Proceedings of the Standing Senate Committee on
National Finance

Issue 21 - Evidence - November 19, 2014

OTTAWA, Wednesday, November 19, 2014

The Standing Senate Committee on National Finance met this day at 1:47 p.m. to study the subject matter of Bill C-43, A second Act to implement certain provisions of the budget tabled in Parliament on February 11, 2014 and other measures.

Senator Joseph A. Day (Chair) in the chair.


The Chair: Honourable senators, this afternoon, we are continuing our study of the subject matter of Bill C-43, A second Act to implement certain provisions of the budget tabled in Parliament on February 11, 2014 and other measures.


This afternoon we have two panels, honourable senators. I propose that we deal with the video conference group first, so I will introduce those witnesses. We thank you all for being here.

When you're speaking or if you wish to intervene in a question that's posed if you could identify yourselves because we don't see your name tags and that would be helpful.

Katie Walmsley is the President of the Portfolio Management Association of Canada. She is appearing from Toronto. Ms. Walmsley will be speaking on Part 1, clauses: 2, 9 to 16, 26 to 29, 38, 42 to 46, 71, 72, 75, 81, 84, 86 and 87. Those begin at page 1 of the bill. They're all on those various clauses. We try to follow those, witnesses, as we're going through. If you're making reference to a particular clause, sometimes you have to give us a little time to get to that particular one. We will all help one another in terms of trying to find the page.

Ms. Walmsley is accompanied by Lindsay Rogan, who is the Managing Director of Rogan Investment Management; Michael Friedman, Partner at McMillan; and Joseph Micallef, Partner at Ernst & Young LLP.

Thank you very much. Is there one or more of you who would like to make some introductory remarks?

Katie A. Walmsley, President, Portfolio Management Association of Canada: Thank you very much, Mr. Chair. I will start by providing some background on PMAC and the two issues we wanted to focus on today. As I mentioned, I will then turn it over to Lindsay Rogan, who will provide some comments.

First of all, for those of you who don't know, PMAC represents over 200 investment management firms from across Canada that manage assets for private individuals, foundations and pension plans. In terms of Bill C-43, we wanted to focus our comments on two issues related to trusts: first, the trust loss restriction rules as they apply to investment funds and specifically pooled funds; and second, the elimination of graduated rates of taxation for testamentary trusts and other trusts.

I'll start with the trust loss restriction rules. By way of background, in March 2013, under Bill C-40, section 251.2 came into force. This new trust loss restriction provision was enacted to prevent arm's-length loss trading transactions that have been developed and that purport to enable one taxpayer to access the unused losses of another. Investment funds, including mutual funds and pooled funds, which are formed as trusts, were inadvertently captured under this provision.

So how were funds captured? In simple terms, Bill C-40 included changes to trust loss event rules. Specifically the rules are triggered whenever a person becomes a majority interest beneficiary or when there is more than a 50 per cent change in the beneficial ownership of the trust. The loss restriction rules can have significant consequences to funds that are structured as trusts. These include a deemed taxation year, or in some cases multiple taxation year ends that may require additional distributions and filings; unused capital losses; unrealized losses on non-depreciable capital properties; and a potential for negative impact on an investor's returns.

Various industry stakeholders made submissions and raised concerns about the impact of these rules on investment funds and pooled funds. I'm very pleased to report that many of the concerns that were raised were actually addressed in Bill C-43. We applaud the government for expediting these changes so quickly.

While the amendments to Bill C-43 are positive and truly a step in the right direction, they do not go far enough in exempting certain situations. In particular, the relief does not capture pooled funds that are managed to comply with investment and restrictions under the Pension Benefits Standards Act or similar restrictions under provincial law.

First, some background on pooled funds. Pooled funds are very similar to mutual funds but with a few key differences. Mutual funds are sold to the public by way of a prospectus, versus pooled funds, which are offered via private placement through an offering memorandum. Recent estimation indicates that there are over $120 billion in pooled fund assets in Canada. Many of these pooled funds hold pension plans, both defined contribution and defined benefit pension plans. Pooled funds represent a very important option for Canadians that allow for the management of volatility and they comprise the necessary component of investment strategies, particularly for institutional investors. They also have the advantage of fees generally being 50 per cent lower than that of mutual funds.

As mentioned, Bill C-43 goes a long way, with its amendments, to address some of the concerns that were raised, but does not provide relief for pension pooled funds that contain pension plan assets under the Pension Benefits Standards Act.

I'll provide a simple example. If we had an investor, Mrs. Smith, whose retirement savings were invested in a pooled fund and that pooled fund also contained pension plan assets, the relief provided under Bill C-43 would not necessarily apply, and potentially there would be some negative aspects on the returns of Mrs. Smith's retirement savings.

In slightly more technical terms, pension rules apply a book value test in determining the permitted investment concentration rather than a fair market value test as contemplated under the trust loss relief in Bill C-43. Consequently, this would mean that a significant portion of the $120 billion in pooled fund assets in Canada would not be able to rely on the relief it provided in Bill C-43.

For an individual investor such as Mrs. Smith, her investment returns could be potentially lower simply because she was in a pooled fund. Had she been in a mutual fund, the relief would have been granted due to the exemptions provided in Bill C-43.

That being said, the investment restrictions under the Pension Benefits Standards Act are under review. The expectation is that they will be changed to market value test in the future. Thus today, what we're recommending is that there be some type of transitional relief provided for those funds that are managed in accordance with the Pension Benefits Standards Act investment restrictions. We do not see a justified policy to continue to exclude pooled funds from the exemptions in Bill C-43. As the standing committee is aware, this relief could be granted by way of a comfort letter or possibly through clarifying explanatory notes in Bill C-43.

I now want to cover the second issue, which is the elimination of graduated rates of taxation for testamentary trusts and other trusts. I will turn it over to Lindsay Rogan, who is with a firm, Rogan Investment Management, which manages investments for a number of private clients.

Lindsay Rogan, Managing Director, Rogan Investment Management: Thanks Katie. Good afternoon. We understand that the government is concerned with the use of testamentary trusts and with tax motivated delays in completing the administration of estates. However, we believe that there are other ways to address these concerns, rather than penalizing the beneficiaries of testamentary trusts that have been established or maintained for a variety of reasons, which are totally unrelated to tax.

Some of those reasons might include: management of inheritances for minor beneficiaries, before they reach the age of majority or perhaps complete their education; management of estates for elderly spouses who, because of age or lack of capacity are vulnerable to financial abuse; protection of capital from potential creditors; staged distribution to spend thrift or vulnerable beneficiaries; preservation of family inheritance for one's children; professional investment management of the assets; or the inability to fully administer an estate for non-tax reasons.

After January 1, 2016, all income retained in a testamentary trust will be taxed at the highest rate applicable to individuals in the province of residence of the trust. This is particularly problematic for trustees without the power to distribute certain types of trust income. This significant change in tax policy in Canada does contain some limited exceptions and especially important is the treatment of disabled beneficiaries. But, I'd like to focus my comments around three key recommendations, which relate largely to clause 71.

First, we would ask that the 36-month period after death be reconsidered. So, for the first 36 months after the date of death, graduated tax rates will apply to an estate. If the estate remains in existence for more than 36 months, it will then be subject to the highest marginal tax rate applicable to individuals, for all the income retained in the trust. We feel that the 36-month period is arbitrary. It's not responsive to the non-tax related circumstances of many estates and is therefore unreasonable.

An estate is merely a holding vehicle for a person's property, which is created automatically on their death and graduated tax rates should apply to the income on the estate as long as there are legitimate non-tax reasons for that estate to exist. We believe that 36 months, in many cases, may not be a reasonable period of time for winding up an estate, in particular, for cases involving illiquid assets, beneficiaries who are hard to find or locate, or where litigation is involved.

Second, a 36-month administration period should perhaps be reconceptualized as a safe harbour period, and the Department of Finance should consider a specific anti-avoidance purpose test to tax those estates whose continued existence is primarily tax motivated.

Third, we note that the 36-month period is also inconsistent with provincial legislation. Our second recommendation would be to allow for ministerial discretion to obtain relief in certain cases and include grandfathering options. Like any policy change, there will be unintended consequences when administering the new rules. These concerns could be addressed if there is the ability for the minister to provide relief and extend the period during which the estate is subject to tax at the graduated levels.

The Income Tax Act should provide this flexibility. For instance, many Canadians may have provided for the establishment of testamentary trusts in their wills and no longer have capacity to make changes. We also believe that consideration should be given to grandfathering options, such as extending the period during which graduated rates apply to testamentary trusts with minor beneficiaries until they reach the age of majority at least.

The third recommendation would be to relax the implementation date to 2017. Given the aging population of Canadian investors, we believe that a significant portion of Canadians will not be aware of this change. Many wills established testamentary trusts structured on the expectation that they would be taxed at a graduated rate as a way to mitigate the difference between income for tax purposes and income for trust purposes.

The loss of access to those rates will negatively impact many Canadians who thought they had planned prudently many years ago. This will cause many clients and their advisers to rethink existing estate plans and this will take time and effort. One thing is clear: Estate and tax planning and administration in Canada will change as a result of Budget 2014. The bigger questions are whether Canadians will be aware of the significance of these changes on their life savings and if they will have enough time to plan accordingly. We recommend a longer transition to 2017 in order to allow more time for awareness and planning.

PMAC thanks the Standing Senate Committee on National Finance for the opportunity to make these submissions.

The Deputy Chair: Thank you very much. I'm Larry Smith, and I'm filling in for Senator Day who is giving a speech in the chamber.


Senator Bellemare: Would you like the bill amended to delay the implementation date to 2017 and prolong the 36-month period you mentioned in your first point?

I have a question about your recommendation to allow for ministerial discretion. Could you elaborate on the scope of that discretion in terms of its application here? In your view, is it typical in Canadian tax legislation for the minister to have such authority or would this set a precedent?


Michael Friedman, Partner, McMillan: Thank you very much for that question. We would submit that it is quite typical in the context of Canadian tax legislation for discretion to be vested with the minister either to grant relief from the application of a particular rule or alternatively relief from a penalty or filing requirement.

You look at section 220 of the Income Tax Act, which grants the minister broad relief to extend election periods or to grant relief from interest in penalties. What underpins all those rules is recognition that circumstances for particular taxpayers differ, and hard and fast rules can penalize taxpayers in a particularly burdensome fashion. Our suggestion and submission is that this would be consistent with the structure and scheme of the Income Tax Act as it stands and protect those who would be unduly prejudiced by a very blunt and wide-spanning rule.


Senator Bellemare: Do you have a specific idea as to how those amendments should be formulated?


Mr. Friedman: In that context there would be two alternatives, as Ms. Rogan proposed at the outset, with respect to the 36-month rule for graduated taxation. It could be formulated first as being a safe harbour and then from that point, in the context of our self-assessment system of taxation, taxpayers would elect to apply the graduated rates if they believe that in their estate there was an impediment to winding that up. It would then be open to the minister to challenge that and the burden would be placed upon them.

Alternatively, you could maintain the 36-month rule and then there would be a requirement to seek relief from the minister through an application that the minister could perhaps delegate to the Canada Revenue Agency to administer. An administrator, executor or executrix of an estate would apply in advance for that relief. In the context of your question, you asked previously whether that would be a recurring application or an application that would be made once. Again, there would be flexibility in that regard. It could be on a year-by-year basis, it could be for a block period, or it could be a mechanism that someone elects to do, without permission, which would then be reviewed by the minister at a later date.


Senator Bellemare: Thank you. That is helpful.


The Deputy Chair: I will ask the group, because we have varying degrees of financial expertise around this table, if you could give us a simple example of a case you could construct immediately showing someone under the present laws with a trust with X number of dollars, and someone under the new rules. For those people under the new rule — I'm not going to say ''penalized'' — how would the amounts they'd have to distribute differ? I think that would be a very helpful example, if the committee agrees with this question.

Mr. Friedman: We will be happy to do so and we will construct immediately a very simple example, but I would stress we could probably spend hours.

The Deputy Chair: I'm sure you could. We would appreciate your efforts to construct something quickly. You're all financial wizards over there anyway.

Mr. Friedman: Let's take an example of an estate with a very simple investment that had $100 of income each year. An estate executor is appointed, but by the terms of the estate, they are having difficulty finding beneficiaries. They may have a common name, be located in different parts of the country and they are unable to administer the estate within 36 months. They have made all reasonable efforts to locate the beneficiaries. There is some debate and it takes five years to administer the estate rather than 36 months. Under the current circumstances, you would expect that estate to be taxed at graduated rates. The income — perhaps $100 is too low for the purposes of our graduated rates, so let's say it was $50,000 or $75,000 of income — would be taxed at the graduated rates that all the individual members would be familiar with, and that would extend through the administration of the estate.

By contrast, under the proposed rules with a 36-month fixed period, after three years that amount of income would no longer be taxed at graduated rates but at the top marginal rate applicable to individuals. That's solely by virtue of circumstances that have absolutely nothing to do with tax planning, nothing the executor could have done. In our example they were working with due diligence to try to administer the estate; they simply had trouble locating the beneficiaries. That would be a very simple example of a circumstance where equity is not preserved. In this particular case, there was no tax planning motive whatsoever, but by virtue of the simple practice of administering an estate, the hard and fast 36-month rule prejudices the estate under the new proposed legislation.

The Deputy Chair: So if we had a case where the trust was distributing $100,000 a year, as a more simple example, and they did find the beneficiary but the beneficiary was at the highest tax bracket, what would happen to that 100,000? Are you saying it would be taxed at 49 per cent?

Mr. Friedman: Under the rules, if it's maintained in the estate, it would be taxed at 49 per cent. If it was distributed it would be included in their income.

The difficulty would be if that beneficiary was taxed at the lowest marginal rate. Under that example, suddenly, if it was taxed in the estate, it's taxed at 49 per cent. Had it been distributed to that individual, it might be taxed at a lower rate or no rate at all, depending on their circumstances or the losses from other sources, so in that particular case, we have inflated taxation.

There is a lack of integration, which is inconsistent with the scheme of the act or tax policy as we understand it.

The Deputy Chair: Let's go on to Senator Chaput, Manitoba.


Senator Chaput: I have a very quick question, Mr. Deputy Chair.

At the very end of your brief, you say that the bigger questions are whether Canadians will be aware of the significance of these changes on their life savings and whether they will have enough time to plan accordingly.

Who do you think is responsible for letting Canadians know about these changes and what is the best way to do that?


Ms. Rogan: That's an interesting question. I think it will fall upon the government, financial advisers, accountants and lawyers to inform their clients of these changes. I tried to imagine in my business all of my clients rushing to have their wills redone and updated all at the same time and then extrapolated that across the entire industry. It takes time for people to undertake that planning. They often have issues that are not related to tax, which are even more complex in the construction of an estate.

People will need to rethink some of the basic methods that have been used by Canadians to protect their inheritances for their children, where you have Canadians who have second marriages, want to provide for their surviving spouse, and to protect the capital for their children. You have existing trusts that have no provision to distribute the capital gains as income, so the children will be paying the highest marginal rate on the income retained in the trust for their benefit, with often no ability for the trustee to flow that income to them at their own marginal tax rate.

It would be very complex for people to reconstruct their estate plans, and I am not sure even the legal community has capacity.

The Deputy Chair: You talked about pooled funds on the second page of your presentation. It says:

While the amendments in Bill C-43 are positive and a step in the right direction, they do not go far enough in exempting. In particular the relief does not capture pooled funds that are managed to comply with investment restrictions . . . .

Can you give us some examples of that, please?

Ms. Walmsley: Sure. I will ask Joseph Micallef to comment.

Joseph Micallef, Partner, Ernst & Young LLP: Thank you for the question. With respect to pooled funds, currently, the way the proposed amended legislation is reading, the way in which the measurements currently provide for exemptive relief for pooled funds certainly does not take into consideration a number of ways in which pooled funds measure their investment holdings on an ongoing basis.

To be specific about that, a pooled fund, which has obviously defined pension plans, other institutional money in it, tends to hold investments in a particular security. The way in which the revised definition for exemptive relief for commercial investment funds currently stands, they're basing it on fair market value concepts that aggregate all of an investor's overall concentration of holdings in comparison to the value of the entity, which, I might point out, isn't necessarily available on a daily or more frequent basis than what public disclosures demand.

Currently, the issue stands between what the investor restrictions have currently as the fund itself, so, for instance, measuring investment concentration, and/or investment restrictions based on the cost basis initially on day one, as opposed to what the legislation in the act has, which is looking at a fair market value of all sorts of investments that a particular pooled fund may hold in itself.

BlackBerry is good example. If the fund holds BlackBerry and they have pref shares issued, common shares in debt, and that fund has investments in all those areas for whatever reason on their investment strategy, they may be perfectly fine within the confines of the investment restrictions defined, for purposes of being on side as the fund investment strategy. Unfortunately, where BlackBerry would not be available for the fund to measure or determine if they are outside the exemptive relief issues, is how do you measure fair market value when that information is only available on a quarterly basis or even not at all?

It is a very challenging relief or exemption to get relief provided for. That is the issue. It isn't about the question of whether or not losses themselves reside in the trust. It is very clear from a policy perspective that trust loss restriction trading overall is to be voided between arm's length individuals.

However, the legislation, as currently drafted, which was intended to provide relief for pooled funds, makes it almost impossible for a fund to actually reap those registration-like measurement requirements under the proposed law.

That's a simple way in which to characterize the scenario, which, unfortunately, unless other sorts of tools or systems or processes were implemented — and, quite frankly, the industry is at a loss on how to do that — this would make the problem still exist for a vast number of these pooled fund plans across the country.

The Deputy Chair: Well, that was quite an answer. It sounds like it is going to garner lots of business opportunities for you folks to try to figure it out.

Mr. Micallef: The problem is if I had that magic bullet, I wouldn't have a problem with this. Unfortunately, I don't have access to public information on a daily basis because the act only requires you to be offside one day in the year, even if instantaneous, and it is clearly impossible for any fund to absolutely get those measurements to comply with the way the act reads currently.

The Deputy Chair: Thank you.


Senator Bellemare: According to the documentation, the full financial impact of these measures for the government will be $245 million over 5 years.

It says here that the personal income tax measures related to graduated rate taxation for trusts and certain estates will have an initial impact of $20 million, for a total of $245 million over 5 years. Do you agree with that estimate?


Mr. Friedman: With respect, one of the challenges that commentators in the community have raised repeatedly is it is very difficult to understand how those figures may have been computed and the basis upon which they have been divided among years.

Presumably, the intention of the government would be to promote a system that is integrated. So in order to compute the amount of tax that will be earned by moving away from the graduated rates, presumably you would then have to be able to identify how taxpayers would adjust by paying amounts out, what rates that will be taxed at. That raises a number of questions that have difficult answers, and we have difficulty quantifying that amount.

The other question I would raise is that's additional revenue being earned, but at what cost? It strikes us that one of the underlying assumptions may be this is a tax planning mechanism, that if these amounts were distributed otherwise, they would be subject to higher tax rates in the hands of the beneficiaries of the estate. We would question the basis for that assertion in all circumstances.

It may well be that this will generate additional tax revenue, but that will come at the expense or be borne by taxpayers who would otherwise be subject to tax at lower marginal rates.

We have two fundamental questions: How are those figures computed; and there may be additional revenue but who is bearing the burden of that revenue? If it is taxpayers at lower marginal rates, it raises some critical and important policy considerations about whether that is prudent tax policy.

The Deputy Chair: You made three suggestions to reconsider the 36-month period after death, allow for ministerial discretion to obtain relief in certain cases including grandfathering options and delay the implementation date to 2017.

Again, if you were able to translate this into a case with a $100,000 or $200,000 estate or trust, could you walk us through what the implications could be to that particular trust, with your recommendations? Would you be able to do that in terms of giving us some practical examples of what would come forth from your changes to this specific case?

Mr. Friedman: If we were to construct a more nuanced legislative system, you would have legislation that would recognize and accommodate non-tax planning considerations, whether or not they're imposed on an estate. Borrowing upon a previous example and circumstances where an estate can't be administered because it is subject to litigation or has difficulty in finding beneficiaries, an added tax burden that is not justified would be placed on that estate by imposing a hard and fast 36-month rule.

Similarly, for our second recommendation, in the context of that estate with $100,000 of income, it may be that there are non-tax planning reasons why the amount of that estate shouldn't be distributed. For the reasons that Ms. Rogan pointed out, the circumstances of the beneficiary may be such that they can't manage their own affairs or they're subject to a disability where there are prudent and reasonable financial reasons why those assets should remain in the control of the trustee that has been appointed.

By imposing these rules that are now proposed, the estate is essentially forced to distribute those assets prematurely or, if it doesn't, face an added toll, added tax burden that is totally unrelated to tax planning, but is simply viewed as the cost of protecting the interests of the beneficiary. It is truly a peculiar result.

Finally, on the question of providing notification, in the example of our estate that was $100,000, it may arise under a pre-existing will. Let's assume that the testator doesn't pass away until 2016, in the middle of the year. If we don't provide a significant or reasonable amount of time for people to adjust their wills, we may be in a circumstance where, unbeknownst to them, they structured their will in a way that it created testamentary trusts rather than preserving the assets in an estate. As such, it will be immediately subject to taxation at the highest marginal rate.

Had they been given a reasonable opportunity to adjust their will and for that information to disseminate among the public, they would have changed the terms of that will to accommodate the new legislation. So in each of these circumstances, we have a will with an estate with $100,000 of income, but depending on the circumstances, they can be prejudiced in a variety of different ways. We have attempted to propose three relatively simple solutions that will accommodate the nuances of estates.

As you know, every individual's circumstances will differ. They're coloured by the nature of their family, their beneficiaries and their personal circumstances. When we have a simple rule that has bright line tests, we fail to accommodate these circumstances and people are undoubtedly prejudiced.

We realize there's a balancing act here, that there has to be some pragmatism balanced against the need to accommodate these situations. Our view and submission is that the subtle changes we have suggested would go a long way to preserving and achieving a more appropriate balance.

Senator Eaton: I grew up with a lawyer. My father was a lawyer. I know how careful and thoughtful you are. I also sat on the Roloff Beny estate for many years and I finally got off after three years because it still wasn't settled. Can you give us a percentage of your cases where the estate would take longer than three years to settle?

Mr. Friedman: It would be very difficult for me to give a percentage. I'm not trying to dodge the question. I would say if you ask 10 different lawyers, they will give you 10 different answers. It depends on the nature of the estate, the nature of the pool for range of beneficiaries and the reality is that variance underscores the importance of having flexible rules.

Senator Eaton: I understand all those things. In your case, in your firm, are we looking at 10 per cent, 1 per cent, 50 per cent?

Mr. Friedman: In our case it would be a material percentage. Would it be 100 per cent? No. It certainly would be above the 25 or 30 per cent range, but again that would depend on the nature of the estates we're dealing with.

If it is a simple estate with one beneficiary and limited assets, it generally won't take as long to administer as a larger estate or an estate that has beneficiaries with unique challenges or needs. In some ways I would be concerned about trying to break matters down to percentages, because we may be misled or guided off the fact that the very taxpayers who require the protection of the law, those with special needs and special financial circumstances, may not represent the majority of estates. By the same token, the law should be particularly catered to ensuring that they're not unduly prejudiced.


Senator Bellemare: I have a philosophical question for you, since you brought up the issue of fairness. You said that the proposed changes pose a fairness problem, especially if beneficiaries have a lower tax rate than what is provided for in the legislation. There is increasing support for the idea that generational income inequality is on the rise, and I would like to know where you stand on that. Do you think inheritances and estates should be subject to more taxes? That gives rise to another problem when it comes to societal fairness. Would you care to comment on that?


Mr. Friedman: My apologies, but the transmission broke out halfway through. Could I impose on you to ask the question again?


Senator Bellemare: My question was probably not very clear. It was philosophical. Economists have often noted that income gaps in society are on the rise. Some argue that all estates should be subject to more taxes. The proposed measures provide for the implicit taxation of estates, which you believe gives rise to an equity problem in the reverse sense.

I understand the equity problem when we are talking about low-income beneficiaries, who are not taxed at the highest rate. But I wanted to hear your thoughts on applying this logic to estate taxation. Does estate taxation not actually foster greater income equality in society? Does that make my question clearer?


Mr. Friedman: I do. I understand the notions of vertical and horizontal equity, and trying to maintain a balance between a very large population of income and resources. How do you achieve the appropriate balance? We would all agree there's no perfect balance.

However, I would suggest that the Tax Act, as it stands now, has already taken many steps to try and deal with those questions of equality. For instance, as many of the members already know, upon the passing of an individual, there is a deemed disposition of their assets and that triggers accrued gains and taxation.

Similarly, in the context of the current legislation, there are anti-avoidance rules meant to try to counteract plans that are aimed at duplicating access to marginal rates. There is an anti-avoidance rule in section 104 of the act that already addresses that. I appreciate and respect the concern about ensuring that we are not exacerbating inequalities by not taxing income at an appropriate rate, but what we are proposing is simply a system that ensures that tax is integrated properly and that we are not disadvantaging those who, if they had received the income directly, would be taxed at a lower rate.

I would suggest to the members that it is important to place matters in context. I have seen statistics that have suggested that the annual savings between taxing a stream of income at marginal rates versus the highest rate may be approximately $15,000. I would suggest to the members that the type of planning that we've seen, that will be hindered by these rules, is predominantly not geared at trying to achieve or capture that $15,000. It's often and predominantly motivated by non-tax reasons.

While I appreciate the concern about not exacerbating inequalities, I would suggest that that has to be balanced against the, arguably, more important concern of making sure that those that are potentially disadvantaged aren't disadvantaged in the hopes of ensuring that we have a system that captures every tax dollar.

The Deputy Chair: Maybe just a final comment for this group: If I understand the suggestions that you've made, are these suggestions largely driven by the timing of implementation or the actual implementation? Therefore, if it's the timing of the implementation, what you're really saying is that we need more time to make sure we can manage this more effectively for our client base; is that what you're saying?

Mr. Friedman: I think there are two elements. The first is ensuring that Canadians, citizens, understand that this change is coming, particularly elderly citizens who won't have access to the same online resources that perhaps others would, making sure that people have the opportunity to consider, understand and organize their affairs consistent with the law. That's the first point on timing.

The second is on administration, how the rules actually apply in the context of a particular estate. As it stands now, there is proposed a very hard and fast, bright light, 36-month rule. That, when it is applied, will apply to the prejudice of many taxpayers for reasons that have absolutely nothing to do with tax planning. I would suggest that there are two elements to this, the timing of implementation and then the mode in which these proposals will operate once implemented.

The Deputy Chair: Are there any other questions from our committee for this particular group? Seeing that there are no further questions, I would like to thank you very much for your time, and we will move on to our next group. Thank you very much.

I'd like to also welcome our two individuals from the Intellectual Property Institute of Canada. David Schwartz is President, and Stephen Perry is Chair of the Industrial Designs Committee. They will be speaking to Part 4, Division 1, clauses 102 to 142, which begin on page 221 of the bill.

Would either one of you like to start?

David Schwartz, President, Intellectual Property Institute of Canada: Thank you, Senator Smith; I'll proceed first. I will speak briefly about the patent law treaty aspects of Bill C-43.


Thank you for inviting us to appear before the committee today.


IPIC is the professional association of patent agents, trademark agents and lawyers practising in all areas of IP law. We are pleased to have the opportunity to speak to you today, and we support the government's commitment to improving Canada's IP laws.

The patent law treaty provides welcome safeguards to prevent unintentional loss of valuable patent rights due to failure to comply with formality requirements or time limits.

Much essential detail is to be left to future amendments to the patent rules — the regulations under the Patent Act — so I will talk only about two major changes to our patent laws that arise under Bill C-43.

First, under our current law, when a patent office deadline is missed — and this happens quite routinely for any number of reasons — there is usually an opportunity to reinstate or restore the application to good standing as of right, upon payment of a fee and without special reasons. When I say ''as of right,'' I mean that there is an inalienable and absolute right to take corrective action, and you pay a penalty by way of a fee.

Under Bill C-43, this reinstatement may only be permitted if the patent office is satisfied that the applicant exercised what they call ''due care.'' What would constitute due care is not known at present, and Bill C-43 finds, very importantly, that a finding of due care can be reversed by the federal court later on during litigation of a patent. So there could be due care found by a patent office but later the federal court says, no, that wasn't due care. Assessing due care is more work at the patent office level. They have to assess whether the applicant has taken the required level of care and it leads to long-term uncertainty due to the possibility of court review.

Importantly, PLT doesn't require this. PLT does not mandate use of a due care standard. What IPIC recommends is that the patent rules continue to provide a reasonable window for reinstatement as of right, before the due care standard must be met, so to continue the current procedure under the law where there is an opportunity to fix the patent application upon payment of a fee.

My second point is that our current law does not provide any relief by way of what we call intervening rights to a third party who uses an invention during a period when the application or the patent is abandoned, thinking that no patent will issue or that the patent won't be revived.

PLT doesn't mandate intervening rights, but Bill C-43 introduces them to our law for the first time. You will appreciate that intervening rights are inherently uncertain. They arise in Bill C-43 in connection with infringing acts committed ''in good faith.'' What does that mean? Or where there have been serious and effective preparations to commit the infringing act. The meaning of this language isn't going to be known until interpreted by the courts and, even then, its application will be very fact dependent.

IPIC recommends that the patent rules provide a reasonable window for reinstatement prior to the possibility of intervening rights. That is, there is an option, a slip rule, to fix the problem, the abandonment, on a reasonable basis, before the prospect of these complex intervening rights arise.

I have great confidence that Industry Canada will put in place suitable procedures when it comes time to make the regulations and we look forward to consulting on that process.

Looking ahead, IPIC has for many years advocated changes to our patent laws so that inadvertent errors do not lead to a loss of patent rights. Bill C-43 addresses many of these issues and we are very happy to see that. The changes under Bill C-43 were driven by international harmonization efforts under the patent law treaty, so, in other words, to the interest in putting an international treaty into effect. That said, similar results could have been achieved by independent amendments to our patent laws at Canada's own initiative.

We encourage the government to continue its important work to improve the Canadian IP system beyond what we need for the treaty implementation. We are very happy to see important changes going ahead, and we would like to see the government continue to pursue this. The law must continue to adapt to developments in the jurisprudence, as well as science and technology. IPIC has made detailed proposals concerning, among other things, the protection of confidential communications between IP advisers and their clients, as well as, for instance, the law of double patenting, a court-made doctrine. We look forward to the opportunity to cooperate further on these and other issues.

Finally, on a positive note, I would like to take a moment to express IPIC's gratitude to Senator Day for his longstanding commitment to raising public awareness of the importance of innovation and intellectual property in Canada. April 26 is World IP Day. That's an event coordinated by the World Intellectual Property Organization, WIPO, a UN agency responsible for administering many global IP treaties, including the PLT and Hague, which we are discussing today.

Senator Day has made it possible for IPIC to host an annual World IP Day event in Centre Block, where members of the profession, government personnel, senators, MPs and guests gather to discuss intellectual property matters. Many times we have had young students attend and present their science fair research. I must say, as a parent myself, the once-in-a lifetime opportunity for these children to come to Parliament Hill and actually be here and speak before senators and MPs will leave terrific and indelible memories for them, for this future generation of Canadian innovators, and we are pleased to have had the support of the Senate in making that possible.

Thank you very much. If you have questions about what I've said, and I'll stick my neck out, any other part of the PLT, if you've looked at that, I'll try to address them. I'll let Stephen speak about Hague.


Stephen Perry, Chair of the Industrial Designs Committee, Intellectual Property Institute of Canada: Again, we would like to thank the committee for the opportunity to discuss industrial patents.


The Canadian Industrial Design Act bears a remarkable similarity to a British statute of 1842 relating to designs. It was described about 80 years ago by a Canadian court as being a piece of legislation that seems flimsy and incomplete, ill-adapted for its intended purpose and seriously in need of amendment.

Small but important changes were made in 1993 to correct the most serious and glaring deficiencies, and the revisions proposed in Bill C-43 will finally bring the Industrial Design Act out of the 19th century and will provide a more modern framework for encouraging design innovation.

For one thing, the legislation will permit to accede to The Hague agreement, which will provide a streamlined and cost-effective mechanism for Canadian designers to be able to obtain international design rights.

The legislation also introduces novelty provisions and a grace period that is similar to those that have been in place in the Patent Act for several decades.

There are aspects of the proposed legislation that provide regulation-making authority that we believe would have been better to have been included in the legislation itself. For example, the provisions relating to abandonment of design applications and the procedures for reinstatement of those applications have been eliminated from the Industrial Design Act in favour of regulation-making authority. Also, our written submission focuses on clause 105 of the bill, which adds a new subsection 8.2(1)(c), that provides a first-to-file provision so that a design application having an earlier effective filing date will take priority over an application having a later effective filing date for any design disclosed in that earlier application.

This is similar to a provision that has been in the Patent Act for many years. Basically, on the Patent Act side, if two inventors file patent applications for the same invention, the first one to the patent office wins. However, whereas the Patent Act provision applies to applications filed by different applicants, draft subsection 8.2(1)(c), contained in Bill C-43, does not. This means where a Canadian designer files two applications for design elements relating to a particular product, for example, the first design application might be filed for the overall shape of a smart phone and then a second application might focus on the configuration of the keyboard. Depending on how the regulations end up being implemented, the application having the earlier effective or priority date may destroy the novelty of the second application having the later date, even if the dates are only one day apart.

This doesn't happen in the patent context because the counterpart provision of the Patent Act applies only to applications filed by someone other than the applicant. We call this self-collision. The Patent Act voids it. We believe that the Industrial Design Act should do the same rather than leaving it to the regulations.

I would like to leave you with one final thought. Although the Industrial Design Act will finally be liberated from the 19th century, the Canadian design framework needs to be even further modernized, in the opinion of the institute, to bring it squarely into the 21st century. The very recent amendments to the Trade-marks Act that I think many of you are familiar with recognized that a trademark can be more than a word or a logo. It can include colour, it can be a hologram, sound, scent, taste or texture. There is no similar proposal to expand the definition of what constitutes protectable design subject matter under the legislation. Under the existing law, a Canadian design cannot include colour and arguably does not extend to animated graphical user interfaces. If the Canadian law of designs is to become truly relevant in the 21st century, the definition of what is acceptable subject matter should be expanded to include 20th century design innovations.

The Deputy Chair: Thank you very much, Mr. Schwartz and Mr. Perry.


Senator Hervieux-Payette: Welcome gentlemen. I would like you to please explain the notion of double patenting. If an application has already been filed but the deadline passes and another company files an application, does that nullify the application for registration filed by the company that missed the deadline?


Mr. Schwartz: Thank you for the question. The situation is slightly different from that. The concern we were discussing is the public notice function of the patent — and I think this is your question; please correct me if it's not the answer you're looking for. During the patenting process, sometimes you would be surprised but there are many reasons why deadlines get missed accidentally or it's difficult to meet them, but there is a time to set things right: annual fees, a tax or a maintenance fee that you must pay to keep the application alive, third parties might be paying that; the case falls out of good standing and then you revive it.

The other party we are talking about is typically not someone trying to obtain a patent. It would be someone, a competitor, for instance, who wants to use the invention. They want to make, use or sell the thing that has been patented. Under the current law, once the case is restored to good standing, that's the end of it. The competitor has to say, okay, they've put it right, we have to deal with their patent; either we don't infringe it or we think it's invalid.

What the law is proposing is that during that period of time when its abandoned — they didn't pay the fee? What's happening? Are they going to proceed or not? I'll start using the invention. I'll build a factory or start selling the product. They would be protected by having what you would call an intervening right. If they did that in good faith — I'm not sure what it would mean to do it in good faith — or if they took reasonable, serious and effective preparations to start infringing, what would that mean? I've taken out a lease on a building that I'm going to use to sell the product, or I have hired salespeople or I've bought a machine. They would get to continue to conduct those infringing acts.

Ultimately, there is some sense to that. It has to be fair, but in our view this is a very difficult thing to work out. It's going to end up in the courts. Everyone is going to be uncertain about what it means. So what we're asking for simply is that before you get to this intervening rights standard applying, let's make sure that we continue to have a period. Okay, the deadline is missed; let's fix it right away in good time, no harm done, like we have currently.

I don't want to make too big a matter out of this, because I am very hopeful that when the regulations address this that it would make sense that that would occur. It's so difficult when you're seeing the legislation but you don't know how the mechanics will work later.

Senator Hervieux-Payette: Let's say for my colleagues and the people who might follow this thing, I have the impression, from what I gathered in the past, that the patent office and the inventor are in a dialogue situation, so they supply all the information. It's not something where you arrive one day, you put the document on the table, it's over and they're going to give you the patent. You have to have a dialogue, complete the file and it's a back-and-forth process. It's a process; it's not a one-shot deal. This means it's over a period of time, and, eventually, the company may comply or misses the deadline or whatever. That's what I want us to understand. It's not that you apply and then you don't finish the whole process.

Mr. Schwartz: That's right.

Senator Hervieux-Payette: And the delay has expired. Somebody else has known about the product, as you say, starts using it, and then you ask yourself who owns the patent. Sometimes millions of dollars have been spent. I want us to understand very well why this situation that seems to work well has been changed. What is the purpose? Why would the government make a change that is not in favour of those who are inventors? It's a tough thing to do.

Mr. Schwartz: That's an interesting point. First off, you're absolutely correct; it can take a very along time to get a patent. I hate to admit it. I have patents that we are still trying to get after the 20-year term has expired. It's not all my fault; there is some back and forth here. Other times, patents grant early, in a couple of years, but you still must pay your annual fee through the 20-year life.

Senator Hervieux-Payette: And it's years; it's not days.

Mr. Schwartz: It's typically a number of years to get a patent.

To your second point, I don't have background as to where the intervening rights as a general concept were suggested in the process. That's not a proposal that has come from IPIC and it is not a requirement of the PLT. I don't have background on that point.

Senator Hervieux-Payette: In order to get a patent, you have to register, and then, of course, you more or less almost have to give the secret formula of the Coca-Cola. At the end of the day, your competitors have access to the information. Of course, they say, ''I can use it with my own company. I am in the same field.''

Because of the fact that somebody else who has not spent much money is using something that is in the making for a number of years, why would we change the situation from what we have now and, as you say, sometimes after 20 years? Is it just a matter of the non-payment of a yearly fee and then you reinstate the whole thing by paying the fee? Why would we, in fact, put uncertainty for the original inventors?

Mr. Schwartz: If I were to be as neutral, fair and even-handed about it as I can be, the current law provides a one-year period to reinstate. If you miss that period, nothing will help you. The Federal Court of Appeal won't help you; they've said that. That's the act. You have a year.

As the PLT works, there would certainly be some instances where you might get more than a year. It might even be more generous. I would say — and I'm here to speak on behalf of IPIC and it's a bit of a personal view as well — it makes some sense to me that to cut into that original year is taking away what people already have under the current law. Fairly, you have to say if intervening rights were to occur within that current year, that is a diminishment of the patent right that is not mandated by the PLT.

On the other hand, if I try to be kind of equal about this, if patentees are going to get something more, yet a further opportunity, even after a year, maybe it would make sense to say, ''All right, you're getting something new. The part of that bargain is you have intervening rights.'' We heard some good back-and-forth with practical questions to our previous speakers about some real examples. I can't give you a real situation where I'm aware of intervening rights where someone legitimately said, ''Hey, I thought they weren't going to proceed with this patent. I started practising the invention. It sprung back to life, now what?'' I can't tell you that I think there's really ever been a clear case for intervening rights. I do think it would be legitimate to say let's not put it into that first year where we haven't had it before. Maybe into that later period if the government in its wisdom thinks we should have it.

Senator Hervieux-Payette: How do we compare with other OECD countries? Patents have to be registered in every country, and this is a very costly process.

Once we get the patent in Canada, in other places it's not a process; it's a registration. How do we compare? We have fewer patents for the kind of economy we have. Really, we should not make it more difficult. We should make it easier for inventors to have access. I'm not speaking about revenue; I know it's a costly process.

Mr. Schwartz: That's probably a question I should come here prepared with an answer for: How many countries have intervening rights? I stand to be corrected, but I am not immediately aware of major places, like the United States or Europe, where there are intervening rights in the patent process. I have heard that Australia has introduced a procedure for it, but that's anecdotal. I've been told that. If you wish, we could probably pull some information together for you, but I don't know the basis on which Australia thought it was necessary. But I'm not aware of or being alerted by my colleagues in foreign countries that if you miss a deadline there could be intervening rights. I think it's fairly limited.


Senator Hervieux-Payette: Mr. Chair, it would be beneficial to see how other countries work. If we find out we are the only ones doing it this way, especially since we behind in terms of quantity of patents, I do not think we should add more barriers to the system.

I just have one last question for Mr. Perry.


Mr. Perry, were you consulted for these amendments?

Mr. Perry: Let me preface my answer by saying that the institute, the Canadian Intellectual Property Office and Industry Canada have a very good working relationship.

Most of the key initiatives that the institute has wanted to see in the Industrial Design Act are here as a result of dialogues over many years.

This legislation has been an accelerated process, but even in the context of that, it is my understanding that there was consultation in pre-drafts of the legislation that came under confidentiality agreements with the government.


Senator Bellemare: My question is for Mr. Perry. You said that we should reconsider the definition of what constitutes a registrable design, extending it to areas such as colour and digital graphics. If I understand correctly, that is something you are suggesting for the future and does not fall within the scope of the amendments currently being proposed to the Patent Act. This tax legislation does not introduce that new view of registrable designs. From your concluding remarks, I gathered that you would like to see the definition reviewed in the future. Did I understand you correctly, or are you suggesting that we make that change in this bill?


Mr. Perry: The question I was addressing was more in the context of the Industrial Design Act as opposed to the Patent Act, which faces its own challenges in terms of what is acceptable subject matter. We've heard about business method patents, software and things like that. For industrial design, it's probably best if I quote from the act:

''design'' or ''industrial design'' means features of shape, configuration, pattern or ornament and any combination of those features that, in a finished article, appeal to and are judged solely by the eye. . .

Designs relate to appearance, whereas patents relate to inventions. The Trade-marks Act, as you pointed out correctly, has greatly expanded the proper subject matter that can become a trademark. A hundred years ago, a trademark was just a name or a logo, but the act has been opened up to recognize the 21st century developments.

The Industrial Design Act, as I mentioned, is a very old piece of legislation. We are extremely grateful for the modernizations that are coming. We would hope that in the future there can be additional modifications and expansions. Right now, the Industrial Design Act is colour-blind in that it doesn't recognize colour and it doesn't recognize animated graphical user interfaces and the sorts of innovations that are moving us forward in the 21st century.


Senator Chaput: Gentlemen, I have a very simple and straightforward question for you. From everything I have heard, I gather that filing a patent application is a lengthy, complicated and costly endeavour. Will the changes proposed in this bill make the application process easier or more complicated?


Mr. Schwartz: On the whole, it will facilitate the process, not complicate matters. Our comments today are largely about good news. It is somewhat a working discussion to leave with you the message for when the regulations are made that we hope it will be done in a sensible way and that there won't be added complexity. On the whole, these will facilitate and simplify procedures and will not add costs to the law of obtaining patents. I will let Stephen speak to the design aspect.

The points I raised, we discussed because we think these could be substantive. The PLT is supposed to be a matter of formality, simplification and harmonization. We raised two areas: the idea that you can only revive by due care, and the intervening rights, because those would be substantive reductions in the innovator's rights under a patent. If those were to arise and there's a requirement to demonstrate due care for having missed a deadline, then it would add cost, I think.

Today, you have to take the action, pay a fee and request reinstatement. A clerk does that. However, it's not a clerical task if the patent office has to be satisfied that you are only entitled to revive the right if there has been due care in consideration of the circumstances. It's a matter of weighing the facts and the situation, which would add cost. If a court has to review that, it certainly adds more cost. If you get to court and there is an issue, for example, can I use this invention because it was temporarily abandoned, then you will have uncertainty and legal costs. On its face, if things are done in a good systematic way as we propose, we will not see added costs. It will simplify the procedure.

Stephen, is there anything on the design aspect? I don't know if Hague deals with such things.

Mr. Perry: The Hague Agreement Concerning the International Registration of Industrial Designs is somewhat different than the patent law treaty in that it's a registration system that goes much further. In point of fact, it will greatly simplify, streamline and lower the cost for obtaining international design registrations.

Quite possibly, members of my profession, who rely on a lot of in-bound filings, may or may not feel any changes as a result of that. Certainly it is a good thing for Canadian designers, for designers anywhere, because it will simplify and reduce the process for obtaining international registrations.


Senator Chaput: If I own a small business and I want to apply for a patent on a unique clothing design I have come up with, say, what additional requirements will I have to meet under this bill?

You said this will simplify things, not complicate them. That is not clear in my mind; as I see it, the bill imposes additional requirements. How will a patent application filed under this new legislation differ from one filed last year?


Mr. Schwartz: The changes for a small business obtaining patent protection will be very few under the PLT. I don't like to diminish PLT, but it is somewhat a housekeeping exercise as PLT simplifies and harmonizes some filing procedures and prevents rights being lost because you don't have a translation available immediately or you can't pay a fee immediately.

I see implementing PLT as an exercise to get the treaty done in Canada for whatever that treaty does. It is a treaty on formalities. At the global level, at the World Intellectual Property Organization, WIPO, when you are trying to harmonize the substantive patent law amongst many countries, developed, less developed or developing, it's a big job, and matters proceed slowly.

The PLT we're dealing with today is a simple series of steps that many countries can agree on, although not everyone is on board with PLT yet. The big issues, if they ever come, will come later under something called the treaty on the law of patents — they reverse the letters a little bit as this is the Patent Law Treaty. Substantive patent law will be the treaty on the law of patents where we're going to discuss, I suspect, things like what you can patent. Can you patent a plant? Can you patent an animal, software, or computer-implemented inventions? I hate clichés, but low-hanging fruit. PLT fixes some little problems in the application procedure.

In direct answer to your question, there is the possibility that if a mistake were to be made, PLT could fix it. I'm less familiar with this where we have a more substantial and lengthy discussion. I'm going to give you a simple example of something that, I believe, likely would have been corrected by PLT. There was a case not long ago in Canada called DBC Marine Safety Systems Ltd. I don't know for sure but I think DBC is a Canadian company. There was a patent on some kind of lifeboat invention, a mechanical contrivance for an improved lifeboat and the patent office sent them a requisition to say, ''Here's what's wrong with your application. You have to correct it.

As part of this, let us know what prior art or what information has been cited by other patent offices.''

A response was filed in time. But the agent essentially forgot to do the second part, to say what was the prior art from other countries. I'm working off the top of my head, that is my recollection of the case, but I don't think anything turned on that. There was nothing hidden from the patent office. I think that information either had already essentially been supplied or was generally available. No one noticed that the second step hadn't been taken. So the applicant thought that they had met the deadline and the patent office didn't say otherwise. It got a little bit complicated, but more than a year later, once the reinstatement period was gone, it was noticed that part of the response was missing. The court ultimately held that there was an obligation, not just to file a response, but to do two things: fix up the drawings or change the scope of the invention; and also to separately file this information. It was an innocent mistake, but the patent application was dead. That's what the Federal Court said. That's what the Court of Appeal said. Largely under PLT, and I have to look at the specifics, in a situation like that you would have an opportunity to respond. I hope this is the way it would work in this situation. You would get a notice that you have missed taking a step and you could be protected.

So for your example of a small company, you hope this never happens, but perhaps in various instances PLT will provide some relief for unfortunate mistakes like that. It doesn't change the law a great deal but it may help fix some problems.

I tried to pick one out of the air using some real facts. It could be when we had the power blackout, we all remember that one, the recent blackout or the ice storm years ago. If you file a patent application, globally you get to file one application and then make your decision about the rest of the world 12 months later.

That 12-month deadline has historically been absolute in Canada. Other countries have provided a little bit of grace; you can file that application a bit later if you have a good reason. In Canada the PLT would fix that. If you couldn't take action on that 12-month date because your office was shut down or you couldn't get there because of an ice storm you would get an extra two months. You would get 14 months instead of the 12 months. So there are a number of things that PLT does, which provides helpful little fixes for mistakes that you hope will never happen but sadly in the real world they do.

The Chair: That concludes, honorable senators, all of our senators who have indicated an interest in intervening. I would like to thank Senator Smith for subbing for me for a short while this afternoon. Totally by coincidence, I was speaking on C-8, which is also before the Senate, dealing with amendments to the Copyright Act and the Trade-marks Act. So we have dealt with patents and industrial design and they're the four major pillars in the area we call intellectual property.

We rely heavily on the Intellectual Property Institute of Canada, and Michel Gérin, who is also here along with Mr. Schwarz, the President, and Mr. Perry, head of the Industrial Designs Committee. Thank you very much for being here and helping us out. Thank you for your continued support.

The fact that there are these two pieces of legislation before the Senate is an indication of the importance of this area of intellectual property in our society.

The meeting is concluded.

(The committee adjourned.)