Proceedings of the Standing Senate Committee on
National Finance
Issue 28 - Evidence - November 6, 2012 (afternoon meeting)
OTTAWA, Tuesday, November 6, 2012
The Standing Senate Committee on National Finance met this day at 1 p.m. to examine the subject matter of all of Bill C-45, A second Act to implement certain provisions of the budget tabled in Parliament on March 29, 2012, and other measures, introduced in the House of Commons on October 18, 2012.
Senator Joseph A. Day (Chair) in the chair.
[English]
The Chair: I call this meeting of the Standing Senate Committee on National Finance to order.
[Translation]
Honourable senators, we will carry on this afternoon with our study of subject-matter of Bill C-45, A second Act to implement certain provisions of the budget tabled in Parliament on March 29, 2012 and other measures.
[English]
Honourable senators, this is our second meeting on the subject matter of Bill C-45. This afternoon, we will hear from government officials, primarily, if not exclusively, from the Department of Finance. They will take us through the bill in a clause-by-clause manner, explaining what the initiative is with respect to each of the clauses.
After there has been an explanation by one of our witnesses in relation to a clause, I will look around the room and see if there is anyone who wishes further clarification or has a point to make. If not, we will proceed to the next matter.
Witnesses, I would ask whoever will speak to please indicate your name and position for the record. I believe we are at page 13 of the bill of 400 and some pages. It is clause number 8.
Mr. Cook, did you want to help us clarify a point that was discussed this morning? Senator Callbeck asked the question with respect to the Atlantic credit for mining, gas and oil. It was our understanding that maybe that applied to other industries, but could you help us with that?
Ted Cook, Senior Legislative Chief, Department of Finance Canada: Certainly. With respect to the Atlantic Investment Tax Credit, the only measure that is being proposed in this bill is to phase out the AITC with respect to oil and gas and mining. After this bill, manufacturing and processing, farming or fishing, logging, storing grain and harvesting peat will all continue to be eligible for the AITC. The phase-out in the bill is just with respect to oil and gas and mining.
The Chair: Thank you. Senator Callbeck, are you okay now?
Senator Callbeck: Yes, thank you for the clarification.
The Chair: The reason we have these hearings is so that we can understand the legislation.
Clause 8.
Senator Buth: Which clause was that in?
Mr. Cook: That was a general question to the minister. That would actually be found in clause 27.
Senator Buth: Okay, so we will come to that.
Mr. Cook: Yes, we will come to that later.
Senator Buth: I was just looking at where we are right now.
The Chair: Clause 8.
Mr. Cook: To reintroduce this group to the committee, my name is Ted Cook; I am Senior Legislative Chief. I am here with Geoff Trueman, Director, Business Income Tax; Shawn Porter, Director, Tax Legislation; and Ian Pomroy, Senior Tax Policy Officer, Tax Policy Branch.
The Chair: All Department of Finance?
Mr. Cook: All Department of Finance.
Clause 8 contains consequential changes relating to PRPPs. The most important one is to ensure that employers making contributions to a PRPP will be able to make a deduction.
Turning to clause 9, it amends section 37 of the act, so that will be page 14 of the bill. It goes on for a couple of pages, but really all this clause does is to implement the measure relating to capital expenditures in the calculation of scientific research and experimental development. Certain amendments are made by this clause that will no longer allow capital expenditures to be eligible for SR&ED treatment or the associated investment tax credit.
The Chair: That capital expenditure being capital equipment that might be purchased to do the work?
Mr. Cook: That is right. It will be purchased capital equipment or equipment that is leased that, if it had been purchased, would be capital equipment.
The Chair: That is being eliminated from the deduction.
Mr. Cook: That is correct.
The Chair: The deduction itself is also being reduced by 5 per cent. That is my recollection from the discussion.
Mr. Cook: The general rate is being reduced by 5 per cent. At the same time, the enhanced rate of 35 per cent, for which Canadian-controlled private corporations are eligible, will stay the same at 35 per cent.
The Chair: Okay.
[Translation]
Senator Bellemare: What will the dollar impact of these changes be? I need to know, in order to see whether what we here are big changes, or shall ones.
M. Cook: This particular change concerns $40 million.
Senator Bellemare: Forty millions dollars.
The Chair: That the federal government will save, is that correct?
Mr. Cook: Yes.
[English]
Senator Callbeck: Has an analysis been done to show the impact that this will have on scientific research?
Geoff Trueman, Director, Business Income Tax, Department of Finance Canada: This measure was undertaken in response to one of the recommendations made by the Jenkins panel on R & D. One of the items that the Jenkins panel put forward was to reduce the complexity associated with the SR&ED program and to facilitate compliance with administration. Capital is probably the most complex element that is currently included in the base of eligible expenditures. There are special rules that relate to the acquisition of capital, the disposition of capital and the use of it over time in terms of calculating R & D tax credits. Eliminating it from the base should greatly facilitate compliance by business and the ability of the CRA to administer the R & D tax credit overall.
Senator Callbeck: Will this have a negative effect on scientific research?
Mr. Trueman: Capital is a relatively modest proportion overall of R & D tax expenditures, so we do not expect the impact to be overly significant.
Senator Callbeck: Thank you.
Senator Bellemare: Do you have the proportion?
The Chair: Relatively modest means different things to different people.
Mr. Trueman: One of the working papers that were put out by the secretariat of the Jenkins panel indicated that it was in the range of 5 per cent for a particular tax year.
The Chair: Clause 10 is next.
Mr. Cook: Clause 10 is a consequential amendment relating to the measure to implement transfer pricing secondary adjustments. Perhaps I will say a few words about that to introduce the topic to the committee.
"Transfer pricing" describes the prices at which related parties transact across international borders. Manipulating transfer pricing is a way multinational groups try to move income out of high-tax jurisdictions to lower-tax jurisdictions by way of changing the prices at which goods are sold or the prices that are paid for services.
Under the Income Tax Act, the CRA already has an ability to adjust these transfer prices to what arm's-length parties would have paid. These are called transfer pricing primary adjustments. Transfer pricing is maybe the most important international tax issue out there today.
However, even in cases where the CRA has adjusted the transfer price, there still may be a benefit conferred on the non-resident party by the Canadian. Even though you may reduce Canadian taxpayers' expenditures, they have sent the money offshore, which represents a benefit conferred on the non-resident. To tax that benefit conferred on the non- resident is a matter of the Income Tax Act's Part XIII withholding tax. This measure clarifies the ability to do so. CRA's practice is currently to impose this Part XIII withholding tax on the benefit conferred on the non-resident, but this measure simply makes it clear in the legislation that this is the result.
Senator Callbeck: Could you give us an example to make this clearer?
Mr. Cook: Yes. Let us say a Canadian company is selling a product to a non-resident sister company — they have the same parent company. The Canadian company sells a product to the non-resident company. Let us say the Canadian company receives $80 for the product. If they sell the product to a stranger, the real market value of the product is $100. So, for Canadian tax purposes, they have reduced their income by $20. The CRA can go in and say, no, no, no — what you sold is worth $100 so we are going to tax you as if you had earned $100. Even so, that difference between what the non-resident paid, which was $80, and what they should have paid, which was $100, represents a benefit conferred on the non-resident. If they had paid a dividend to the parent corporation in the amount of $20, it would have been subject to withholding tax under the Income Tax Act.
In these kinds of situations, we are trying to ensure that our system of non-resident withholding tax applies appropriately.
Senator Callbeck: Thank you.
Mr. Cook: Clauses 11 through 13 of the bill provide additional consequential amendments with respect to pooled registered pension plans. In particular, they provide some rules that operate in the context of rollovers of amounts on death of a PRPP member.
Clause 14 relates to a measure to allow pension income splitting in respect of an RCA in prescribed circumstances where the person is more than 65 years old. The income out of the RCA is supplementary and related to a registered pension plan. It is subject to a dollar limit of approximately $93,000.
The Chair: What is an RCA?
Mr. Cook: An RCA is a retirement compensation arrangement. Many RCAs are separate trust structures used as supplements to other retirement savings, usually in the context of an employment.
The Chair: Is that the second part of parliamentarians pensions that we just looked at recently?
Mr. Cook: Yes, it would potentially apply there.
Senator Callbeck: I will ask for another example of the schemes that might be used to use the value of that retirement compensation arrangement.
Mr. Cook: I will note to the committee that two measures in Bill C-45 relate to RCAs: One allows pension income splitting in certain prescribed circumstances, and the other is a more general set of rules to get at the schemes that I think the senator is referring to. I am quite happy to provide an example of that.
RCAs are subject to a separate tax regime. They are not taxed under Part I of the Income Tax Act. An employer and an employee can make tax deductible contributions to a retirement compensation arrangement. These RCAs are subject to a special set of tax rules. In fact, 50 per cent of the contribution to an RCA is paid as tax and 50 per cent of any income earned by an RCA is subject to tax. These refundable taxes are paid back when amounts are distributed out of the RCA to the person who is the recipient of the income.
The CRA found that schemes have developed to try to take advantage of the attributes of RCAs. For example, when an amount of $100, say, is paid into an RCA, they pay their refundable tax of $50. They may go out and borrow from an arm's-length party to top up the RCA back to $100. Then, they lend that money to essentially a shell corporation, which may be controlled by the controlling party of the entire arrangement. The money makes its way out of that corporation and is back in the hands of where it started.
What makes this work is the recognition of the fact that invested money may lose value as well. A provision in the RCA rules says that where all the property of the RCA has lost value, you can get, upon application to the minister, a refund of the tax if the investments have all lost value. They basically set up the circumstances to get the money out of the RCA so that the investment becomes valueless. At that point, they ask for a refund to the minister of national revenue. Rather than pay money directly to someone, you create a tax deductible contribution to an RCA, the money circles back out and ends up where it started and all the refundable tax is back in the hands of the parties.
Senator Callbeck: How frequently does this happen?
Mr. Cook: The CRA indicated that they get between 120 and 180 new RCAs each year. It does not sound very attractive — 50 per cent tax on contributions plus 50 per cent tax on any income. The CRA's view is that of the major employers that are likely to have set up RCAs in the past, most are what we call "closely held RCAs" that are probably being used for tax planning purposes.
Senator Callbeck: Thank you.
The Chair: On to the next, clause 14, at page 18.
Mr. Cook: Clause 14 is the one I mentioned. This is the RCA pension income splitting.
The Chair: Yes, thank you.
Mr. Cook: Clause 15 relates to PRPPs and is an exclusion from certain trust attribution rules.
Clause 16 is a consequential relating to the foreign affiliate dumping rules that we talked about earlier.
Clause 17 introduces a measure and is probably the next clause of interest to the committee. Clause 17 deals with tax avoidance through the use of partnerships. In certain circumstances where a taxable Canadian corporation acquires control or buys another taxable Canadian corporation, they can wind up or amalgamate with that corporation they have acquired and do what they call "bumping the assets of the corporation" that has been acquired. By "bump" I mean increase the cost base in recognition of what they paid for the shares of the corporation they acquired.
This bump or step up in cost base is only available in respect of assets that give rise to capital gains and do not give rise to regular income. Taxpayers have taken assets that are not eligible for this increase in cost base and have stuck them underneath a partnership because an interest in a partnership is generally a capital asset and is eligible for this step up in cost base. This measure is purely an anti-avoidance rule to ensure that in cases where there is a partnership interest, you look through the partnership interest and see what the composition of the assets is underneath it.
Senator Callbeck: You say they take assets not eligible. Can you explain that? What assets would those be?
Mr. Cook: Certainly. For example, as I described, you can have a taxable Canadian corporation that acquires control or buys all the shares of another taxable Canadian corporation. Let us say the corporation that has been acquired has two assets; one is land, which is just a capital asset, and they also might have some machinery, which is depreciable property. When you sell depreciable property you might have a capital gain, but you might also have recapture, or getting back at the depreciation that you claimed over the years, and that is on income account.
The land would be eligible for this step up in cost base, but the depreciable property would not. Taxpayers will currently create a partnership underneath the corporation, put the depreciable property underneath the partnership, get a step up in cost base of the partnership interest, and then they will just sell that to whoever wants their property. Instead of having recapture on income account, they will purely have a capital gain in respect of the partnership interest.
The Chair: We are learning lots of tricks here.
Mr. Cook: Hopefully by the time you learn them they will not work.
The Chair: Yes, we are learning only the ones we are closing.
Senator Bellemare: Is this a big loophole?
Mr. Cook: The anecdotal evidence from the CRA is that there are individual transactions, but some of them are fairly large dollar transactions. It is not prevalent in terms of the number of transactions, but certainly there can be large dollars at stake where it is potentially being used.
Senator Chaput: How much?
Mr. Cook: Hundreds of millions.
The Chair: We had better get on with this then.
Mr. Cook: That measure is contained in clauses 17 and 18.
The Chair: Clause 19 is at the bottom of page 23, first column.
Mr. Cook: Again, we have already talked about foreign affiliate dumping. Clauses 19 and 20 again are consequential amendments with respect to foreign affiliate dumping.
The Chair: There seems to be quite a few measures to prevent tax avoidance. Is it usual, or is this just an extraordinary year that we are getting a lot of this?
Mr. Cook: I would say that this is a year where we have introduced a good number of anti-avoidance measures.
The Chair: Okay. Thank you. Carry on. Tell us what section you are on.
Mr. Cook: Again, clause 21 is simply part of the measure I just explained with respect to partnership. There are certain rollovers available in the context of partnership, with rollovers being tax deferred transfers. This is just to prevent these rollovers being used to circumvent the rule we just discussed.
Senator Finley: To follow on Senator Day's point, I have a very quick question. What is the estimated total revenue gain for these tax-avoidance measures that you are legislating for? I guess it would be a revenue gain for CRA? Is there an estimate of the total?
Mr. Cook: It depends on the particular measure. Some of the measures, such as the one I just referred to, are seen as a base protection measure in order to ensure that the Income Tax Act operates and is administered in the manner in which it is supposed to be. There is no amount booked fiscally for that issue. For the foreign affiliate dumping, an estimate was made, and I think it was alluded to earlier that it is approximately $1.3 billion over the five-year period. For the Overseas Employment Tax Credit, a specific estimate was made, and I believe that is in the neighbourhood of $95 million. It varies as to what the particular nature—
Senator Finley: If you added up all of the pluses and those they do not count in terms of revenue growth, what are we looking at as a total?
Mr. Cook: It would be simply an exercise of adding up what we put in the fiscal framework.
Senator Finley: We do not have to take up the committee's time by doing arithmetic here, but perhaps you could give us a response to this later.
Mr. Cook: Sure.
Senator Finley: Thank you.
Mr. Cook: If I could draw the committee's attention to clause 22 on page 26, this is the second part of the measure relating to tax avoidance through the use of partnerships. Section 100 of the Income Tax Act currently has a rule to provide that when a partnership interest is sold to a tax exempt entity, essentially the appropriate amount of the gain is taxed either as capital gain or as income, depending on the assets held by the partnership, to prevent partnerships from being interposed between assets that otherwise could have been sold directly and would be subject to tax on income account as opposed to on capital account.
There is an existing rule that applies in the case of sales to tax-exempt entities. This measure extends that rule to sales to non-residents as well.
Senator Hervieux-Payette: Is this measure mostly used by individuals or by corporations? I want to make sure that I understand what you are talking about. Are you talking about partnership of individual people?
Mr. Cook: Certainly it does not have to be partnership of individual people. A partnership is just an aggregation of taxpayers carrying on business together, so it may very well be a corporate partnership.
Senator Hervieux-Payette: I am talking about lawyers, accountants and all the professionals.
Mr. Cook: Those would be partnerships, but I do not think that partnerships of law firms, accountants and those types of people would be engaging in the kinds of transactions we are interested in here.
Senator Hervieux-Payette: I do not see how they would do that.
Mr. Cook: Exactly.
Senator Hervieux-Payette: I see the word "trust" later in the article, so is it a measure for people who do their tax planning within a family?
Mr. Cook: I do not think our expectation is that this has been used or would be used in the context of professional partnerships planning for themselves or family tax planning. We have seen large transactions where corporate groups or corporations are looking to sell a business or part of a business to a non-resident, and then they start looking for vehicles that might be used.
The reason you see "trust" in the article is that when you are creating rules that apply to just corporations, people start asking, "What if I use a partnership?" Then when you cover off corporations and partnerships, the next thing they do is ask, "What happens if we interpose a trust? Can we break the application of the rule?"
This rule contemplates sales of partnership interest directly to taxpayers — it might be an actual person or corporation — to other partnerships or to trusts.
Senator Hervieux-Payette: In the past, we had these partnerships that were popular for oil and gas, where you were buying a share. Do you think this covers that situation? We were buying it. You were not a shareholder; you were a partner. There were a lot of tax measures related to that. Does this apply to that?
Mr. Cook: Based on your description, I think you are probably talking about something where you buy an investment and it has particular tax attributes — perhaps expenses are being remunerated to you or that kind of thing. However, this is specifically not in the context of you as an individual purchasing a partnership interest, but rather on sales of partnership interest to a non-resident.
The Chair: Let us move to clause 23, page 31.
Mr. Cook: Clauses 23 through 25 are simply PRPP consequential amendments. I guess we will defer our discussion of PRPPs to when we actually reach that particular clause.
The Chair: All of these we see are consequential to that, are they?
Mr. Cook: That is right. We have to put PRPP in many places in the act.
The Chair: PRPP stands for pooled registered pension plans, colleagues.
Mr. Cook: We have already discussed to some extent clause 26, which is on page 32. This is the clause that implements the phase-out of the Overseas Employment Tax Credit, which we discussed earlier.
The Chair: Yes. That is where it is.
Mr. Cook: Clause 27 is on page 34. It amends section 127 of the Income Tax Act. This is the section of the act that deals with investment tax credits and the Atlantic Investment Tax Credit. There are a number of measures that are implicated in this particular clause. I would note to the committee that subsection 5 of the clause reduces the general rate for the SR&ED investment tax credit from 20 to 15 per cent. That is at page 35, subclause 5.
Senator Buth: We are not going through the bill; we are using the description.
The Chair: I have been following the bill. That is what you will be asked to vote on — not someone's briefing note.
Senator Buth: This is just the description.
Mr. Cook: The general rate is being reduced from 20 to 15 per cent.
This clause also implements the measure with respect to arm's-length contracts for SR&ED and to eliminate the profit element of arm's-length contracts by way of a proxy amount. The investment tax credit with SR&ED is of expenditures on arm's-length contracts. Additionally, this clause implements the measure phasing out the exploration and the Corporate Mineral Exploration and Development Tax Credit.
The Chair: There is a lot packed into this clause.
Mr. Cook: Yes. Section 127 is a difficult section of the act to manoeuvre around.
The Corporate Mineral Exploration and Development Tax Credit is being phased out. There are two types of expenditures: what we think of as the pre-production exploration expenditures, or the grassroots expenditures; and the pre-production development expenditures, which are clearing, removing overburden, sinking a mine shaft and those types of expenditures. There are two phase-outs: one with respect to the exploration expenses and the other with respect to the development expenses.
For the exploration expenses, the investment tax credit will be 10 per cent before 2013, 5 per cent for 2013 and 0 per cent after that; whereas for the development expenditures, the rate will be 10 per cent before 2014, 7 per cent in 2014, 4 per cent in 2015, and then 0 per cent after that.
The Chair: We see these years. Are these just calendar years?
Mr. Cook: That is right. Generally, if you just see a reference to a year, it will be a calendar year. If it is a taxation year, it will say 2014 taxation year.
The Chair: Okay.
[Translation]
Senator Bellemare: What is the rationale behind this measure? Have you measured the impact that this will have on investment? How much do you expect to earn from this? Is this consistent with what other countries are doing?
I have a couple of quick questions, but logically, when you want to encourage investment, you have to wonder if this might not have a negative impact on investment.
[English]
Mr. Trueman: I am happy to respond to that. The Corporate Mineral Exploration and Development Tax Credit was introduced some time ago — early in the 2000s — at a time when Canada's corporate income tax structure was quite different from what it is now. Over recent years, we have seen a strong reduction in corporate income tax rates overall, dropping from 22 down to 15, and we have also seen the removal of the capital tax in Canada at the federal and the provincial levels. Those are some pretty fundamental changes that affect all industries, and the mining industry in particular with respect to the capital tax.
The removal of the Corporate Mineral Exploration and Development Tax Credit is consistent with the government's approach to having a more neutral tax system overall, one that provides more equitable treatment among industries so that none are in a tax-favoured position.
That is the rationale that underlies the removal. It is a credit. The usage over recent years was in the range of $20 million per year. Therefore, it is an amount that is a more modest amount; it is not a significant amount to the mining industry.
Senator Callbeck: On these two tax credits, the Atlantic area will lose; that is going from 10 per cent now to 0 per cent. The Mineral Exploration Tax Credit is 15 this year, is it?
Mr. Trueman: I believe that is correct, yes.
Senator Callbeck: We are really talking here about 25 per cent for Atlantic Canada. Will that not have a big effect on that whole sector?
Mr. Trueman: The revenue impact of the AITC is phased in over time as a result of the transition in grandfathering laid out in the budget. That $15 million comes into play starting in 2014-15, and that is for the AITC. The revenue number for the Corporate Mineral Exploration and Development Tax Credit would apply across Canada. The impact in the Atlantic region would be a portion of that but obviously a smaller portion of that overall.
Senator Callbeck: In Atlantic Canada, those two tax credits amount to 25 per cent, right?
Mr. Trueman: Correct.
Senator Callbeck: Will that not have a big effect on the mining industry in my area?
Mr. Trueman: I think the important thing here is the fact that the measures have appropriate transitioning and grandfathering in place and that, overall, the conditions in the mining industry have been quite strong, including in Atlantic Canada. The fact is that, as mentioned in the budget, the Corporate Mineral Exploration and Development Tax Credit is no longer necessary in the mining industry.
Senator Callbeck: You do not think that this will affect the junior mines in my area?
Mr. Trueman: Junior mining is generally geared toward exploration, for example. This budget does extend the Mineral Exploration Tax Credit for flow-through share investors. That is directed at junior mining and their ability to raise capital. Producing mines would be where the Corporate Mineral Exploration and Development Tax Credit would come into play.
Senator Callbeck: For the producing mine, it is 25 per cent, then?
Mr. Trueman: No, there are two different measures, the Corporate Mineral Exploration and Development Tax Credit and the AITC. There could be a combined effect for those, but, at the same time, each measure evaluated does have a rationale for its phase-out.
Senator Callbeck: The bottom line is that there are two tax credits, and they add up to 25 per cent in my area, right?
Mr. Trueman: Correct.
Senator Callbeck: Has any analysis been done as to how that will affect the mining industry in Atlantic Canada?
Mr. Trueman: Absolutely. The analysis that has been done indicates that, overall, the mining industry is in a strong and robust position and that it should be able to weather the removal of these tax preferences.
Senator Callbeck: What you are saying then is that this 25 per cent that will be lost by the mining industry in Atlantic Canada is not going to affect that sector?
Mr. Trueman: Well, to say that there will be no effect is strong. Obviously, the fact that the government is booking revenue for this means that there will be an impact on companies.
Senator Callbeck: What are you thinking the impact will be?
Mr. Trueman: In terms of what?
Senator Callbeck: Dollars.
Mr. Trueman: The dollar impact is quantified in the budget. As I say, the backdrop for this, in the Atlantic region, is robust levels of employment, capital expenditures, and value production.
Senator Callbeck: How much is the government planning to save by eliminating these tax credits from the mining sector in Atlantic Canada?
Mr. Trueman: The impact of the AITC would come from the Atlantic sector. That would be the mining and the oil and gas combined. As for the phase-out of the Corporate Mineral Exploration and Development Tax Credit, a portion of that would be attributable to the Atlantic provinces. We do not have a breakdown by province on that.
Senator Callbeck: I know you do not have it now, but it seems to me that it is a big reduction for Atlantic Canada.
Mr. Trueman: It is a reduction. Again, I would point to the transitioning and the grandfathering that are available under the AITC, which provide an appropriate removal of those tax preferences over time.
Senator Callbeck: Have you done an analysis on Atlantic Canada that can indicate how many dollars you think the government will save by doing away with the 10 per cent and the 15 per cent?
Mr. Trueman: With respect to removing the 10 per cent AITC, the fiscal line booked in the budget would represent the savings coming from the removal of the AITC.
Senator Callbeck: How much is that?
Mr. Trueman: The AITC, starting in 2014-15, starts at $15 million. It is $35 million in 2015-16 and $85 million in 2016-17.
Senator Callbeck: For 2016-17, it is $85 million?
Mr. Trueman: Yes.
Senator Callbeck: For the 15 per cent, you do not have a breakdown of that by regions?
Mr. Trueman: I do not have a regional breakdown of it. The number there, for the corporate mineral tax credit, starting in 2013-14, is $10 million, then $25 million and finally $30 million in 2016-17. The Atlantic provinces would be some portion of that.
Senator Callbeck: It is $30 million, but the Atlantic one is $85 million.
Mr. Trueman: The Atlantic one applies to mining as well as to oil and gas, and there is fairly significant oil and gas activity in the Atlantic provinces.
Senator Callbeck: The other one says mining.
Mr. Trueman: Correct. The AITC is mining and oil and gas, and the other one is simply mining.
Senator Callbeck: Okay. Thank you.
The Chair: Thank you. We go on to the next one. We will remember section 127 of the Income Tax Act.
[Translation]
Senator Chaput: My question concerns section 27(3), at the bottom of page 34. You say that you have altered the definition of "shared-use-equipment."
Would you tell us what the previous definition was, and why it has been changed? Also, did the previous definition primarily concern scientific research and experimental development?
[English]
Mr. Cook: The changes to the definition of "first term shared-use equipment" relate to the changes for scientific research and experimental development. Shared-use equipment is equipment that is used for both SR&ED and for non-SR&ED purposes, and the shared equipment rules provide the appropriate proration between the two. There is sort of an ongoing rule that there is first term shared-use equipment and then second term shared-use equipment. This amendment applies only with respect to the removal of capital expenditures. We needed to keep the definition of first term shared-use equipment because it is used in subsequent taxation years. All we did was to ensure that it applies only to capital equipment purchased before 2014.
[Translation]
Senator Chaput: Concerning only scientific research?
[English]
Mr. Cook: Exactly.
We have talked about the phase-out of oil and gas and mining, and that is contained in clause 27 as well. In particular, in subclause 16, we introduced the phase-out schedule for equipment purchased for oil and gas and mining so that the rate is 10 per cent before 2014, 5 per cent in 2014-15 and 0 per cent after 2015. The one other measure contained in this particular clause is to add certain electrical energy generation and conservation equipment to the eligible equipment for the Atlantic Investment Tax Credit.
The Chair: Am I reading correctly that Labrador and the Gaspé are part of the Atlantic region for the purposes of this tax credit?
Mr. Cook: That is correct.
Moving on, clauses 28 to 32 are various consequential amendments relating to the SR&ED changes that we talked about, pooled registered pension plans and foreign affiliate dumping. The next clause that has an actual new measure is clause 33.
The Chair: Is that on page 53 of the bill?
Mr. Cook: Exactly. This measure relates to registered disability savings plans and provides for the rollover or transfer of investment income earned in a registered education savings plan to an RDSP in certain circumstances, particularly where the RESP and the RDSP share a beneficiary and that beneficiary is unable to pursue post-secondary education as a result of a mental impairment.
Senator Chaput: Does that happen very often?
Mr. Cook: No. The expectation is that such a rollover would not occur on a frequent basis.
Senator Chaput: Why would we change that?
Mr. Cook: The basic policy of registered disability savings plans is to save and provide for the long-term care of people with significant medical concerns. At the same time, we have the registered education savings plan and the person may become unable to pursue post-secondary education because of mental impairment. When a subscriber withdraws money from an RESP, it can be subject to tax at normal income tax rates as well as an extra 20 per cent to recognize the time growth value of the money within the RESP. This measure recognizes that both measures are savings vehicles and so it makes sense to allow, recognizing that the person cannot pursue post-secondary education, these medically related saving needs to go on a tax-deferred basis.
Senator Chaput: They would pay less tax or it would be deferred.
Mr. Cook: When they start to withdraw money, the RDSPs are taxed such that there is a taxable portion of a withdrawal and a non-taxable portion, depending on how the money came into the RDSP. There would be some tax paid by the beneficiary of the RDSP, but on the actual transfer, there would be no tax.
Senator Callbeck: A review was done on the registered disability savings plan in 2011. Is this where these changes are coming from? Were these recommendations from that review?
Mr. Cook: Certainly, this bill contains four or five measures with respect to RDSPs. In large part they reflect the kinds of concerns that were raised. I could not say whether this particular change was a result of particular comments that were received, but the review was held, as you point out, in 2011. The department received approximately 280 submissions, and many of the comments were around one of the changes being proposed — the impact of making withdrawals from an RDSP. Currently, you have to pay back the entire assistance holdback amount, and we are introducing a proportional repayment rule. That is probably the most important change as a result of the consultation, which flagged a number of issues around the ability to access funds and what they are used for. Whether this was as a result of a specific submission, I could not say.
Senator Hervieux-Payette: When people are using the fund for people going to school, who allows the students to study abroad and qualifies the institution? Let us say you want to study in Paris, which is a nice place. Does the Minister of Finance give the okay to a particular institution for a student? Where does the approval come from?
Mr. Cook: I am sorry but we are looking at this measure related to transferring money from an RESP to an RDSP. I am afraid I do not have the answer as to how foreign institutions get qualified for RESP.
Senator Hervieux-Payette: In Canada, it is easy but since we want more and more people to have exchanges, I was wondering about that. I have some examples of people who want to go to an institution in Australia, and I am not talking about Melbourne. Some institutions are qualified and some are not. Who makes these decisions?
Mr. Cook: I do not know that.
Senator Hervieux-Payette: If you find someone in your department who knows, it would be good for us to know, because I could not give the answer.
The Chair: On to the next one.
Mr. Cook: Clause 34 relates to pooled registered pension plans and simply allows for transfers to a registered retirement income fund and transfers out of a registered retirement income fund.
Clause 35 relates to a number of measures with respect to registered disability savings plans. I would note that with respect to withdrawals from registered disability savings plans, this clause in the bill would take an existing requirement that only applies to RDSPs funded primarily by government grants and bonds. These plans have the requirement that once people turn 60, they have to start making withdrawals every year; and the minimum withdrawals relate to what we call the "lifetime disability assistance plan formula." This takes that requirement and extends it to all RDSPs in line with the notion of the RDSP that it is supposed to provide for the long-term care of the individual involved.
Senator Chaput: Does that make it easier for people with disabilities to have access, or does it make it more difficult or complicated?
Mr. Cook: I do not think it will affect the complexity of the way that RDSPs work. It helps to ensure that the RDSPs are being used for the right reasons. Currently, there is a requirement to make a withdrawal once you turn 60, but that withdrawal can be any amount. In cases where small withdrawals are being made, you sort of question whether the RDSP is there to provide for the long-term care of someone. If they are not withdrawing funds once a person reaches the age of 60 or over, what is the rationale for those funds staying in the RDSP?
Senator Chaput: The funds were there to begin with to help the disabled person, were they not?
Mr. Cook: That is right.
Senator Chaput: What is the real problem?
Mr. Cook: At some point, the funds should start coming out to pay for the expenses of that person rather than just staying in the RDSP and accumulating more income that may never be used for the care of the individual.
Senator Chaput: Have you done any study that shows such funds should have been withdrawn before, or is it just based on logic?
Mr. Cook: It is logical based on the way the provision is laid out that there is no requirement that the funds be used.
Senator Callbeck: On the pooled registered pension plans, I believe that draft legislation was put out, was not it not, to groups a while ago for their feedback?
Mr. Cook: That is correct. Draft legislation was released in December 2011 for comment.
Senator Callbeck: Have their concerns been addressed in what we are looking at today?
Ian Pomroy, Senior Tax Policy Officer, Social Tax Policy, Department of Finance Canada: The draft legislation was released about a year ago, and a handful of technical adjustments have been made mainly in response to the feedback we received from those comments, yes.
Senator Callbeck: They were just technical things that were changed in the legislation, but were there any major concerns you heard from these groups that are not addressed here?
Mr. Pomroy: The changes that were made reflect the comments that we felt were useful adjustments that could be made to the draft rules that went out. They were mainly technical.
Senator Callbeck: The changes you made were technical, but were any major concerns addressed by the groups who received this draft legislation?
Mr. Pomroy: The adjustments responded to specific concerns that were raised and were judged appropriate to address. There was one change to allow status Indians to participate in PRPPs. That was not in the draft legislation, but there are provisions in the bill that allow status Indians to participate in a PRPP based on their tax-exempt income. It allows them to contribute 18 per cent of their tax-exempt earned income so they can participate in these plans.
Senator Callbeck: When the legislation was put out to various groups for feedback there were no major concerns, I take it.
Mr. Pomroy: The majority of the concerns were technical. We had a previous consultation in the summer of 2011 with pension experts and other stakeholders, so the rules were developed with that consultation in mind as well.
Senator Callbeck: To come back to my question again, is it fair to say that when the proposed legislation was sent out to groups there were no major concerns expressed to you that have not been taken care of in this legislation?
Mr. Pomroy: I would say that is how we would see it from our perspective, yes. We took into account those concerns that we assessed were appropriate to make, but there were no major changes to the draft rules other than the one I described.
Senator Callbeck: No major concerns were expressed?
Mr. Pomroy: We evaluated the feedback that we received and made certain adjustments that were considered appropriate. Most of them were minor.
Senator Callbeck: I still do not think I got an answer to the question.
Senator Nancy Ruth: With disability pensions, if the disabled person dies, do the remaining funds remain part of his or her estate, or is it taxed in a different manner?
Mr. Cook: It is essentially treated as a withdrawal. The assistance holdback amount still has to be repaid, if you will. The assistance holdback amount is the government grants and bonds that had gone into the RDSP in the last 10 years, and the remainder goes into the estate of the individual.
Senator Nancy Ruth: Thank you.
The Chair: We are on to clause 35.
Mr. Cook: I spoke about the minimum withdrawal requirement for all RDSPs. Under current rules there is also a maximum withdrawal rule that applies with respect to plans that are primarily government-assisted, or primarily funded by government grants and bonds, to provide greater flexibility to the beneficiaries of those plans. That upper limit is being increased from the existing amount, which is a formula-based amount, to the greater of that formula and 10 per cent of the plan assets. Up to 10 per cent of the plan assets will be able to be withdrawn by RDSP beneficiaries.
The clause also provides a number of administrative changes to RDSPs as a result of consultation between issuers of RDSPs and Human Resources and Skills Development Canada. They are just things like changing particular day deadlines to a more flexible approach to making transfers and notifications to HRSDC.
The last main measure in clause 35 is with respect to disability tax credit eligibility. Currently, if a person ceases to be eligible for a DTC or disability tax credit, they have an obligation to wind up their RDSP. Recognizing the potentially episodic nature of some illnesses, the rule will now provide that on an elective basis a RDSP can remain open for up to five years following the first year that they are no longer disability tax credit eligible. This can be done if a medical doctor certifies in writing that the person is likely to become DTC eligible again in the foreseeable future.
The Chair: It seems like we have had something in each of these budget implementation bills for the last two or three years with respect to RDSPs.
Mr. Cook: Certainly since I have started doing this, there has been.
The Chair: It is a good initiative, but why are we catching up all the time?
Mr. Cook: As Senator Callbeck noted with respect to amendments this year, there was the planned three-year review for RDSPs and a significant review process that we went through in the fall. As I indicated, we received approximately 280 submissions, and as a result of that we continue our work on this area.
Senator Callbeck: I have a question on the registered disability savings plans. Would you comment on the proportional repayment rule and why the ratio is three to one?
Mr. Cook: It is probably best to start with the existing rule. Under the existing rules, where any withdrawal is made from an RDSP, the individual has to pay back the assistance holdback amount, which is all the grants and bonds that have been contributed by the government over the last 10 years to the RDSP. That fit in with the initial plan of how these plans were supposed to work. There would be an income contribution accumulation phase, which would presumably last up till the person is 49, and a growth phase where the investments could grow and would last up until the age of 59 for the individual. The withdrawal phase would start when the person is 59 or 60, and then they would take out money each year to support their long-term needs.
The assistance holdback amount, in support of this view, was that if you made a withdrawal of $1 you would have to pay back all the grants and bonds in the prior 10 years. The view came to be that this was a rather harsh result; if you made a very small withdrawal, you would have to repay everything that you received over the last 10 years. I guess the three-to-one proportional repayment rule is significantly less harsh than the existing rule. The assistance holdback amount still forms the ceiling but serves as a deterrent for using other than for the intended purpose.
Senator Callbeck: Is there any rationale for the ratio of three to one, rather than four to one or two to one?
Mr. Cook: I think the rationale is no more than a review and analysis to suggest an appropriate ratio. It would deter withdrawals, but at the same time not be overly punitive when a person makes a small withdrawal from an RDSP.
Senator Callbeck: Thank you.
The Chair: We are now on clause 36, page 62.
Mr. Cook: Clause 36 relates to pooled registered pension plans, and this is the main operative provision that sets out the base operation of the pooled registered pension plans. If the committee would like, Mr. Pomroy could provide a very brief overview of how it will operate.
Mr. Pomroy: The PRPP tax rules were designed to ensure that these new pooled registered pension plans would fit within the basic system of rules and limits that we have already for registered retirement savings plans and registered pension plans. PRPPs will receive tax-deferred treatment like our registered pension plans and RRSPs; that is, contributions will generally be deductible, the investment income will not be taxed in the plan as it is earned, and payments and withdrawals will be included in income for regular tax purposes.
Employers will be able to make direct contributions to PRPPs, and all member and employer contributions will need to be made within a person's available RSP limit for the year for those contributions to be deductible.
There is also a dollar limit on employer contributions, and that is there to help ensure that members are not put into an over-contribution situation by the unintended actions of an employer. Now they can direct an employer to put more in than that limit if they so choose.
As I mentioned before, status Indians will be able to contribute to PRPPs based on their tax-exempt earned income. There are provisions to deal with that in proposed section 147.5.
There are a couple of investment rules that are there really as safeguards to ensure that PRPPs are not used for tax avoidance and self-dealing purposes. Those two rules are the following: Essentially, PRPPs will not be able to hold an investment in which a member has a significant interest, and small PRPPs will not be able to invest in a participating employer. The existing transfer rules for transfers that apply to defined contribution registered pension plans will apply to PRPPs, and those will govern transfers between one PRPP and another, or between a PRPP and other registered plans like a registered pension plan or registered retirement savings plan.
The retirement income vehicle options for pooled registered pension plans will be the same as exist for defined contribution employer-sponsored registered pension plans — that is, transferred to an RRSP or registered retirement income fund, the purchase of an annuity, or the funds can be paid out directly from the member's PRPP account as variable benefits.
Finally, on death, there are rules that parallel the registered pension plan and RRSP rules that will allow a continuing deferral of tax if a member's PRPP account funds are left to a surviving spouse or common-law partner, or an infirm, financially dependent child or grandchild; otherwise the funds are generally included in the income of the deceased.
That is an overview of how those rules will work.
[Translation]
Senator Chaput: Why have you chosen to include in the pension income that can be shared new amounts such as those that come from a retirement compensation arrangement?
[English]
Mr. Pomroy: PRPPs will be part of the system of registered plans for retirement for Canada, so it was logical to ensure that payments and income from those plans would be eligible for the pension income splitting measure that exists.
Senator Chaput: They were not before? They will be now?
Mr. Pomroy: Yes. Pooled registered pension plan payments and income will be eligible as of age 65 for pension income splitting. Yes.
[Translation]
Senator Chaput: How much will it cost to include this new income? How much will that cost the government? Will you incur a tax lost?
[English]
Mr. Pomroy: We do not have a revenue estimate of that. Since the contributions to PRPPs will be within the system of available limits, any costs would be within that available limit already.
[Translation]
Senator Hervieux-Payette: I do not understand what you mean when you say that it seems to balance out. You cannot from one day to the next have one person making $125,000, and the next $65,000 each. This must give rise to a tax loss. Let me use a fictitious example, but one way or the other, if there is a $90,000 pension, each person getting $45,000, as the amount decreases, the tax rate will also go down. This sharing of income must result in a tax lost for the government. That seems obvious to me, and though I am not an economist and do not work for the department of Finances, we could, in order to arrive at an estimated figure, start with a representative sample of Canadian couples and we would certainly not need to study $50,000 of them.
[English]
Mr. Pomroy: As I said, we do not have a revenue cost estimate for that. Like I said before, PRPP contributions will be made within the existing system of RSP and RPP limits.
[Translation]
Senator Hervieux-Payette: You have announced a new measure to allow income sharing between spouses, and I cannot understand how you did not analyze the impact that that would have on our tax system. You do not stop paying tax just because you are retired, do you?
[English]
Mr. Pomroy: I can only repeat that I do not have a revenue cost estimate for that aspect.
Senator L. Smith: The minister alluded earlier to the fact that the provinces have to come on board with the pooled registered pension plan program. From your perspective, are you folks in discussions with the provinces? Do you know who is where and what, and what objections they have, so that you could forecast when this thing will be implemented in terms of the program?
Mr. Pomroy: My colleagues in the Financial Sector Policy Branch have been working with the provinces in the development of the federal rules. We have been encouraging the provinces to come forward with their legislation as soon as possible, but I do not have any more specific information on that.
Senator Buth: I want to come back to the comments about the income splitting. This applies to PRPPs, which have not existed before; is that correct?
Mr. Pomroy: No, it is a new plan.
Senator Buth: A brand new plan. We are bringing in a brand new plan and it will follow the same rules as RSPs and RPPs, will it not?
Mr. Pomroy: Similar rules.
Senator Buth: Is income splitting allowed under those plans?
Mr. Pomroy: Subject to specific conditions, yes.
Senator Buth: Will the same conditions apply to PRPPs?
Mr. Pomroy: As I mentioned, income from a PRPP will be eligible as of age 65 for pension income splitting.
Senator Buth: Is that the case now for RRSPs and RPPs?
Mr. Pomroy: That is the case for RSP annuity income and RRIF income, yes.
Senator Buth: Ensuring a new plan conforms to what we can currently do with RPPs and RESPs just makes common sense to me. I am trying to get at what you said, namely that the reason an analysis might not have been done was because it is fitting under the current contributions that are available to each individual. They might have had a RPP, but their company did not provide it. They might have some RRSPs, and now they will have the opportunity for a PRPP. Am I reading that right?
Mr. Pomroy: Yes, it is a plan that will fit within the existing system of limits and rules that apply to RSPs and RPPs, yes.
Senator Buth: Thank you.
The Chair: Do you contemplate that an individual might have a registered retirement savings plan, and then they would move along and have an opportunity to get into a pooled plan and would have both of them going?
Mr. Pomroy: They could choose to contribute to an RSP or a PRPP or a combination.
The Chair: As long as it is within the limit of the RSP.
Mr. Pomroy: Exactly.
The Chair: Why could this not operate without the provinces being on board?
Mr. Pomroy: Here, we are just discussing the tax rules for PRPPs, which will apply to all PRPPs in Canada, whether federally or provincially regulated. There is another system of rules that overlie PRPPs, and those are the pension standards rules that, federally, are contained in the PRPP act and regulations. Provinces will need to come forward with similar pension standards rules for provincially regulated employers, but the tax rules will apply to all PRPPs across the country.
[Translation]
Senator Bellemare: Quebec has put in place a voluntary and pooled savings plan which is more or less the same, except that employees have to contribute to it. They take money out, but as long as they are employed the contributions are automatically levied. Have you taken into account existing tax legislation, and do the new measures take into account the fact that the plan established by the province of Quebec is compulsory to begin with although people can later withdraw? I imagine all this will have an impact on taxation and therefore on the taxes that people have to pay. I imagine this will have been taken into account.
[English]
Mr. Pomroy: Yes, but I think you are discussing certain rules that are not contained in the tax rules. The previous Quebec government did announce that it would essentially harmonize its tax rules with the federal tax rules, yes.
The Chair: We will move on to the next section, clause 37, I believe, on page 79 of the bill.
Mr. Cook: Clauses 37 through 39 are, again, just more PRPP consequential amendments.
Clause 40 applies with respect to employees profit sharing plans, and it simply ensures that any EPSP tax goes into the instalment tax base for a taxpayer. That is clause 40. Clauses 41 through 43 are again more PRPP consequential amendments. The next clause of interest to the committee is likely clause 44.
The Chair: Is PRPP over-contribution in clause 43 just going to be the same as the rules with respect to registered retirement savings plan over-contributions that some of us, unfortunately, are familiar with now?
Mr. Cook: That is correct.
Clauses 44 and 45 implement the anti-avoidance rules with respect to retirement compensation arrangements. Essentially, these rules are very much like the rules that were introduced last year with respect to RRSPs. They are rules with respect to prohibited investments and taxes on advantages provided. We have already talked, to some extent, about the kind of tax planning that these changes are aimed at. I had indicated that one of the things that often make tax planning work is the ability to obtain a refund of the tax that had been remitted to the CRA. There is an amendment to the ability to obtain a refund where property has lost value if the property that has lost value is a prohibited investment or an advantage in relation to property of the retirement compensation arrangement. Those are clauses 44 and 45.
The Chair: Clause 45, rather than amending, seems to add a significant new portion, which surely must, therefore, be a new concept?
Mr. Cook: These are the rules with respect to prohibited investments and advantages that I alluded to. The same rules were introduced with respect to RRSPs last year. If a retirement compensation arrangement acquires what is called a prohibited investment — an investment that has too close a connection between the beneficiary and the employer — then there is a tax imposed on 50 per cent of the value of the prohibited investment. That tax can be refunded if the prohibited investment is disposed of by the RCA.
As well, there is a tax payable with respect to advantages obtained by an RCA. Again, this is, for example, income earned on a prohibited investment and certain types of non-arm's-length loans or other investments. In the case where there is an advantage, the tax imposed on that is 100 per cent of the value of the advantage.
The Chair: Who has the advantage at 100 per cent?
Senator Chaput.
Senator Chaput: I am okay.
The Chair: Good. Glad to hear that.
Mr. Cook: I would note the taxes imposed on the custodian of the RCA. In certain circumstances, there might be joint liability for the tax for beneficiaries who knew or agreed to the course of conduct giving rise to the tax.
The Chair: You are not okay any longer, Senator Chaput?
Senator Chaput: What happened before what you have just explained to us, the imposition of the 50 per cent tax? What was happening before this?
Mr. Cook: Before, people were contributing money to an RCA and taking a tax deduction for the contribution to the RCA. They would pay the RCA tax, but then they would enter into a series of transactions that would allow them to get the money back out and back into the hands of the person who made the contribution in the first place. Then, they would arrange their affairs so that they could get a refund of any tax that had been paid by the RCA. It would avoid income being earned directly by the individual. The employer might get a deduction for the contribution, and there would be no tax paid.
Senator Chaput: Thank you.
The Chair: I probably should know the answer to this, but the heading at page 91 is "Tax on Excess EPSP."
Mr. Cook: That goes back to the discussion we had earlier on employees profit sharing plans. This is the tax that we discussed earlier relating to excess EPSP contributions, which had been used to split income, avoid CPP and EI contributions and also to defer tax. We have talked about it before, but this is where the actual tax is housed.
The Chair: We have talked about it before, saying that you should not do it.
Mr. Cook: This is why you should not do it.
The Chair: This is definitely why you should not do it.
Are we up to clause 47 now?
Mr. Cook: Clauses 47 and 48 are, again, just more PRPP consequential amendments. For example, clause 48 has to do with payments being made to a non-resident and whether they are subject to a PART XIII withholding tax.
Clause 49, at page 93, is the main clause and is the measure with respect to foreign affiliate dumping, which we discussed earlier.
The Chair: Is it a taxing measure?
Mr. Cook: It is a taxing measure in the sense that it can deem a dividend to be paid to a non-resident, and that deemed dividend will be subject to a PART XIII withholding tax. In this one, we indicated that over the planning period we booked approximately $1.3 billion. This measure continues until page 121, where the next clause starts.
The Chair: That is an awful lot of words to achieve what you have told us in half a minute.
Mr. Cook: Certainly, we can either stay at a higher level or go into great detail.
The Chair: No, I think the higher level is good. Senator Bellemare would like a little more detail.
[Translation]
Senator Bellemare: Have other countries implemented this type of measure? Are these reciprocal measures, or are they particular to our tax system?
Senator Hervieux-Payette: The situation is worse in France.
[English]
Shawn Porter, Director, Tax Legislation, Department of Finance Canada: That is a good question. The bottom line is that in one form or another, most of our major trading partners would have a provision of this nature. It would not take this particular form because they have to add and incorporate it into their existing legislative scheme that covers how they tax international inbound and outbound transactions. The form, words and phrases would not be the same. Many countries would think about how to protect their domestic tax bases against this kind of tax planning.
It really touches on the earlier question of whether this will impede ordinary course transactions or make Canada less attractive as a destination for foreign capital. In order to respond to that confidently and say no, it requires a lot of line-drawing because the range of ordinary commercial transactions that take place in the marketplace is quite diverse. Much of the detail and the prescription that you see in the provision is the result of responding to what we have heard in consultations to try to provide safe harbour and passage for those foreign-based companies not engaged in the kind of abuse of tax planning at which this rule is aimed.
The Chair: We will move on to clause 51. Is that correct?
Mr. Cook: Clause 50 is next.
The Chair: Is it page 121?
Mr. Cook: Exactly. Clause 50 is part of the thin capitalization changes that we talked about earlier. Specifically, this change will provide that a deemed dividend is subject to part XIII tax in certain circumstances. The thin capitalization rules deny interest expense. If you have too much debt and are paying too much interest to a non-resident, then the existing rules simply deny the interest expense.
The character of that payment has not been changed, so it is just the interest expense. In particular, interest paid to the U.S. is not subject to withholding tax under the Canada-U.S. treaty. Even where the thin capitalization rules apply and reduce your interest expense, there may still be an incentive to engage in this kind of arrangement because of your ability to pay interest and not have it attract part XIII withholding. For example, a dividend would attract a part XIII withholding tax.
Under this measure, to the extent that you have denied interest, that interest will be a dividend paid to the person you paid the interest to and will attract a part XIII withholding tax at the appropriate rate.
The Chair: That scheme is devised to get around the tax treaty between Canada and the U.S.
Mr. Cook: I would say that the current approach to planning is to take advantage of different provisions of the tax treaty between Canada and the U.S. This change recognizes that this kind of excessive interest expense is a way of extracting profit out of Canada that should be treated as a dividend.
The Chair: On to clause 51, page 122.
Mr. Cook: Clause 51 relates to foreign affiliate dumping. This is a consequential amendment that deals with situations where a corporation emigrates from Canada.
Clause 52 provides some rules with respect to penalties in the context of the thin capitalization changes and the secondary adjustment changes.
Clause 53 relates to PRPPs and covers the ability to share information with respect to the administration of PRPPs.
Clause 54, on page 126, is the primary clause setting out the rules relating to transfer pricing secondary adjustments, which we have already discussed.
Clause 55 makes some changes to definitions in section 248, which is the main definitional section of the Income Tax Act.
Clauses 56 through 60 provide various consequential amendments with respect to pooled registered pension plans, including the requirement for PRPP administrators to file an annual information return with the CRA.
The Chair: It would have been helpful had these been put in the bill together rather than in so many clauses. I assume that is because you are trying to fit all this into an existing piece of legislation.
Mr. Cook: That is correct. The way in which the Income Tax Act is laid out, there is computation of income rules and special rules that apply to taxpayers. Then, we created a new special rule with respect to PRPPs. It is very much a case of trying to fit it all in everywhere in the ITA that the changes have to go.
Next is clause 61 on page 132.
The Chair: Okay. There is a lot of dark print here. We are almost to the bottom.
Mr. Cook: Clause 61 provides the rules that allow accelerated capital cost allowance for certain clean energy equipment and provides that plant residue will be an eligible waste fuel.
The Chair: Did we just pass a milestone here? Are we now into regulations?
Mr. Cook: We are now in the regulations.
The Chair: I think you should have mentioned that. We are done with the act and we are now into the Income Tax Regulations. This is going along very nicely. Thank you.
Mr. Cook: Currently, when waste-fuelled thermal equipment is used, it is only eligible for accelerated capital cost allowance under Classes 43.1 and 43.2. If it is being used in an industrial process or in a greenhouse, this measure will take out the requirement that it must be used for heat or power generated; it can be used for any purpose. As well, plant residue becomes an eligible waste fuel.
Mr. Trueman: It also extends it to include the use of district energy equipment that is fuelled by that same waste — the ability to distribute the heat across more than one building, for example.
The Chair: This is a new initiative to make up for some of the other initiatives that have been taken away.
Mr. Trueman: Correct.
Senator Finley: For clarification, is this residue that is produced or a by-product of the industrial process itself? Let us say a greenhouse wants to convert municipal garbage to heat and power. Is that affected by this?
Mr. Trueman: This particular measure includes residue of plants, such as straw, corncob and similar organic waste by the agricultural sector, and this allows it to be used for heat generation.
Senator Finley: It does not include household waste, for example municipal collection of household waste.
Mr. Cook: There is an existing definition of eligible waste fuel that currently includes biogas, bio-oil, digester gas, landfill gas, municipal waste, and pulp and paper waste. There is an existing group of materials that are eligible waste. I think for what you have asked, municipal waste is already contemplated; it is just adding the plant residue.
[Translation]
Senator Chaput: Is it not usual to first draft the bill, and then the regulations? What we have here is a bill and the amendments to regulations, both in the same document. Is this usual way of proceeding?
[English]
Mr. Cook: You are quite right. There is a separate process with respect to regulations. With respect to the Income Tax Act, particularly when we are implementing budget measures, you need to make amendments to both the act and the regulations. It is felt that as a matter of making sure that the measure gets in at the same time and appropriately, they should just fit together.
Senator Chaput: Thank you. It could be done both ways too but for this —
Mr. Cook: Absolutely. We certainly do regulatory projects that are not done through the bill process.
The final point with respect to the accelerated capital cost allowance is that this bill would also implement a rule to provide that the accelerated capital cost allowance is not available unless the equipment we are talking about here, at the time that it becomes available for use, complies with all appropriate environmental regulations. If it does not comply, it would just fall into whatever other class that would be applicable.
The Chair: Do we find that wording in clause 61?
Mr. Cook: Yes, you do. You would find it in your copy on page 133 in the black; it is subsection 3. Then 17(b) says:
at the time the property becomes available for use by the taxpayer, the taxpayer has not satisfied the requirements of all environmental laws, by-laws and regulations
(i) of Canada, a province or a municipality . . .
The Chair: If we had the full section or the section before, we would see that there is an accelerated capital cost clause in there and that this creates an exclusion?
Mr. Cook: That is exactly right.
The Chair: We will move on to clause 62.
Mr. Cook: Clause 62 provides a change with respect to scientific research and experimental development. This is where the change in the proxy rate is contained. The proxy rate is a proxy for overhead expenditures relating to SR&ED. Taxpayers have the choice of itemizing and claiming appropriate overhead expenditures with respect to SR&ED, or they can use a proxy based on salaries and wages of their employees engaged in SR&ED in Canada. That proxy rate is currently 65 per cent and is being reduced to 55 per cent.
The Chair: It is 65 per cent going down to 55 per cent?
Mr. Cook: That is correct.
The Chair: Did we discuss earlier that that might encourage more detailed calculations?
Mr. Cook: It would be up to the taxpayer. If they felt they would be better off doing an itemized list, they could do that and be eligible.
The Chair: Is the policy purpose behind this that we should not be using a proxy and an estimate and we should have more specific numbers?
Mr. Trueman: It is a mix of those two. The proxy is intended as a simplification measure. However, at the same time, in the interest of cost effectiveness as identified by the Jenkins panel, it is to reduce that proxy rate a little bit for businesses but retain the option that they can keep that itemized record and submit overhead expenses if that is more advantageous to them.
The Chair: I think we discussed that earlier today.
Senator Callbeck: It has gone from 65 to 55 per cent, so why was 55 per cent picked?
Mr. Trueman: It is being phased down from 65 to 60 and then to 55 per cent over a two-year period. That reduction was chosen as a reasonably modest reduction that would remain relatively the same rate for taxpayers but would provide some of the cost-effectiveness that the Jenkins panel was looking for. It is unlikely that there is one proxy rate that is correct for all taxpayers. This moves it down a little bit but leaves them the option of calculating actual overhead and claiming those amounts where they choose to do so.
Senator Callbeck: That is what the panel recommended?
Mr. Trueman: It is consistent with the recommendations of the panel regarding cost-effectiveness.
The Chair: This may be a question for the minister; it may be a policy issue. We had a discussion this morning about the Jenkins report, the removal of these credits and encouragement as a substitute for more direct investment by the government. We are getting the removal of the credits, but we are not seeing any direct investment plan. You would not be involved in that aspect of things, would you?
Mr. Trueman: You are absolutely right. As the taxation bill, this only brings the tax measures to us. I can give you a little bit of background and overview on the spending side.
The findings in the Jenkins panel were that among its competitors, Canada has an overreliance on indirect support through the tax system when you compare us to most of the other G7 or G20 countries. The idea from the Jenkins panel was to rebalance that a bit by reducing indirect support through the tax system and increasing direct support through program spending.
What we have talked about here today are the changes to the SR&ED tax program that reduce its generosity and make changes in that regard.
On the spending side announced in Canada's Economic Action Plan 2012, there is $1.1 billion in new spending over the framework, as well as $500 million on the venture capital side, $100 million to the BDC and $400 million in a venture capital fund.
Those are the offsetting, if you will, increases on the expenditure side. It is important to know that those are being undertaken as well. I will not go into detail — it is not my area of expertise — but certainly that balancing act is laid out in Budget 2012.
The Chair: Are we likely to see the $1.1 billion and the $500 million in venture capital direct investment somewhere else in this particular legislation as a Budget implementation, or more likely in one of the supplementary estimates?
Mr. Trueman: Not in this budget bill but more likely through the spending side, yes.
The Chair: We will keep an eye out for that. Thank you.
Mr. Cook: Clause 63 simply has some consequential changes with respect to SR&ED and the AITC oil and gas measure.
Clause 64 repeals a provision that has to do with capital with respect to SR&ED, so it is no longer needed.
Clause 65 provides for the computation of an interest rate. I mentioned earlier with respect to foreign affiliate dumping that there was the ability to elect to have an income inclusion. This provides the rate for that income inclusion.
Clause 66 provides further consequential changes with respect to the Atlantic Investment Tax Credit.
Clause 67 again just adds some references to pooled registered pension plans for some of the rules and regulations.
Clause 68 defines "permanent establishment" as generally being a fixed place of business, most relevant where non- residents are carrying on business in Canada. This relates to the rule relating to tax avoidance through partnerships, and there are amendments to section 100 of the act. A Canadian taxpayer can avoid the application of section 100 if they are continuing to use the assets in Canada through a permanent establishment.
Clause 69 simply adds a reference to the PRPP rules in new section 147.5.
The Chair: Were there consultations that took place, and were all of these regulations published so people could see them?
Mr. Cook: The pooled registered pension plans information was released for consultation on December 14, 2011. All the legislation that is here was released in draft form. I guess I should note that a fair bit of this was in fairly advanced states and released as part of the Notice of Ways and Means with Budget 2012. It was all released in draft form in August for consultation, with the exception of the PRPP legislation, which had been previously released, and the one measure with respect to the pension income splitting measure for RCAs.
The Chair: Does whoever is reviewing this have the opportunity to see what the proposed legislation is upon which these are being built? Is that in draft form and circulated as well, or do they have to read between the lines here?
Mr. Cook: Generally, our process is to release the draft legislation and then we have the consultation period. We analyze the comments we get with respect to the draft legislation and then we make whatever changes we think are appropriate to the legislation. Then that is the legislation that is tabled.
The Chair: I will go back to Senator Chaput's question. We feel better if the people who are impacted by these regulations have had a chance to review them and understand them.
Mr. Cook: Even the regulations have all been released as draft legislation, the same as the changes to the Income Tax Act. In terms of releasing in a draft for comment, we do not really make a distinction for budget measures between regulations and changes to the actual Income Tax Act, if that responds to your question.
The Chair: It is getting there. Thank you.
Mr. Cook: I guess what I am saying is that we release in draft, people get to comment, and we make the changes that we think are appropriate. At that point, we do not go out again and ask if it addresses their concerns. Our response is the legislation that we table.
The Chair: I understand from your saying "we release in draft" that you release in draft both the proposed changes in the legislation and the regulations.
Mr. Cook: Yes, that is correct.
Senator Chaput: Released how? Is it released through the Canada Gazette?
Mr. Cook: No, we do a separate news release for the Department of Finance Canada and it is posted on our website. It is available to everyone.
Senator Chaput: Is it not in any newspapers, just on the Web?
Mr. Cook: It is on the Web, not in any newspapers. Certainly all the tax services will know, and within hours — not even hours — there are notifications going out. The tax community does not miss much.
Senator Chaput: How long do they have to get back to you?
Mr. Cook: It will depend on the particular type of consultation. For example, for part of the foreign affiliate dumping, we specifically asked for comments after budget and there was a 60-day period for that. The draft legislation itself was a 30-day consultation period.
The Chair: We were at clause 70, were we?
Mr. Cook: Yes, I believe we were.
The Chair: Over to page 138.
Mr. Cook: Clause 70 relates to the accelerated capital allowance for clean energy and the particular measure that we talked about, which is taking out the requirement for the energy to be used in an industrial process or greenhouse. This is where that change is.
The Chair: All right.
Mr. Cook: Then clauses 71, 72 and 73 all relate to RDSPs. In particular, clause 73 is where the RDSP change relating to proportional repayment is found.
The Chair: To "proportional . . ."?
Mr. Cook: Repayment. That is the rule where, if you make a withdrawal from an RDSP, you pay $3 for every $1 that is withdrawn instead of having to pay back the whole assistance holdback amount. That can be found in new sections 5.3 and 5.4.
Senator Callbeck: With clause 71, the Canada Disability Savings Regulations, you are talking about the transfer to a new issuer. It says that this budget proposes that Human Resources and Skills Development Canada rather than the original issuer be responsible for providing this information to the issuer of the new plan.
Why are you making that change?
Mr. Cook: This is to facilitate transfers between issuers of RDSPs. Currently, when a beneficiary of an RDSP wants to change from one issuer to another, the person who is leaving the RDSP has to provide all the related transactional information to the new issuer. As we talked about earlier, if you make a withdrawal from an RDSP, you are potentially liable for the assistance holdback amount. That means that any RDSP issuer must have a full record of all the transactions, grants and bonds paid into the RDSP in the prior 10 years.
Human Resources and Skills Development Canada has all that information. Therefore, this is to make life easier for issuers; HRSDC has the information and they can provide it to the new issuer rather than requiring one issuer to provide it to another.
Senator Callbeck: That makes sense. Thank you.
The Chair: I see no other senators wishing to ask any questions. I suspect that this is the end of your work, because we just got to the end of Part 1, which has been very good. Mr. Trueman, Mr. Cook, Mr. Porter and Mr. Pomroy, thank you very much for being here. We hoped that we would get quite a ways in this, but did not imagine that you would be able to get us all the way through Part 1.
Tomorrow at two o'clock in the other room here in the Victoria Building we will start Part 2, which deals with the Excise Tax Act. The idea would be to do Part 2 and Part 3. Part 3 is quite short. Then, when we get back after our break, we will have Part 4 to wrestle with. We are moving along nicely.
Thank you, Department of Finance, for your work and Mr. Cook in particular for leading the group.
Mr. Cook: Thank you.
The Chair: This meeting is now concluded.
(The committee adjourned.)