginning to do quite well in many ways that we are not aware of? Is it possible?
Mr. Locke: It’s possible. Our expertise doesn’t extend that far.
Senator Cools: It doesn’t extend that far.
Mr. Locke: We’re geographically limited, spatially limited.
Senator Cools: I understand. The Maritimes are very beautiful, so the beauty makes up for it. I thought it was useful if such data could be found. It is something that we should always take in mind, especially because at the end of the day this part of Canada is its own region. It really is.
Mr. Locke: The data we have here are available for every province. We just asked for Newfoundland because we’re presenting at a Newfoundland session.
Senator Cools: Yes, you’re presenting a Newfoundland point of view.
Mr. Locke: Yes.
Senator Cools: Thank you so much. Come again and come often.
The Chair: Senator Oh is here replacing Senator Neufeld, and now the chair will recognize Senator Oh for questions.
Senator Oh: Last night I was having dinner with some local Newfoundlanders. They all told me that this province is rich. It’s supposed to be rich in everything. You guys have everything down here, but the problem now is that Newfoundland and Labrador is close to bankruptcy.
Will these proposed tax changes have even more impact on this province?
Mr. Locke: We have the highest per capita revenue in the country par none. We have the highest per capita expenditure in the country par none. Unfortunately, our per capita expenditure is higher than our per capita revenue, which means that we now have a fiscal situation that is difficult.
To the extent that the CCPC increases the progressivity of the tax system, that will be beneficial to the province in the sense that they will collect more revenues on a base that is now expanded. To the extent that we have a relatively high tax rate, which we do on a lot of aspects, and we make one component of it yet higher still again, it will have the implication of making us relatively less attractive. That is true.
I think you told me that your friends were doctors. They may have opportunities elsewhere in this country or in other countries that are adjacent to this country. To the extent that we raise their taxes and reduce their after tax income, it will not bode well for the long term for here. I think that’s a statement we can say.
Senator Oh: Have there been a lot of small business closures in the last few years?
Mr. Locke: Again, you’re going to be speaking with Dorothy Keating from the board of trade. She can answer those questions for you better than we can
Senator Marshall: The graphs are really interesting. Perhaps you might even be able to give some insight into it, but I’m back looking at the graphs on page 11 where we’re talking about the top 0.1 per cent and even the top 1 per cent. You were saying there are only 200 tax filers in that group, right?
Mr. Locke: Yes.
Senator Marshall: At 53 per cent that would be 106 filers, and then it dropped by 11 down to 95 filers. It would be really interesting to know what lines of small business they were in. You have no insight into that. Is that what you’re saying?
Mr. Locke: What we did say to you was that we are looking at that. We will make this presentation available publicly to something called the CARE website, the Collaborative Applied Research in Economics.
It is our intention to go beyond here to look at the industries these come from and which structures they come from. When we get that done we will commit to sending it off to your committee.
Senator Marshall: Some additional details.
Mr. Locke: We think it’s important and we think it’s worth our time to do it.
Senator Marshall: Yes, it is. I have another question. You said that 50 per cent of taxpayers are contributing and 50 per cent are not contributors.
Mr. Locke: It is 50.4 per cent that are not contributing more than they’re getting in terms of transfers.
Senator Marshall: Yes.
Mr. Locke: That includes income tax and sales taxes.
Senator Marshall: Would that also include the Canada child benefit?
Mr. Locke: It would be all of those, yes.
Senator Marshall: I just wanted to make sure I understood the data.
The Chair: To the witnesses, Professors Locke and May, thank you very much for sharing your recommendations. I would say they have been educational and very important for the work of the committee.
As we go forward to December 15 when we table our report in the Senate of Canada, if you want to add something, please do not hesitate to send additional information through the clerk of the committee, Ms. Lemay.
Mr. Locke: Thank you for allowing us to talk to you.
The Chair: Senators, on our second panel we have with us Ms. Dorothy Keating, Chair of the St. John’s Board of Trade. Also joining us is Mr. Bill Stirling, Chief Executive Officer of the Newfoundland and Labrador Association of Realtors. I thank both of you for accepting our invitation.
I have been informed by the clerk that the first presenter will be Ms. Keating, to be followed by Mr. Stirling. Please keep your remarks within five minutes so that senators have time to ask questions.
The floor is yours, Ms. Keating.
Dorothy Keating, Chair, St. John’s Board of Trade: Good morning, Mr. Chair and members of the Standing Senate Committee on National Finance. Thank you very much for taking the time to come to St. John’s to listen to the concerns of the business community and taxpayers in general. It is a great pleasure to join you here today.
The St. John’s Board of Trade has been in existence for over 40 years. We represent over 800 small businesses in the province. These businesses employ thousands of Newfoundlanders and Labradoreans. Never in the history of the St. John’s Board of Trade have we heard such an outcry from our members as what we had heard pending the proposed legislation introduced in July of 2017. It’s because those changes are so widespread, so broad, so far-reaching and with so many unintended consequences.
In response to the July tax changes and the call for consultation, the board provided a 28-page document which highlighted some of the specific concerns of our members, with examples from our members of how these unintended consequences would specifically impact them.
Family businesses are called family businesses specifically because it is like every restaurant or fish plant in Newfoundland and Labrador. There’s not one that does not have family members working in it.
A good financial practice would dictate that a business should develop a strong balance sheet which would include savings to enable businesses to expand or grow or potentially to weather economic downturn.
During the week of October 16, only two weeks after the deadline for submission of the response to consultation, the government announced in a series of news releases and press conferences changes to their proposals. While the follow-up measures appear to represent some steps forward, these proposals continue to raise many questions and concerns for our members.
Unlike the July 18 announcement, the October announcements had little in the way of details or specifics to allow for full understanding of the potential impact of the changes on our members. There is considerable lack of clarity over which proposals will proceed, which proposals will be amended and which proposals will be abandoned. The follow-up measures are also unclear as to when the various proposals will take effect.
As a result, businesses are left in a very uncertain environment. We at the board know that to thrive and grow the one thing that business needs is certainty in taxation. Our current taxation climate that the federal government has created has exasperated this air of uncertainty. This is not good for our economy, for the financial health of our province, or for the financial health of our small businesses.
Many unanswered questions arise from the October announcements. If we look at the taxation on income splitting, in our submission we gave multitude examples from our members of how these changes had unintended consequences. As a result of the October consultations and submissions and the government’s changes in their proposed measures, we do not see a significant change in how these concerns have been addressed.
While they’re certainly a step in the right direction, based on information provided in the recent announcements, it’s difficult to understand how these rules will actually be simplified. Once again, we are left as a business community with uncertainty. Questions still exist.
Why shouldn’t spouses be allowed to split income, particularly if their personal assets, the house, the car and the family savings, are pledged as collateral to these businesses in the event of failure? If one spouse is working 12 hours a day, the other spouse must pick up the slack at home. Does the spouse’s effort to support the business at home have no value to this government?
Will there be guidance on the amounts that are reasonable? What does the government mean by family members that contribute meaningfully to a family business? What do they mean by contribute?
When will this new simplified draft legislation be released and effective? Taxpayers cannot retroactively tax plan. Why should they be subject to retroactive taxation by the government?
What will be required of business to meet documentation requirements to demonstrate this reasonable contribution, and at what cost to those businesses? Will the conversion of capital gains to ordinary dividends remain in the new simplified legislation?
Passive income is a much talked about section of the proposals: On July the 18 the government proposed to increase tax on corporate passive investments funded from after tax business earnings. As the board demonstrated in our October 2 submission, this new proposed taxation would result in our province of Newfoundland and Labrador having the effective tax rate of 73 per cent on business owners of those small businesses.
The October response by the government was to propose that a new tax increase would only apply to passive income that exceeds an annual threshold of $50,000. This in a Department of Finance news release equated to a hypothetical 5 per cent rate of return on a $1 million savings amount.
We do not understand the rationale for this arbitrary line in the sand. The government has said this will only apply on a go-forward basis. No draft legislation has been released. Once again small businesses are left to wonder what this will mean to them.
There are still many unanswered questions. Will this measure only apply to CCPCs or to all companies? When will this measure take effect and will small business be given time to rearrange their affairs? Will the 50,000 annual passive income threshold be available to each shareholder, or will it be required to be shared among shareholders of the business?
The government has said that there will be grandfathering. What is being grandfathered? Is it an asset test? Is it a retained earnings test? How long will grandfathering be permitted? Is there a forced drawdown on the grandfathered investments?
What will be considered a passive investment, particularly when investments are made in other private corporations? How does the passive investment rule impact venture capital and angel investment?
As you can see, although the movement to allow some arbitrarily level of passive income to remain at the current taxation rate, uncertainty still exists with what is the government’s intention.
The result of the tax change should not be to stifle economic growth and deter investment. Budget 2018 should not serve the purpose to deter business investment and growth in our country.
Canada’s tax system could be redesigned to support investments in productive assets and business growth. Instead of penalizing passive savings, Canada should offer incentives to businesses to invest.
As an interconnected world, technology and capital are increasingly mobile. This mobility is driving competition for business investment. Canada must remain competitive with the world market and in tune with the tax reform that is happening around the globe.
The U.S. Congressional Republicans are determined to press ahead with their biggest tax reform in 30 years. Rather than reactively waiting for the Americans to move before we figure out how to respond, let’s proactively get our house in order and bring down rates to boost Canadian competitiveness.
Canada needs to attract and retain world class talent both for skilled workers and entrepreneurs. This means that we also need to look at personal income tax to determine if the top marginal rate of 53.1 per cent in Newfoundland and Labrador is driving people away. Many of the people affected are not just the maligned high income earners. They are also the innovators and creative visionaries who can lead the businesses into the 21st century.
Finally, we need to confront the overall cost of doing business in Canada, the serious cumulative impact of the growing burden posed by fees, taxes and regulations the private sector is being asked to bear.
Our members are deeply worried about their ability to grow their businesses in Newfoundland and Labrador and to compete for investment and customers from abroad.
The current taxation system has not had a comprehensive review in over 50 years. A comprehensive review is long overdue. This is the reason why we are urging the government to take these proposals off the table. Piecemeal changes to the Canadian tax system do not simplify our Canadian tax system. As we have seen with these July proposal and subsequent October announcement, they create further complexities, inefficiencies and unintended consequences.
If we are truly committed to a fair tax system that supports growth and benefits all Canadians it is important to take the time and get it right. Launch a comprehensive tax review with meaningful consultations with the business community to address any shortcomings in the tax policy without unfairly targeting businesses. The sober second thought and thorough study of the Senate hearings are precisely what are needed.
Establish a royal commission to undertake a comprehensive review of taxing statutes guided by the principles of simplification and modernization, as well as of globally reducing compliance costs, to give Canada a competitive tax regime once again.
With some hard work and such an independent review Canada could create an internationally competitive system of business taxation that rewards entrepreneurship, encourages business to invest in the technologies, skills and capacities they need to grow and to attract capital, product mandates and high quality people from around the world.
Thank you, senators, for initiating your important study. I look forward to answering your questions.
Bill Stirling, Chief Executive Officer, Newfoundland and Labrador Association of Realtors: My association is a member of the St. John’s Board of Trade and we certainly would reiterate everything that Ms. Keating has said.
Our association represents approximately 700 licensed real estate professionals across Newfoundland and Labrador, around 70 of which are private corporations. In Newfoundland and Labrador, real estate agents are not allowed to self-incorporate so most of our members are self-employed, independent contractors licensed in the name of a broker.
Through our national partner, the Canadian Real Estate Association, we submitted a response to the original consultation back in July on behalf of our 125,000 members. I’ve provided a copy of that with my package for your consideration.
We certainly recognize the government has altered its proposal significantly since that time. The issue of passive investment is one that’s very, very important to our industry. It’s one that we are working on with CREA, the Canadian Real Estate Association, to understand what the changes in the proposal means to our industry.
Today I would like to draw your attention to other matters where national policy may be having unintended consequences on the Canadian housing market. Those topics in particular are a seemingly unrelenting focus on house prices in the Toronto area and Vancouver and the overwhelming concern with Canadian indebtedness, both of which are having unintended consequences on housing markets across the country.
The federal government has clearly stated one of its main objectives is to create a healthy and growing economy in which businesses generate well-paying jobs and where the middle class and those working hard to join it have confidence that they can succeed. We completely agree with this objective and certainly our members work hard to contribute to a growing economy.
Real estate is the largest single contributor to GDP in Canada. Our members themselves are primarily middle class Canadians. Most importantly, the homeowners that they serve are primarily middle class Canadians.
Today, I will suggest to you that the federal government consider a regional approach to housing policy as a way to meet its objectives of fairness and support to the middle class.
First, let’s look at the focus on Toronto and Vancouver house prices and the effect it’s having on real estate markets. All real estate markets in Canada are local in nature. Being a middle class Canadian includes owning your own home and using that home as part of a financial plan to accumulate wealth and to save for retirement. The growth in pricing in Vancouver and Toronto were brought on by a series of local market factors driven largely by issues of supply and demand. Affordable housing and the Canadian dream of home ownership should be within the grasp of all hardworking Canadians, but clearly affordability is an issue in these two markets in particular.
The federal government, however, in trying to cool these markets has thrown a wet blanket across markets in the rest of the country that don’t need the same level of intervention. Indeed, in some markets particularly here in Newfoundland and Labrador, the cooling effect seems to have led to declines in both demand and supply and has delayed our market recovery.
The only tools the federal government has at its disposal to try to control pricing is to dampen demand for housing in those two markets by placing it out of reach of the average Canadian. Increasing down payment requirements or reducing the amount that buyers can qualify for on a mortgage has been the federal government’s answer to this problem. Provincial governments have also weighed in with a series of taxes, fees and other measures designed to deter demand as well. Overall, these measures really have had minimal impact in the long-term price trend of the big two markets, but the impact of the unintended consequences on real estate markets in other regions of the country are starting to become clear.
In Newfoundland and Labrador we’ve seen three straight years of average price declines. The number of MLS transactions is down year over year. This afternoon you will hear from my friends at the Canadian Home Builders Association who will tell you that housing starts are down by 75 per cent in the last five years.
As of October of this year our sales year over year are down. The number of sales is down by 6.2 per cent. While those initial declines in the market were due to impacts of the falling oil prices and mineral resource prices, there’s no doubt that the delayed recovery is at least in part due to dampening effects of federal interventions.
Let me now turn to the concern over household indebtedness. This has been a concern for the federal government, the Bank of Canada and financial institutions around the world for several years. We’ve seen a series of efforts taken by the federal government in recent years to limit the amount of borrowing Canadians can take on in relation to their primary real estate. Limits to home equity lines of credit were introduced several years ago. The insured mortgage stress test was introduced last fall. There was an increase in down payment requirements on houses over $500,000. There is the soon to be introduced stress test on uninsured mortgages where the default rate is in the point tenths of a per cent across Canada, the so-called B20 guideline. All of that is aimed at real estate debt.
Economists, such as the two gentlemen who were here before us, have long described real estate debt or home ownership debt as good debt, as it’s generally taken out to acquire assets that will appreciate in value over time. Bad debt on the other hand is generally on depreciating assets or has overly high cost of capital. The long term impact is a drain on finances as opposed to help building wealth.
The federal government in its drive to help Canadian reel in their debt levels have been entirely focused on limiting access to good debt while doing little to deal with the true problem of seemingly unlimited access to high interest consumer debt.
Mortgage interest rates are at historically low levels. Even with a rise of 1 to 2 per cent over the next few years rates will still be historically low compared to the last 40 years.
On the other hand, bad debt such as retail credit cards often have a cost of capital an order of magnitude larger than a typical home mortgage, with much lower qualifying requirements. Retail financing for vehicles, RVs, off-road vehicles, furniture, appliances and more, all for the most part bad debt, are not the target of government intervention but could arguably be seen to be the real cause of household indebtedness problems. For example, half of new car loans are now being amortized for seven years or longer and a typical owner is in a negative equity position for the first 5.5 years of that loan.
Government is making it tougher to qualify for a mortgage in Grand Falls-Windsor, Newfoundland, but is doing nothing to stem the tide of consumer debt that an over leveraged homeowner in Toronto is struggling to stay above water. We would encourage the federal government to look at Canadian household debt problem in its entirety and build a strategy to limit bad debt.
For 150 years Canada has been a country of regions with the federal government challenged to reconcile the needs of a region versus the good of the country as a whole. We see that now as government struggles to deal with the issues particularly in Toronto and Vancouver around housing affordability. We are encouraging the federal government to consider a regional approach to housing market policy development.
There’s plenty of precedent here where government has adopted regional approach to policy and program development before. We have long had a regional approach to the federal government’s interventions in economic development across the country, including at least six regional development agencies responsible for regional economic development across the country.
In this part of the country we have the Atlantic Canada Opportunities Agency. In Ontario there’s FedNor and the relatively new agency for southern Ontario. Members from the west would be familiar with the Western Diversification Program. They’re all instruments of government policy with similar mandates operating with economic development objectives and priorities of the regions that they serve.
Similarly, for a long time we have seen regional approaches to labour market development and programs such as employment insurance. Access by Canadians varies across the country based on local labour and market conditions.
Real estate markets are local in nature and are driven by local economic and labour market conditions. Areas with high economic growth, low unemployment and tight labour markets, for example Fort McMurray before 2014, often see conditions which lead to rampant housing price inflation with high demand and low supply. Those are the conditions that we now see in Vancouver and Toronto.
Conversely, areas with slow or no economic growth and higher unemployment often see real estate markets that are more balanced in terms of supply and demand and are able to regulate themselves without any need for intervention by government. This is the case in many medium size and small size markets across the country today.
We would encourage the federal government to consult with industry and explore the linkages between housing, economic conditions and local labour markets, and to consider adopting a regional approach to housing policy.
The federal government is quite rightly focused on a healthy and successful middle class. The unintended consequences of interventions on the national housing market while trying to address two local markets in particular is not serving the middle class well in the rest of the country.
I thank the committee for its time. I recognize I’ve strayed from the stated topic for today, but I appreciate your indulgence in a matter that is important to me. I would encourage you to consult with us further on these issues.
The Chair: Thank you very much. Both presentations were very informative.
Senator Marshall: I’m thinking of a strategy now for questions because I know the chair will cut me off. I will start with Mr. Stirling because it’s more specific, and then I will ask Ms. Keating some questions.
You can talk about household debt as it relates to Newfoundland and Labrador. Right now I would say we are going into a downturn in that interest rates are going up. It looks like we are to have an economic slowdown. We have these proposed tax changes now on small businesses.
What impact do you think it have on even the household debt? What kind of squeeze will that be putting on individuals?
Mr. Stirling: The real estate market, which is the one that I’m familiar with, is driven very much by emotions and very much driven by confidence. Since the downturn of the oil industry and of the mineral resources industries and the precarious position that the provincial government is in financially, we have seen a lack of confidence in the market here. That’s indicative of why our recovery has been delayed. People are less confident that they will be financially better off next year than this year.
Anything that will impact confidence in the market, certainly the uncertainty around the tax changes, leads to a lack of confidence. Anything that impacts on confidence in your own financial position will impact the housing market and activity in the housing market.
Senator Marshall: Yes. We say that for mortgages you have an asset backing it up, but the value of assets also goes down. When interest rates go up there will be a pressure. I think you even said that the average value of a Newfoundland home has decreased in the last couple of years. That sort of indicates a problem.
Mr. Stirling: Yes, average price has come down, but we’ve seen a shift in the marketplace. We came through several years of very strong growth in the early teens. Up until about 2013-2014 we’ve seen tremendous growth both in terms of volume of sales and average prices. A lot of oil money from across the country flowed into our real estate market, particularly in St. John’s and in the regional centres across the province of Gander, Grand Falls and Corner Brook. That market dried up. The oil money funded parts of the real estate market. The high end, the half million and three-quarter million dollar properties, has dropped off. We’ve seen a shift downward in the market.
Our volume in the $250,000 to $300,000 range probably hasn’t changed all that much. We use the analogy of lining up all the kids in a classroom by height. Then, if you take away the four or five tallest kids, the average height is going to drop but the kids haven’t changed. Our average price has come down but that doesn’t mean average value has come down as much because we’re selling a lot more houses in the lower end of the market, we’ll say.
Senator Marshall: Ms. Keating, you were saying in your opening remarks that the board of trade represents 800 businesses. I would be interested in hearing what they are saying to you about the proposed tax changes and what they are doing in anticipation. I know you emphasized the uncertainty. We really don’t know what the tax changes will be.
What are they saying to you and what are they doing? When we were out west we were told that some companies are actually making changes in anticipation. They’re second guessing what will happen. I’ll go back a bit. What are they saying and then what are they doing?
Ms. Keating: Senator Marshall, the board of trade has 800 members. When this proposal came out in July we struck a tax committee. It was the first time ever that the St. John’s Board of Trade drew upon our members who actually were practising in tax. We had tax lawyers and tax accountants that came together to review these proposals, speak with members, educate and discuss this.
In our submission we gave numerous examples of very specific circumstances where those impacts would be seen. When we say we speak for 800 businesses, through the tentacle of our tax committee we are actually speaking for thousands of businesses in the province. Those professionals have as their own clients thousands of businesses.
We’ve heard through the process of the level of uncertainty that has rippled through the business community with respect to these proposals. Make no mistake, they have been listening to the announcements that happened as of October 16 when the minister came out and made some comments with respect to sections they will potentially be repealing or things that they will be changing. Those have not quashed the uncertainty in the business community whatsoever. If anything, it’s created more uncertainty because it has exasperated the situation.
I know firsthand of businesses that have decided to stop being in business, to sell their business and to get out of it. They have had enough of the roller-coaster ride of uncertainty. There are individuals that have followed the tax rules and the tax plans for the last 20 and 30 years. They are now moving into, as we all are aware, the bubble that is happening with the baby boomers. They are moving right now into the precipitous of their retirement. They have literally had their entire tax planning which they have done for the last 30 years completely upheaved with the proposed new rules with respect to passive income. Those are significant changes for those individuals.
There are those who are talking to their advisers wondering if they should pull everything out of those businesses now and suffer an exorbitant tax at this time. The uncertainty that is rippling through the business community is nothing like the board of trade has ever seen. Businesses are contracting because of that. They need funds to invest and grow. Not knowing the playing field they may be faced with, come budget next year, they are contracting. They are not doing things as they normally would do until they figure out what playing field they are actually on.
Senator Marshall: In your brief you talked about the complexity of the tax system. Is that a big factor with the organizations that you represent? Are people not quite sure of what they will do or what direction they should go in?
Ms. Keating: With respect to the entire taxation system, personal and corporate income taxes are extremely complex documents requiring a multitude of professionals to interpret what is in there and provide advice to the various businesses. These new rules have added another layer of complexity.
The proposed legislation that came out as part of these proposals in July was submitted as part of the document we submitted to the Finance Committee and shared with the Senate. There are areas in that where there’s actual contradiction and circular references that are occurring. When you’re trying to interpret or give advice to someone in the realm of a tax professional, that level of uncertainty and being unable to decide what that will mean for your business have completely unearthed what has happened with respect to the business community.
The taxation system in Canada was complicated as it was. This has added another level of complexity that boggles the mind. The passive income proposals with respect to how you’re supposed to keep track of the various buckets of funds, the amount of actual cost that a business may incur to try to meet the regulations in those various proposals, and to meet some arbitrary standard that a CRA auditor may come out and impose upon you after the fact, have businesses completely uncertain in terms of what to do next.
Senator Marshall: I think the term you used in your brief that was submitted was bewildering complexity. You mentioned the passive income part of the proposal. I know in your brief you also talked about the grandfathering provisions.
There’s a reference in the finance documents that there will be some grandfathering, but we don’t know what it is. What would you like to see in the grandfathering? I know you spoke about the $50,000 threshold, but we have to make recommendations in our report. What do you see as a reasonable and realistic grandfathering provision?
We don’t know what the grandfathering provision will be, but can you give us some idea as to what you think would be reasonable?
Ms. Keating: I guess the issue with that is that it will be different for each type of business. If you look at the passive income, I think part of the issue or part of the problem goes to a question that was earlier asked of Dr. Locke with respect to the comparability between an employee and a business owner.
How do you establish that relative risk? Is that an apple and an apple that you’re comparing? As representatives of the business community we would tell you absolutely not. That is not an apple and an apple comparison. There is no factor included there with respect to risk to understand the differentiation between the two of those.
If I am a business owner and I am toward the end of my business cycle, I must look at how that business is constructed. I’ve been in the ups and downs of my business over the last 30 years. I’ve not been able to avail of other tax saving measures such as RRSPs and the like. I’m looking at the potential sale of my business as being my nest egg that will bring me into retirement so that I’m not dependent upon government funding and government subsidy. If you look at what such individuals would look for in grandfathering, it would be around the actual investment they have in terms of asset.
If I’m an active business trying to reach out with tentacles to actively invest and try to keep cash so that I can grow and develop my business, I’m more asset-based. Are retained earnings the correct mechanism for me to use? I would say probably not. I may need cash for investment that doesn’t materialize to actual revenue and retained earnings for many years, in terms of when I get there.
There is not one solution in terms of I can look at you and say it should be based on retained earnings or it should be based on a cash value.
Senator Marshall: We had the Minister of Finance and officials from the Department of Finance testify before us, but the impression I’m getting is that it will be like a one size fits all. It seems like there may be some sort of special provision for farmers, but the impression I get is that it will be a one size fits all. Whatever grandfathering is there will be one generic grandfathering provision. I expect it’ll be complex but it won’t be tailored to different situations at all.
I had a lot of questions for you after reading your brief. You mentioned retained earnings. When you are talking about passive income, you are really talking about part of your retained earnings.
Ms. Keating: Yes.
Senator Marshall: We don’t even know what passive income will be. I was trying to find the definition on the Department of Finance website, and I couldn’t find a definition there for passive income.
The concern for me is: What message is that sending to other companies? I know we’re talking about the CCPCs right now, but the government is looking at retained earnings. Now they are to put rules in for how companies deal with their retained earnings. For me, this is really a precedent.
Can you comment on that? I know you are a CPA and you work with a firm. Do you sense the same discomfort I feel when I see that the government is like putting their fingers on the retained earnings of a company?
Ms. Keating: The one thing that the proposals of July should tell us as Canadians is that the legislation was well thought out by the individuals who did the proposals and came forward with the legislation. That legislation was tabled in the form of proposals. Individuals such as me and others around the country got a hold of that legislation and read it. I know the Department of Finance has received documents that are hundreds of pages long. The board of trade document was 28 pages. It was a fairly comprehensive document, but I know that there are others that are hundreds of pages long.
One thing should concern senators and all Canadians. When you try to do something such as tag retained earnings, dive specifically into one issue and use a mallet to drive a nail, it will reverberate through many other areas. To take retained earnings, as with anything, will drive behaviour. That behaviour will not be investing and growing our Canadian economy. That will drive behaviour, which will cause contraction. That is the last thing we want happening in our Canadian economy right now.
We cannot ignore what is happening with our friends to the south. They have an extremely business friendly tone when you look at what they are doing. They understand. Some 70.8 per cent of Canadians are employed by small business. That is your economic engine. You should not, as a government, be doing things that would cause those who those risks and endure those uncertainties to contract.
Senator Marshall: I’ve asked this question of other witnesses. When you propose things people will say this will happen and that will happen. I specifically asked this question of the doctors because they always say, “If you do that, we’ll leave the jurisdiction.”
Do you think the changes will happen and businesses will react the way you think they will react, or do you think they’ll cope with the changes and just carry on?
Ms. Keating: From the conversations I have had since the July proposals, individual business owners have made the decision to get out of business. They are done. It will have those implications. What the magnitude of those will be is yet to be seen.
Senator Andreychuk: Just following up on the same sort of questioning, when we first started as a Finance Committee to look at this issue, the question was: Why are they doing this? Of course it was the employee example. Then it was building the middle class.
Was there any discussion or pre-notice before July 18 to any of your members or to you as an association?
Ms. Keating: To this magnitude, absolutely not. I mean in previous budgets the government has said, as part of its election platform, that it would be looking to supporting the middle class, growing the middle class and things of that nature. To have seen such wholesale changes having such a ripple effect through the business community, no, there’s no one that would have anticipated a document of this nature coming in July.
Senator Andreychuk: Certainly the minister has responded to some of the July 18reaction. Do you think there is less distrust of what the government is doing now, or do you think the amendments have added to the confusion and distrust?
Ms. Keating: We know that there were 21,000 submissions in response for the call of consultation. There is such ambiguity in the announcements since October 16, if you think about it, that we find it difficult to believe you would wade through 21,000 submissions in two weeks to be able to address and to respond to the concerns that have been raised.
Are we pleased that the government has said it heard there were issues with respect to the legislation? Do we think it is important that much more time and a much more comprehensive review are required?
I don’t know how anyone could conclude otherwise. I do not understand, based upon the magnitude and the depth of what had been presented, how they could conclude anything other than a wholesale change needed to occur in the taxation system and that a Band-Aid solution would not work.
Senator Andreychuk: We’ve heard from some witnesses, and you’ve pointed it out, that for 30 plus years they’ve been managing their affairs and building their businesses. Now, all of a sudden, that’s all up in the air.
One is to get out of the business, et cetera, but the other we’ve heard is perhaps delaying. The government is saying that will implement this immediately, even in January 2018. We’ve heard calls that the delay should be until at least 2019 so that people can adjust what they’ve been working on for 30 years and have some implementation period.
Would you be in favour of that, or are you saying no, we need to scrap these and have a royal commission or some sort of look at the tax system as a whole?
Ms. Keating: To be honest, if the government actually implemented these in the next budget, I don’t know if they would be prepared for the changes they have brought forward, let alone what the business community would have to do with respect to getting their own house in order. I don’t think that the actual government, the CRA or Revenue Canada, has the wherewithal to be able to deal with it.
If anything has taught the government to slow down, take your time and do it right, it should be the Phoenix system. I would say it is the same with these tax changes.
Senator Andreychuk: Following up on that, we heard from CRA officials and auditors who have to implement this system. At this point we don’t know what their test of reasonableness is or what would be acceptable actions on behalf of small businesses. They are saying it’s extremely complex, but they’re in a position of saying that they will manage it, whatever it is.
Have you been in anyway consulted on what these guidelines or protocols will be?
Ms. Keating: No, they have not reached out and consulted. We have not been asked that question.
Senator Andreychuk: We’re coming to a deadline date and your businesses don’t know what to expect.
Ms. Keating: There is the ambiguity of the word reasonableness and of the word contribute in terms of evaluating what someone’s worth is in the contribution of a business. It’s not even through that. In many of the examples we provided in our submission, if you use the government’s most recent discussion one of the issues they had was the proposal with respect to generational transfers of businesses. They have come forward and they have said that they have removed that.
However, if you look at the income sprinkling piece, they very much affirm they will go forward with it. There is the whole generational issue in terms of whether or not someone has many years ago implemented a freeze on their estate, transitioned to their children, and are now passively involved in the business because they have preferred shares they are redeeming. I don’t know how to consult or tell them otherwise, subject to the TOSI rules. I don’t believe that was an intention. Even in the October 16and post discussions those issues are not being dealt with.
Senator Andreychuk: I have a quick question for Mr. Stirling. You pointed out the housing issue. I come from Regina, Saskatchewan. I very much agree with you that we have a different problem than Toronto and Vancouver.
Mr. Stirling: Absolutely.
Senator Andreychuk: It has a lot to do with our oil and potash industries, et cetera. You did some comparison to the automotive industry. Are you seeing here that automotive dealers are switching to leases more, which is another creation problem. Before it was sell a car and now it is more lease a car.
Mr. Stirling: Yes. I wouldn’t have access to that information. I know anecdotally probably 10 years ago most vehicles that were sold here were leased, but I think we’ve seen a switch back. A lot of the manufacturer incentive financing now makes it much more attractive to purchase and finance at zero per cent or close to zero per cent, but I don’t have any access to those data.
Senator Andreychuk: You haven’t seen a switch back to leasing here that you’re aware of.
Mr. Stirling: Not that I’m aware of, no.
Senator Cools: I would like to thank the witnesses for their very spirited presentations, for their comprehension of the issues and for their deep concern for what is happening. You’re very passionate about this and you’re so afflicted by something of a disappointment in what the government has done. I think that is a commonly felt emotion across the country. We heard it daily out west.
What if this situation were reversed and the two of you were senators? As we come down the homestretch of our work, we will have to decide on our recommendations. If you had to choose three recommendations, which recommendations would you put forth if you were allowed to do three?
Ms. Keating: In the summary to the brief we have given the first recommendation would be that these proposals are insane and should be stopped. Let’s call them that.
Senator Cools: You choose a good word for that.
Ms. Keating: Number two would be that the taxation system has not had a proper review in over 50 years, since the 1970s, and we are now in the 21st century. It is long overdue for that to occur.
I guess the third recommendation once again is you need to engage the stakeholders to fully understand the implications of what you are proposing as a government in a taxation regime. It is exceptionally important that you speak to the individuals whom you are taxing so that you understand what you’re doing and how that will implicate and potentially impact on the Canadian economy.
Senator Cools: Well done, I thought.
Senator Oh: That was very interesting and right to the point. My question for you is on the executive summary that you submitted. You stated that the proposed tax changes would revise gender parity gains. Could you please comment on the gender issue?
Ms. Keating: Yes, Senator Oh. One of the things we know, I guess evolutionary throughout business and the Canadian community, is that traditionally the man has been the individual who may have started the business and the woman has been the individual who would have supported the family and taken that unfair share or that added share of burden with respect to the family unit.
In a lot of instances in the examples we have given, a husband and wife may have decided to start a dry-cleaning business. They each bring their life savings as a family into that business. In many instances those businesses that would have been established 30 years ago would have had a nominal amount of share capital and each owning them equally.
Under the proposed regulations of income splitting, we can look at the TOSI rules to establish the value of the stay-at-home spouse, who historically would have been the woman of the family, and what they may have done in terms of contributing but not actually taking remuneration for because times may have been lean.
If you look to marital law, establishment of the family worth is shared equally between spouses. Under the rules proposed by the government, the individuals that have not been active have to meet this reasonableness test and all these vague and arbitrary terms that are currently being used. They are left to prove their worth.
With respect to gender equality, I think that is a massive step backward for our Canadian citizenship, a massive step backward.
Senator Oh: In your opinion the government’s gender impact assessment was not comprehensive.
Ms. Keating: I don’t know how it could have been because once again we get to these definitions of reasonableness. Now spouses who have stayed at home but supported the business, suddenly now have to sit in front of CRA auditors and demonstrate how they contributed and why they are worth what they have been paid. That is not gender equity.
Senator Oh: Earlier you said that the government sees no value in housewives or the spouses helping out behind the scenes.
Ms. Keating: Absolutely.
The Chair: We will conclude the second panel by asking Senator Marshall for a question.
Senator Marshall: I wanted to ask Ms. Keating a final question. When the government released their amendments last month, they also committed to reducing the small business tax rate to 10 per cent this January and 9 per cent the following year.
Does that take the sting out of the proposals that are on the table? Perhaps Ms. Keating and Mr. Stirling you could both comment on that.
Ms. Keating: First, with the proposed reduction in the rates the government is actually making good on a promise that had been made. These rates were supposed to have been reduced. A lot of businesses were disappointed when the rates actually didn’t follow the proposal.
Interestingly enough, in concert with the reduction of the rates, the government has also proposed that they will change the rules with respect to dividend tax credits. We may find in the short term that actually has an additional cost burden on business owners and not actually a savings.
Under the new rules because of these changes the immediate impact of a fundamental integration system of taxation is actually penalizing.
Senator Marshall: The reduction of the tax rates might not be a reduction in taxes.
Ms. Keating: When you look in concert with the increase that they are proposing on the dividend tax credit.
Senator Marshall: Do we know that specific?
Ms. Keating: I can’t tell you that specific. No, I don’t have that specific yet.
Senator Marshall: Mr. Stirling, would you have any comments on that?
Mr. Stirling: Yes. I don’t think the reduction will take the sting out of anything. I think the uncertainty is the big issue here.
I’d like to reiterate for the information of senators that for the most part, if we’re comparing employees and business owners, it’s apples and oranges. Most of our members would be kumquats, I guess, or something different again. CRA has determined that they are not employees in a traditional employer/employee relationship. However, they’re not permitted to be incorporated. They’re licensed under the name of a broker who is incorporated and is dealing with all of these tax changes.
Most of these people are self-employed, independent contractors who like most business people do not have the social safety net behind them. They don’t have access to EI, annual vacation and all of that stuff, but they also don’t have the tax benefit of being able to incorporate.
That’s a piece of work we’re doing provincially in terms of advocacy work. They’re outside of this either apples or oranges kind of comparison. For us it’s interesting. From our brokers’ perspective, obviously, the Income Tax Act changes directly impact them and their ability to weather the seasonality of our industry, both within the year and over the course of an economic cycle up and down.
For many of our members it’s reinvigorating them around the whole self-incorporation discussion. Again, they are unintended consequences.
Senator Marshall: Could I have one final question?
The Chair: A final question because we’re in your territory.
Senator Marshall: One of our other witnesses mentioned about the examples that were in the Department of Finance documents. I can’t remember the wording they used, but the impression they left with me anyway was that the examples in the government’s documents weren’t representative.
I know you had some comments also on the examples. Could you tell us what your opinion is of the examples, whether there was a problem with them or whether they weren’t broad enough?
Ms. Keating: Oh my, we could be here all day, Senator Marshall. No, the examples that are used by the government in the documentation they presented were examples that would favour. When it was of benefit to use a particular province as an example, they would use that province. They have used things that are not like beasts in terms of apples and oranges. The communication that is in that is very opaque in terms of what they’ve used as examples.
There were issues with respect to how they were presenting the situations and what provinces they were using to present those situations, et cetera
Senator Marshall: That reminds that CPA in their brief picked out select provinces. That dovetails into what you were saying.
The Chair: Thank you very much to both Ms. Keating and Mr. Stirling, for sharing your comments. There’s no doubt it has been informative and enlightening.
The Chair: Honourable senators, our next witness is Mr. Larry Short, Portfolio Manager, Senior Investment Advisor and Executive Director, Private Client Group, with HollisWealth, a division of Industrial Alliance Securities Inc.
Mr. Short, thank you very much for accepting our invitation. It’s an honour to be in St. John’s, Newfoundland, like Senator Marshall is always reminding us.
That said, we will ask you to make your presentation and it will be followed by questions from senators.
Larry Short, Portfolio Manager, Senior Investment Advisor and Executive Director, Private Client Group, HollisWealth, a division of Industrial Alliance Securities Inc.: Thank you very much, honourable senators. Good morning and welcome to St. John’s. By way of background, I should make you aware that I come from the same small town as Rex Murphy.
Senator Cools: Oh, well, what a distinction.
Mr. Short: But my choice of vocabulary is infinitely smaller words.
I have been a financial adviser to many business owners over the last 29 years. As their adviser, I’ve heard the joys, sacrifices and worries of these business owners. I bring to you today their views and frustrations that they have brought to me since the announcement of these proposed changes.
There’s little doubt by now that the details of the proposed tax changes are full in your minds. I would like to address two elements of interest, however. In order to present these elements, it would be useful to build on an old analogy that has been used to explain taxation for many years.
That analogy is the example of the tree and the fruit. For years taxation of a business has been described where the tree is the business and the fruit is the income. Regular income taxation arises when the fruit is harvested and a portion of that fruit is shared with the community as income taxes. Capital gains tax arises when the entire tree is sold.
I like this analogy for a number of reasons. First, we can easily visualize that the business owner is the person who takes the initial risk of financing and planting the tree.
Second, many people have favourable views of farmers as common folks, salt of the earth types who spend a lot of time worrying about their crops, in this case their trees. I propose to you that business owners are but just farmers of a different sort.
We often have the vision of the spouse and the children of the farmers contributing and working on the farm, doing their chores, sharing the work and, in doing so, contributing to the results of the farm. Further, we all can appreciate how much farmers work and the challenges they face.
I can tell you that business owners and their spouses worry as much as farmers do, and for good reason. First, the families of business owners often see the hours the business owner is working and the spouse is often left to fill in on family duties.
I can tell you that business owners worry as much as farmers because they often have to borrow money to start their business and incur debt that brings worries. The business owners borrow to start the business the same way the farmers borrow to plant their seeds.
Further, the business has to be nurtured, similar to any growing crop. As has been pointed out in many previous presentations to you, many businesses fail the same as crops often fail. In fact, by comparison actual crop failures these days occur less often than business failures. The business owner is ultimately the person responsible to be called out to take care of the problems as diverse as your building flooding when plumbing fails, finding replacement employees for the early morning shift, or cleaning the driveway when the snow plow operator is sick.
Staying with this analogy, you can see that the tax changes proposed by Minister Morneau are akin to sapping the tree during its life, and in particular in the beginning when it is just starting to grow. The effect of sapping a tree early in its life is to reduce the life of the tree, to reduce the richness of the fruit and to reduce the ultimate harvest value of the tree.
In fact, and this is one of my primary concerns, the proposed tax changes are so detrimental to business that they will most likely kill a considerable number of businesses before they have even formed.
This brings me to my first key point. The new taxes will demotivate a considerable number of individuals who would otherwise take the leap to move from being an employee to become a business owner. This decision point, which I have been pleased to see in many of my clients, is a fundamental part of the success of the Canadians experiment.
A portion of our citizens are visionaries, implementers and risk takers who weigh the odds and determine whether to take the leap to become a business owner. The odds of being a successful business owner are decreasing in Canada every year as barriers to success arise.
These barriers include increased regulation, increased competition from existing larger businesses and now, with these proposed changes, increased taxation. After all, if indeed it is a non-stressful life one is looking for, if you want a job with benefits and a pension or if you’re looking for security, then why would anyone be foolish enough to risk all of their life savings and their family’s future to become a business owner?
Instead of putting up barriers to becoming business owners we should be encouraging them at every turn. Instead of painting them as some sort of low life that is not paying a fair share of taxes, we should be recognizing them as heroes who create wealth from their ideas, from their dreams, from their hard work and from the cultivation of the business, in the same way as we view farmers. However, this is not what we are seeing in the rhetoric about these pending tax changes.
Business owners, by and large, reflect the dictum that you are born entitled to nothing and if you want something you should earn it. However, this sapping of their business is an unnecessary action on the part of a government rushing headlong into making changes without due consideration and will cause many potential entrepreneurs to hesitate or choose not to proceed, making all of us poorer.
If, instead, I suggest one should step back and ask the question why the government is making these changes. Prime Minister Trudeau was asked this exact question in a media scrum in September 2017. His statement was:
The issue here is that the current system we have benefits wealthy Canadians and doesn’t give a fair shake to the middle class, and that is one of the things that Canadians asked us to change.
That being the case, there are alternative methods of taxation that could be employed to lower the benefits that the wealthy have in Canada and could give a fair shake to the middle class. On that premise one particular tax screams for attention, and that is my second point, which is an estate tax.
On the pages that follow is a series of slides. I wanted to make these as a couple of key points, if I could. In hindsight I should have blown these up into full size because all of us are a bit older and a bit challenged when it comes to eyesight. Perhaps I could, maybe as part of a more active discussion, just give you an idea of where this is coming from.
Canada does not have a traditional estate tax as many other countries have. This estate tax has also been called the silver spoon tax. It works on the basis of taxation when an individual passes on, on their final passing, that taxes the entirety of the estate in some fashion.
The Canadian Imperial Bank of Commerce released a report in 2017 saying that there was an estimated $750 billion that will be inherited by members of the boomer generation over the next 10 years. This amounts to $75 billion per year that will be passed from the generation who are older than the age of 70 to those who are in their fifties and younger.
This is quite a significant amount of money. When one considers taxation on this amount, it certainly dwarfs the gain that Minister Morneau is proposing in the tax changes that he wants to bring in. That estimated gain would be about $500 million per year.
Seeing a capital gains tax of somewhere in the order of 10 per cent would certainly bring in $750 million per year. One could also generate this tax without having to hobble business owners who are attempting to create wealth, particularly those at the beginning.
On the next page is an outline of estate and inheritance taxes around the world. The highest estate tax is actually in Japan. The United States is currently at about 40 per cent. You can see that many G20 countries have estate taxes whereas Canada does not. There is always pressure to lower taxes including estate taxes around the world, but it will give you an idea that Canada at zero is well below what the rest of the world is doing.
An estate tax also recognizes the value of a dollar earned to a nation is higher than the value of a dollar inherited. The creation of wealth or the creation of earnings generates significant income to all aspects of our society. Whereas a dollar inherited is a gift that moves wealth from the very wealthy to the newly wealthy.
You can also target the very rich in this process by putting a relatively high hurdle point on the taxation of the amount in an estate. Estates with less than $10 million may have no estate tax applied. Estates with $5 million may have no estate taxes applied. You can see that this would target the very wealthy within the country, which is in keeping with the exact promise that Prime Minister Trudeau is stating he is trying to serve.
There are also significant advantages for Canada to adapt such a tax now because other countries have had these taxes for many years and have made mistakes. We can work on best practices in order to minimize problems that arise in other countries.
One of the arguments against an estate tax is the fact that capital gains are already taxed in Canada. Therefore, aren’t you double taxing? As you’ve heard from the previous discussion the current proposals are in fact double taxing as well.
One can work on that. Again, depending on the success from estate taxes, one potentially could look forward to a day when we actually lower capital gains taxation in Canada to below the levels they are today.
Capital gains tax ties up assets. It diminishes the movement of capital within an economy. It traps capital in areas that do not want to move because of the taxation element, despite the fact that redeploying capital into growing industries would benefit all of Canada and would benefit the society.
This and other provisions are presented to you because I didn’t want to just come here today and say here is why we should not implement the tax. I recognize that we have a need for a change that will benefit the middle class in Canada. A large portion of that middle class is small business owners. To disincentivize them to create that wealth will hurt us all, whereas the taxation of estates will certainly meet the goal that has been outlined and do so without causing further creation of wealth within the Canadian society.
Ladies and gentlemen, honourable senators, that’s my submission.
Senator Marshall: Thank you very much and thank you for raising that issue of the estate tax. Would that be the same as an inheritance tax?
Mr. Short: Yes.
Senator Marshall: It is the same thing. Funny you should mention that because nobody has mentioned it. I think I raised it with Senator Mockler a little while ago.
This is something that you proposed. Have you discerned any interest in that?
Mr. Short: No, there has been very little discussion about that. I’m a bit surprised. Of all of the discussions we’ve seen in the last period of time, particularly recently the Paradise Papers, one is becoming aware of the polarization of wealth within the country. The top 1 per cent, the top half of 1 per cent and then the top 0.1 of 1 per cent is controlling an extraordinary amount of wealth that quite frankly will make no difference in their lifestyles after receiving inheritances, whereas a distribution of that wealth to the middle class, or even more importantly to the very poor in Canada, could benefit our society dramatically.
The argument against the proposed changes that the Honourable Minister Morneau is bringing in is that it will complicate the lives of many Canadians and provide a disincentive. The argument in favour of the inheritance tax is that it will deal with a relatively small portion of the very wealthy within Canada. It will not slow down the growth and movement of capital into growth areas and the creation of new wealth in Canada.
It is, to me, compelling that here is your objective. I agree with your objective. Let’s do something to help not just the middle class but the poor. Here is a means by which one can do so without violating the other principles of taxation and fair law within Canada
Senator Marshall: The only thing I was thinking of when you were speaking about it is that right now the government has all the small business owners upset.
Mr. Short: Yes.
Senator Marshall: If we move to an estate tax or an inheritance tax, the group 75 years and older will be mad because they will not pass on as much. The baby boomers who will be the recipients will really be upset.
Mr. Short: Well, again it depends on the threshold. For an estate to be passed on that is $5 million is one thing. For another one that’s $10 million it will have a portion of taxation.
Senator Marshall: It depends on the rate.
Mr. Short: Yes. The estimate is that $900 billion of value from the generation that’s older than age 70 will have essentially hit the estates within the next 10 years. Some $750 billion will be passed down to the baby boomers. If we looking at $75 billion a year and only $7.5 billion of that were taxable at 10 per cent or 20 per cent, your number is still higher than the $500 million the minister is proposing at this point in time.
Senator Marshall: The figure of $250 million in estimated revenue was put forward for the income sprinkling, for the split income.
Mr. Short: Yes.
Senator Marshall: We were inquiring as to what we thought would be the revenue raised from the passive income. We haven’t been able to get a good figure, but Minister Morneau did say in an interview he did with The Globe and Mail that it would be multiples of $250 million.
Mr. Short: Yes, I do have the source for the calculation here. A report was put out subsequently that showed it would be about $280 million. Between a ballpark at $250 million and at $280 million, that’s where I got the $500 million figure. I can provide you with that.
Senator Marshall: Yes, the revised now proposal on the passive income. Yes, that would probably be it.
I was interested in what your clientele are saying. What kind of response has there been to the proposed tax changes? Are you able to give us any idea as to what employment area they’re in?
The proposals seemed to target at least some doctors. That was the biggest group. I’m interested in what your clientele is saying.
Mr. Short: I’ve been in this business 29 years. My clientele is primarily small business owners. There are some doctors but relatively few. The vast majority is in construction. There was mention earlier about dry-cleaning establishments. If anything, this hearkens back to us: There was a great book put out in 1978. I’m trying to remember the chap’s name. It was called The Millionaire Next Door. It was a U.S. study to determine the source of millionaires in the United States. Many people thought it was doctors, lawyers, accountants and engineers. It turned out that they weren’t in the top 20.
The number one creation of millionaires in the United States was actually dry-cleaning, followed by electrical contractors, pavement contractors, plumbing supplies and the like. It went up from there. With all due respect to doctors, the profile of millionaires in North America tends to be individuals who live in the same home that they purchased in their 20s and 30s. They tend to be married to their first spouse and they tended to have rather modest upbringing. They’re not driving a Mercedes Benz. They’re driving a good vehicle but it tends to be North American. They tend to live rather modest lives.
That is my clientele. That is the group that is very family oriented. They are really outraged by this. They feel that you are certainly targeting individuals. They can see what the intention. There’s an agreement on the intention, but they’re not meeting that intention by complicating the lives of people who have created the wealth from essentially nothing. It’s mechanical.
If you took a list of the owners in an industrial park and saw the types of business that were there, there are some companies that have done a lot of work in the oil industry. However it is food distribution companies. It is franchise owners of McDonald’s and the like. It is relatively small businesses that had to borrow everything, start from scratch and build up. That is the group that really will be hurt.
On the other side of that, once you get beyond a certain threshold of size of business, what will happen is almost irrelevant. If your revenue is $10 million, $12 million or $15 million a year and your net is $4 million or $5 million, then this will not make a big difference. Your competition that has been snipping at your heels trying to grow and innovate into an area in order to do a better job than you do will disappear. You’ll actually see that the larger businesses will thrive and will buy out the frustrated owners, right?
Senator Marshall: Yes, yes.
Mr. Short: They will say, “Look, this is enough. I can’t do this.” The other key element that was brought out was the point about motivation. There is a point where individuals start plumbing contracting businesses or the like. They get to the point of asking, “Should this be in my name alone or am I ready to take the leap to hire two or three people?” That leap requires what is the benefit on the other side. If at the end of the day there is no benefit, then now you’ve quashed the initiative. You’ve demotivated individuals from going any further.
You will not see the effect of that for probably three, four or five years, and by then it’s too late.
Senator Marshall: One of the issues we raised earlier this morning has been raised in other hearings. What are people doing? Are they just waiting for the government to provide the details? We heard when we were out west that some people are actually doing things.
Mr. Short: It’s the final straw. They are choosing to get out of the business because, with all due respect, it is just one more feather on the back. At one point it does break the back of some businesses, and they just say, “I’ve had it.”
Senator Marshall: Are you finding that also?
Mr. Short: Oh, very much so. It is. The one thing we’ve encouraged our clients to do is call their member. A lot of calls have gone in to members to say that this is not acceptable.
I didn’t want to come with here is what you shouldn’t do. I wanted to come with here is what you should do. There has not been a proposal for alternative means to raise the tax revenue. When there is enough debate and discussion about it, there will be people motivated to call and say, “Yes, do that.”
Senator Andreychuk: I will follow up on the same line of questioning. You’ve come to the conclusion that the government is doing this because they need revenue to continue the kind of spending they’re doing or that they contemplate they need to spend, as opposed to tax fairness, which is the way it was presented.
Mr. Short: Oh, I’m not exactly sure.
Senator Andreychuk: You have given us an alternative.
Mr. Short: I’m not exactly sure why the government is doing this. The intention, as the Prime Minister stated, was to deliver fairness. I can only believe what the Prime Minister has said. The difficulty with it is that it may have the appearance of fairness in some way, particularly when you brought up about the doctors. Let me back up a bit.
When I talked about how doctors were not in the top 20 creation of wealth in North America, it’s because doctors tend to spend. They conspicuously spend. They tend to have the larger houses and larger cars. They tend to have big trips. They tend to conspicuously let it be known that they have wealth, which is one of the reasons why we decided not to target doctors as clients. The salt of the earth individuals who have built up businesses over time are the types of clients we love to deal with.
The impression of individuals that he is going after the doctors is very politically astute in some ways. It indicates that the Liberal Party is going after the very wealthy in the country in order to smooth things out. You may have heard several times the terms collateral damage. They may have attempted to essentially go after the public vocal elements to give the impression of fairness by taxing them. Unfortunately, they’re taxing the mom and pop shops, those that have been running businesses, started from scratch, and are not the big spenders.
Their intention, as stated, is to bring fairness. This unfortunately is not bringing fairness in any way.
Senator Andreychuk: It’s interesting you say that the doctors have conspicuous wealth.
Mr. Short: Yes.
Senator Andreychuk: I would say in my province some of them do.
Mr. Short: No, and it will vary.
Senator Andreychuk: Some lawyers, some accountants, et cetera, but some of them work 14 to 15 hours.
Mr. Short: Literally early in my career when I was working late one night, a phone call came in from a friend. I saw that it was from the doctors’ lounge. I said, “What are you doing there at ten o’clock at night?” He said, “I can’t get the head back together”. I said, “Excuse me?” He said, “I can’t get the head back together. I’m 11 hours into a 10-hour operation because I can’t get the head back together.” I said “Well, did you put any new parts in? I mean, why can’t you?” He said, “No, no. In fact I took some parts out but the swelling won’t let me close.”
There’s nothing on the earth that can compensate an individual in terms of money or otherwise for work like that. I know in his particular case he ended up working many hours. At one point the province here had a cap as to how much a person could earn. He worked many hours beyond that without pay.
It is one thing to say as a group that the doctors tend to be more conspicuous in their spending, whereas in actuality the dry-cleaning establishments may actually have more money.
In this particular case, they have come out and said, “We are going to tax these high earners.” They’ve brought in provisions that may have the appearance of balancing out taxation when in actuality it misses the mark entirely.
Senator Andreychuk: We also have heard that they were encouraged to incorporate because of the fixed incomes and settlements with the provinces.
Mr. Short: Yes, correct.
Senator Andreychuk: That was one reason that most doctors are incorporated.
Mr. Short: Yes.
Senator Andreychuk: I asked finance officials if they consulted with the Ministry of Health. We’re an aging population. We don’t need to see doctors move offshore.
Mr. Short: Yes, this was a surprise to everyone. Dorothy Keating who spoke earlier is a CPA. I’m a CPA operating on a different side of the business, on the investment side. In no circumstances have we heard of any consultations that were done with any group prior to this announcement, other than: “Here is what is proposed.”
Senator Andreychuk: I certainly follow international trade and Minister Champagne is out in the world saying that we want to grow our small and medium size businesses because they are the backbone of Canada and supply jobs for Canada.
It would be curious as to why the Ministry of Finance would be targeting the group that every other minister seems to be saying we need to nurture.
Mr. Short: Yes. Again, there’s that inconsistency. It was brought up that 70 per cent of Canadians are employed by small business. That is where our larger businesses have come from. Blackberry started out with nothing and grew quite strongly. It was a small business at some point. All those businesses were small business at some point. Lulu started out as being a small business. It just took off and became incredible. Dollarama was the same.
Why this targeting of the growth engine in the economy is being done is a complete puzzle. It speaks of the potential that this was a rash decision. It was made to say, “We had to do something.”
If we target this and then paint the picture that these people are using loopholes, you have a negative connotation for the entire discussion that it is to correct loopholes when in fact these are principles business has been using for many years.
A loophole is an unintended consequence. This has been specifically set out in tax law for the past 35-40 years. How did this suddenly become a negative loophole? I don’t think it was just thought through well enough.
Senator Andreychuk: You have pointed out that you wanted to put some positive proposal to us, and that’s the estate. I am having a difficulty with that. We’re talking about small and medium size businesses being hurt here. Then you go to the estate tax, where your case is made on the really, really wealthy.
Mr. Short: Right.
Senator Andreychuk: They aren’t even part of this discussion because they are those that hold income trusts, large corporations or legitimate offshore issues.
Mr. Short: Right.
Senator Andreychuk: It would be rather difficult for me, anyway. I don’t know whether the rest of the committee could recommend it. How can we recommend an estate tax that is not targeting the people we are dealing with here? When we really don’t know what the unintended consequences of an estate tax would be. We did have estate taxes or probate taxes which we changed in 1972.
Mr. Short: Yes.
Senator Andreychuk: I happened to have been around at that time. That’s why we went into a lot of this estate planning for farmers and small businesses. As you said, they weren’t loopholes. They were legitimate ways where we transitioned from one type of taxation to another.
Rather than proposing an estate tax, I am wondering if what you’re really proposing is to stand back and look at the tax system to see where the maximization can be. To take it one step further, it seems that U.S. discussions have somehow crossed the border.
Mr. Short: Yes.
Senator Andreychuk: I know that some well-known very, very large corporations, at the time of the presidential election, said they were prepared to pay more but were not talking about small or medium size businesses.
Shouldn’t we be having a full taxation discussion before we embark on an estate tax? To me it’s going back to where we were, to probate taxes.
Mr. Short: There are three points there. I’m trying to remember the name of the study prior to 1972 that showed 95 per cent of Canadians were employed by big business or government. In 1977 was when the change started to happen in North America, but in Canada specifically, where effectively large government and businesses started to downsize and create the entrepreneurial society that we’ve ended up with today. An entire shift occurred.
The rules prior to 1972 on estate taxes did not reflect the fact that we have such a polarization within wealth in Canada. We had a much fairer distribution of wealth prior to 1972. I don’t remember the exact number, but now we have a distortion where the very, very wealthy are holding, I think it is, 54 per cent. All of wealth in Canada is held by 0.5 of 1 per cent of Canadians. It is a time to ask, “Should we be bringing the estate tax back?”
Your second question, though, is how do you look at taxation on small business and say we should be looking at estate taxes instead. The recommendation from this committee should be that an entire review is required because of the impact on society that any changes will have. This is an egregious change that was dropped in without much thinking.
Yes, we do need a proper review, similar to what we reviewed back in 1972. If indeed the recommendation is that the tax should not proceed, fine, but I was trying to bring in estate tax as being another alternative that I haven’t heard any discussion about. We should have an active debate in Canada about what do you do when you have such a distortion of society as severe as we’re seeing.
We have poverty levels that have improved but still we have a lot of poor. We have middle class that is generating a business that would be hampered by this. We have the very, very wealthy whose lifestyle would not be affected by a 10 per cent or 12 per cent tax on their extreme wealth. That’s what I was trying to get across.
Senator Andreychuk: There was a report just now that $29 billion is somewhere out there to be collected.
Mr. Short: Yes.
Senator Andreychuk: To me that might be a better recommendation. It’s already there. It’s legitimate. We should be pursuing it.
Mr. Short: Yes.
Senator Andreychuk: Thank you for your long memory, too. I’m the one who is always talking about pre-1972 because I remember that switch and how it affected, particularly in Saskatchewan, farmers and small businesses. We thought it was a legitimate movement forward, not to be called loopholes.
Mr. Short: Not to be called loopholes.
Senator Oh: My question comes very close to those of Senator Andreychuk. Why do you think the federal government’s choice to focus on small business owners rather than on high income earners?
Mr. Short: As per previous presenters, unfortunately they’re targeting the wealth creators within Canada. I don’t think that is the group they should be targeting.
Senator Oh: You made a good suggestion regarding estate tax, or what some countries call estate duty. Right now the government is targeting hardworking Canadians instead of those who inherited money without having to do so much work.
Mr. Short: Agreed. From time to time, whenever we look at judges and adjudicators, often we say to them, “If you’re not playing the game, you shouldn’t be making the rules.” With all due respect to the Honourable Minister Morneau and the Prime Minister, they have not been business owners and they have been large inheritors. The inheritance tax will have a direct impact on their personal wealth. I’d love to have the question put to them: “What do you think?”
Senator Oh: We talked about family trusts. Then you mentioned earlier that 0.5 per cent of the Canadian population are filthy rich but the money is tucked away offshore on some of the islands.
Mr. Short: Yes.
Senator Oh: What do you think about that?
Mr. Short: In many generations past the highborn would build castles to protect their wealth. What we have now is legal offshore trusts. As a consequence I have had many conversations about this over time. Many things can be legal. In the U.S., and in Canada for a long time, it was legal to discriminate against people on the basis of colour. That was a legal permission within the country. Based on a person’s race or gender you could discriminate against them. It was legal but it’s not right.
In the same way here we may find a way to determine, now that we are getting much more disclosure not just through the Panama Papers but by other means, a required declaration under CRA to declare offshore holdings. The inheritance tax may be slightly different than an estate tax. It may give way and provide for taxation of trusts that were not normally able to be taxed in the past.
Senator Oh: We have an unfair tax system for a certain privileged group of people.
Mr. Short: Oh, heavens, yes. There are no ands, ifs or buts about that. The cost of taxation can be measured in two ways. One is the amount that you pay to the government. The other is the amount you pay to your accountants and lawyers to shield you from the amount that is paid to the government. As long as that number is less than what has to be paid in taxes, effectively you have a tiered tax system in Canada.
The Chair: Senator Cools to end the first round, please.
Senator Cools: Yes, I’m a good terminator.
Anyway, I would like the witness to express a couple of opinions. I thank him for his very thoughtful testimony. It has been raised here a lot that we should contemplate a royal commission into this issue.
Chairman and colleagues, I think we should do a bit of research on the nature of royal commissions. Most royal commissions are constituted under a section of the Inquiries Act. They’re usually very cumbersome processes that require high level talents and skills, expensive staff and so on. We should take a look at the meaning of a royal commission and what it embodies so that nobody could wiggle out by saying it is too expensive or something like that.
I have another question for you. For me it’s a bugbear that many years the Department of National Revenue was converted from a department of government headed by a minister to an agency called the Canada Revenue Agency. I am of the opinion that it should be returned to its original state. I like the idea of a department of government working under a minister much better than an agency.
Have you ever thought about this? Have you given it even a wink or something?
Mr. Short: I’m not so concerned about the structure of the organization itself as opposed to the net effect. In both cases I guess the larger concern is: “Who is the reporting individual to Parliament?”
Senator Cools: Well, that’s it.
Mr. Short: Who is it?
Senator Cools: Well, there’s doubt.
Mr. Short: Is the Minister of National Revenue the key reporting individual? Does he have sufficient authority to make changes on a timely basis to better society? Or, is it the case that being an agency there’s an extra step involved? I would say whichever way is the most efficient in being able to report back to Parliament and adjust to the changes that are coming over the next 10, 20 or 30 years. Unfortunately we tend to look backward whenever we’re analyzing the economy or taxation within Canada. We say, “If we had imposed this tax over the last 10 years, what would we have done?”
Senator Cools: Yes.
Mr. Short: Over the next 10 years we are to face other challenges, and in particular something called cryptocurrencies. We will be faced with transactions that largely bypass the traditional banking establishments. I’m not going to say it’s difficult to trace because it can actually be traceable, but the intermediaries we’ve relied on to gather information in the past will not be able to gather information in the future. We should be looking forward to those things, so it is addressing all of those matters.
Within the mandate of whether it is a commission of inquiry or a royal commission, it should be broad enough to say what the taxation environment will look like in the next 10 years, and then addressing whether or not it continues as an agency or continues as a department.
Senator Cools: I thank you very much for that. Mr. Chairman, we should take a look at that as a committee. Maybe our staff here can bring forward some information, but both of them are very serious matters.
I remember there was a lot of concern at the time when CRA became an agency, but then government individuals were more concerned with things they hoped to avoid. The unions were getting too powerful within government and on and on. There was a host of other things.
We should take a peek at it. I think we should be a lot clearer on it.
The Chair: Before we do close, with the indulgence of the senators, I have a question on the farming community.
When I was chair of the Agriculture and Forestry Committee I had occasion to visit the farming community in Newfoundland and Labrador. I know they’re very buoyant. Last week I had the chance to chat with leaders of the farming community, some across Canada and others in New Brunswick where I come from. I would like to have your opinion on a case in point because it touches a bit on what Senator Andreychuk talks about in the farming community.
In New Brunswick we have approximately 2,600 farming communities or farmers. Only 7 per cent of them are registered or have a plan of succession. Some 93 per cent do not. That said, they tell me it would be alarming also to look at individual provinces because they have the same challenge.
With what has been proposed by the federal Minister of Finance looking at the modernization or reform of the taxation system in Canada, my question to you, Mr. Short, would be: Do you believe it is time the tax law facilitates the transfer of the family farm, with the experience that you have, and what would you recommend this committee do in the particular sector?
Mr. Short: As concisely as I can and without isolating farmers, to say that they should have one plan, maybe people with fisheries licences should have another plan, and then an another plan for aquaculture licences, provides a quilt that is sewn from many different pieces of fabric.
I would prefer a blanket consideration that would cover all transfers of family-owned businesses in some manner, rather than try to appease one sector to the detriment of the others.
With respect to farmers, again they hold a point dear in our hearts. As I mentioned in my presentation, and properly so, it calls into question how different is an aquamarine culture or a fishing licence from someone who is raising cattle. With respect, I’d rather see a comprehensive proposal rather than one isolated by industry.
The Chair: Mr. Short, thank you very much for your presentation. It was very informative.
(The committee adjourned.)