Proceedings of the Standing Senate Committee on
National Finance
Issue No. 9 - Evidence - May 17, 2016 (Morning Meeting)
OTTAWA, Tuesday, May 17, 2016
The Standing Senate Committee on National Finance met this day at 9:31 a.m. to examine the subject matter of all of Bill C-15, An Act to implement certain provisions of the budget tabled in Parliament on March 22, 2016, and other measures.
Senator Larry Smith (Chair) in the chair.
[English]
The Chair: Good morning, everyone. Welcome to the Standing Senate Committee on National Finance. Colleagues and members of the viewing public, the mandate of this committee is to examine matters relating to federal estimates generally, as well as government finance.
My name is Larry Smith, senator from Quebec, and I chair the committee. Let me introduce briefly the other members of our committee.
To my left, a star in his own mind, a great contributor to the Senate — and I'm just poking fun at him because he's the only guy on this side of the table, on the left side of the table — Senator Grant Mitchell, from Alberta. Senator, welcome.
[Translation]
To my right, directly from New Brunswick, Senator Percy Mockler.
[English]
Beside him, from Toronto, Ontario, Senator Nicole Eaton. From the rock, Newfoundland, former Auditor General, Senator Beth Marshall.
Today we begin our consideration on the subject matter of Bill C-15, known as the BIA, An Act to implement certain provisions of the budget tabled in Parliament on March 22, 2016 and other measures. This bill is also referred to as the Budget Implementation Act, 2016, No. 1. In our jargon, we simply call it the budget.
[Translation]
This morning, to begin our study of the subject matter of Bill C-15, it is our pleasure to welcome the following witnesses from the Department of Finance of Canada.
[English]
Robert Demeter, Chief, Business Property and Personal Income, Tax Legislation Division, Tax Policy Branch. Very impressive. James Greene, Director, Business Income Tax Division, Tax Policy Branch. Pierre Leblanc, Senior Chief, Quantitative Analysis, Personal Income Tax Division, Tax Policy Branch. Trevor McGowan, Chief, Tax Legislation Division, Tax Policy Branch. Welcome, gentlemen.
We have received the department briefing binder on the bill, and we thank you for this information. What we are expecting from you now is to go over the measures by part and division — it is my understanding we're looking at Part 1, and we'll see how that works out this morning — to have you explain each clause and how it supports the measure.
If it's all right with you, we would like the opportunity to ask questions as they pertain to each clause explained to make sure we have the full understanding before we move on to the next clause. This is a detailed exercise, and we ask for your patience in this matter. Not all of us are financial experts. There are a lot of intricate elements to what is being proposed, so we want to make sure that we do ask the questions to flush out an understanding on our part. We thank you for your participation.
I'd like it to say hello to Senator Pratte, formerly of La Presse, and of course our veteran leader from British Columbia, Senator Richard Neufeld.
Who would like to start, gentlemen? The floor is yours.
Trevor McGowan, Chief, Tax Legislation Division, Tax Policy Branch, Department of Finance Canada: I'd like to start with a brief overview of the measures contained in the bill before going on to the clauses. I think what we have done in the past is the first time we approach a measure that's in the bill, I'll explain more fully what the measure is about and provide the context for it, and then for each clause explain how that fits into the larger picture.
Part 1 of the bill contains two sets of measures. The first are measures that were announced as part of the recent federal budget. Those include eliminating the following credits: the education and textbook tax credits, the children's arts and fitness tax credits and the family tax credits. It also replaces the Canada Child Tax Benefit and the Universal Child Care Benefit with the Canada Child Benefit. It exempts from taxable income amounts received under the Ontario Electricity Support Program. It maintains the current small business tax rate at 10.5 per cent for years after 2016 and makes consequential amendments to the dividend gross-up and tax credit rules. It increases the maximum deduction available under the Northern residents deduction. It introduces a new school supplies tax credit. It extends for one year the mineral exploration tax credit. It restores the labour-sponsored venture capital corporation tax credit in respect of purchases of provincially registered LSVCC shares. Lastly, it makes a number of changes consequential to the introduction of the new 33 per cent individual top rate in Bill C-2.
I don't believe that Bill C-2 has come before this committee, but in brief, it contains a number of personal income tax rate changes. It lowers the second rate from 22 per cent to 20.5 per cent, and it introduces a new top marginal rate for income in excess of $200,000 at 33 per cent. A number of measures in the act refer to these top rates, either explicitly or implicitly, and so those had to be changed as well when the top rate went from 29 to 33 per cent. About half of those consequential changes appear in Bill C-2 and the other half appear in Bill C-15.
The Chair: Pardon me, Mr. McGowan, but for the members of the panel, we just distributed a summary page that supports what Mr. McGowan has shared with us, and it puts everything in perspective so it's much easier to understand the rest of the document that you have before you. You have it all tabbed off by clause. That will clarify for you if you haven't had a chance to get into it as of this time.
Just for the information of the panel, the Parliamentary Budget Officer has just released a report on an analysis of Bill C-2, which hopefully you'll all have a chance to look at, and we'll be sharing information on that. It's a request that was made by our office so that we could get a better understanding of the implication of Bill C-2 and the distribution to the middle class population.
Continue, Mr. McGowan, please.
Mr. McGowan: That was the perfect endpoint because now we're moving on to the portions of the bill that were announced by the previous government and the current government's intention to proceed with the measures as announced as part of the recent budget. These are technical tax amendments.
The first and the first one in the bill amends an anti-avoidance rule in the Income Tax Act that prevents the conversion of taxable capital gains to tax-free intercorporate dividends. It contains amendments expanding what qualifies as Canadian exploration expenses. It contains rules that amend the anti-avoidance rules in the act that ensure that the reinsurance or the insurance of Canadian risks remains appropriately taxed in Canada and can't be moved offshore.
It contains rules amending the dividend rental arrangement rules where there is what's called a synthetic equity arrangement in place. It contains specific tax rules relating to the privatization of the Canadian Wheat Board as well. It permits registered charities and registered Canadian amateur athletic associations to invest in limited partnerships as part of their portfolio investments. It contains rules providing a simplified and streamlined withholding process for non-resident employers with qualifying non-resident employees working in Canada. It limits the circumstances in which the repeat failure to report income penalty applies to make it more fair. Lastly, it permits the sharing of taxpayer information both within the Canada Revenue Agency for the collection of nontax debts and also with the Office of the Chief Actuary. That's a somewhat high-level overview of all tax measures in the bill.
Moving on to the specifics clause by clause, clauses 2 to 5 in the bill relate to the measure that I mentioned initially that was announced as part Budget 2015 that prevents the conversion of taxable capital gains into tax-free intercorporate dividends. Probably the easiest way to understand how this rule is intended to work is to go through a simple example. As I said, dividends paid between taxable Canadian corporations are essentially tax-free. The actual mechanism is that they're included in income and there's an immediate deduction, so they're effectively tax-free.
Senator Mitchell: Why is it so complicated?
Mr. McGowan: I've often asked. You'll see in two different measures that there are rules turning off the deduction. There are instances where it's not appropriate to grant the deduction to make them taxable; so I think that's the answer.
You have these tax-free intercorporate dividends. If you're selling a corporation with, say, shares worth $1 million and with the tax cost of nil, you would have a $1-million capital gain on the sale. At a 50 per cent income tax rate that might be about $250,000 in tax because of course capital gains are taxed at half the normal rate. What could you do to avoid that?
For example, the $1 million purchase price could be borrowed from the purchaser by the target company that's been bought. A $1 million dividend could be paid out to a holding company of the seller, which would be tax free. The shares would now be technically worth nothing because you have a debt of $1 million debt and assets of $1 million. You sell for them nothing, no gain; and the full $1 million in capital gains has been avoided and converted into a tax- free intercorporate dividend.
Existing rules in the Income Tax Act say that if you pay a dividend out and one of the purposes is to avoid a capital gain and effectively convert it into a tax-free dividend, we're going to treat that as a capital gain; so it triggers a deemed capital gain. Those have been in place for many years.
With recent court cases and recent tax planning, it has come to light that there's a new strategy where there are multiple ways to economically do the same thing. Instead of reducing the amount of a gain on shares by the payment of a dividend, you could pay a dividend to generate an artificial capital loss — to generate an accrued loss. For example, if you put $1 million into a corporation, it now has a tax cost of $1 million, and you pay that $1 million back out as a dividend. Now it has a value of nothing, but it cost $1 million, so it has an accrued loss of $1 million. The planning is to then transfer on a tax-deferred basis your shares with the accrued gain of $1million dollar into this company. It now has a tax cost of $1 million and a value of $1 million and you sell it for no gain.
Economically, the exact same thing was in place with the previous policy, where you're paying out a dividend to avoid a future capital gain, but instead of reducing the amount of the gain, you're creating an accrued loss to use. This measure expands the scope of the existing 55 rules to apply where, instead of just decreasing a gain, you create a loss or you increase the cost base of the property, which is a third way of accomplishing the exact same planning.
That's the context of the rules. There are a number of specific provisions that all fit within there and are spread throughout the bill.
The Chair: For our colleagues, in this document at pages 2 and 3, it is quite complicated, but if you're looking for something to actually physically see that's exactly related to the discussion, you can see the different articles dealing with what was just stated by Mr. McGowan. It's in this document. Senator Marshall, do you have a question?
Senator Marshall: Yes, I have a question on the format of the meeting. Are we going to hold our questions until the end?
The Chair: It depends. What would you suggest, Mr. McGowan? Would you like to have questions at the end of the presentation or during, because you're going to go through clause byclause, correct?
Mr. McGowan: That's correct. We have, I believe, 60 clauses. I know I wouldn't be able to keep all the questions in my head until the end. I would suggest asking as they arise.
The Chair: We would ask colleagues to make sure that your questions are precise so that we're able to get the question out and get the answer, because there are 60 clauses, and they're quite detailed. Senator Eaton, did you have a point?
Senator Eaton: My question was to do basically with children's taxes — nothing to do with dividends. You can take my name off.
Senator Marshall: If Mr. McGowan is finished that section, I have a question.
Mr. McGowan: I had one more point. There's a very important exception that we'll run across in a couple of clauses where you are allowed to pay out a dividend that reduces a gain to the extent of what is called "safe income.'' I don't know if it's any more helpful to refer to it as "tax paid retained earnings,'' but these are earnings in the corporation being sold that have been fully taxed, so there's not the same tax avoidance motive. If you pay out a dividend from safe income, then the deemed capital gain rules won't apply; and we'll see that in a few different places. I just wanted to mention that now.
Senator Marshall: Who decides that there's a tax avoidance scheme in the works — that a particular taxpayer is paying out the dividends to avoid taxes or reduce their taxes? Who makes that decision?
Mr. McGowan: There are two components to that. One is that the rules themselves are quite mechanical in that they apply when a certain factual condition has been met. In those cases, there's no discretion.
However, within the rules, there is a purpose test. What your purpose of doing an action is, in a sense, an objective fact, but it's something that only you know. That's one of the difficulties running through tax legislation, in particular the purpose thresholds. It says "one of the purposes,'' so you don't have to say it's the main purpose.
It is something that the Canada Revenue Agency will determine when assessing the taxpayer. They will look at the outside objective factors. It's reasonable to expect that if you do a particular action, you intend to bring about the consequences of that action. They make inferences. After they make their assessment to the taxpayer, who is in the best position to rebut any of their assumptions, the taxpayer can then bring forth evidence and challenges a conclusion that no, in fact, they did not intend to do this. The taxpayer may have the documentation that shows otherwise.
Senator Marshall: Before we get started on the individual sections, would you be able to tell us how many individual taxpayers there are? Would you have it for the tax year just ended, because people are supposed to file their returns by April 30? When was the most recent year? When we get into the individual sections, we'll be talking about how many taxpayers this affects. How many taxpayers would there be in total?
The Chair: Are you talking about taxpayers, or a combination of taxpayers and corporations?
Senator Marshall: No, not corporations. I might want to know that later on, but right now I just want to know the number of individual taxpayers. There must be many millions.
Mr. McGowan: This is a corporate tax measure dealing primarily with —.
Senator Marshall: I know that, but I'm thinking ahead to the textbooks and child credits and all that.
Mr. McGowan: We have a lot of that information, and my business and personal income tax colleagues will be able to fill in the numbers as we go.
The Chair: Senator Marshall, we had the PBO folks over in the last couple of days, and I think they said that, as of 2013, 27 million people had filed tax returns in our country. That was the number that they gave us.
Senator Marshall: Thank you.
The Chair: Go ahead, sir.
Mr. McGowan: I provided the general framework for how this measure fits together, and as I said, it's in clauses 2 to 5.
Clause 2 deals with stock dividends, where the dividend is paid in stock, and it sets the appropriate cost to the recipient of the stock dividend, where these rules apply.
Clause 3 also deals, in a slightly different context, with the appropriate addition to the tax cost of shares that are in the context of a stock dividend, again limiting the increase in the cost of the shares to the amount of safe income paid.
Clause 4, dealing with paragraph 54 (j), is a rule that applies where you have a deemed disposition of shares. For example, in a winding up or a redemption of shares, you would often have a deemed intercorporate dividend, and this rule says that to the extent you get a deemed dividend, that's not included in the proceeds of disposing of the shares on redemption or winding up. This amends that rule to take into account the new corporate reorganization rules in section 55.
The heart of the amendment is actually in clause 5, and that deals with paragraph 55(2) of the act. That's the one that deems the capital gain. First of all, 55(2) is split into two subsections — 55(2) and (2.1) — in order to add the two new triggering factors. As I said, those are the creation of an accrued loss — or a significant decrease in the fair market value of a share, as it's expressed in the legislation — or to create a significant increase in the cost amount of properties. Those are the two things, in addition to reducing an expected gain, that could trigger the deemed dividend.
In clause 5, there are a series of consequential amendments to that dealing with the amount of the stock dividend — it's deemed to be the greater paid of capital and fair market value — as well as rules on exactly how to figure out the amount of the deemed gain and when there's a significant reduction in the fair market value of the property. Clause 5 contains the substantive portion of the rule.
If I may move on to clause 6, it deals with education and textbook tax credits. It's a new measure. This would eliminate the education and textbook tax credits for 2017, although the current tuition tax credit is going to remain available. These are tax credits for attending qualifying educational institutions and for textbooks, and they're at a rate of 15 per cent. The education tax credit is 15 per cent of $400 per month for a full-time student, or $60 per month. For part-time students, it's 15 per cent of $120, or $18 per month. The textbook tax credit is 15 per cent of $65 a month, or $9.75 for full-time students, and 15 per cent of $20, or $3 a month, for part-time students. Those are not income tested, and they're available to all students.
These two credits are being repealed, as I said, for 2017 and onward, although past credits taken that can be carried forward are not going to be lost. They can continue to be claimed later, because, of course, students often don't have enough income.
Senator Marshall: For each of those tax credits, how many taxpayers will be affected, and what's the dollar value? Do we have that?
Mr. McGowan: I'll let my colleague Pierre answer that.
Pierre Leblanc, Senior Chief, Quantitative Analysis, Personal Income Tax Division, Tax Policy Branch, Department of Finance Canada: Senator, you mentioned we just passed the filing deadline for the 2015 tax year. It takes a while. People still file in May and June. Not everyone meets the deadline and in fact, some people don't file until a year or two later.
We know that in 2013, which is the most recent tax year for which we have full data, about 2.3 million students claimed education and textbook tax amounts. If you can claim one, you can claim the other.
That's not to say that 2.3 million students received tax relief from those measures. As Trevor explained, in some cases, some students transfer amounts up to $5,000 to a supporting relative, and other students can't use those in the current year but can carry them forward and use them in subsequent years.
Senator Marshall: How much does the government think it will save by repealing those tax credits?
Mr. Leblanc: That's in the budget itself, but if you look at the 2016-17 tax year, the expected increase in federal revenues is about $105 million. That will increase to $445 million in the 2017-18 tax year and continue to go up from there.
The Chair: You'll notice that when some of these changes are made, there's an introductorylapse period where you leave the former rule in effect until the new one comes in. Some of them go halfway through 2016 and then into 2017.
I see a little anxiousness among some of our colleagues, which is normal; this happens when we go through budgets. We're trying to get a flow here. If you look at tab A in your document and you go to the Part 1 overview, you'll see some of the things, like the education and textbook tax credits, on page 1 of 7. Then, on pages 8 and 9, you'll see, in the actual tax guide, the explanations in paragraph 6. That just helps you get the flow of how this works. We apologize, gentlemen. We just want to make sure we get ourselves flowing with you. It is fairly complex, as you can see.
Senator Eaton: What is now considered a middle-class income? It changed at the last election. Is it $200,000? Is it $120,000?
Mr. McGowan: I know this came up in the study of this bill, and also Bill C-2 in front of the house Finance Committee. I don't know that it has a specific technical or commonly understood meaning within the Department of Finance. It's used by a number of people refer to a number of different things.
I recall reading some time ago about the percentage of people who self-identify as being middle class, and it's incredible. I think it includes most people who aren't in the top 1 per cent, but I don't know that we have a specific, technical meaning within the Department of Finance.
Senator Eaton: Then I guess it will be hard to ask this question, but I will anyway. With the new childcare benefit or the new tax that's supposed to replace the children's art credit, the textbook tax credit, the child fitness tax credit, the Canada child tax benefit universal, now being replaced by one, what is the difference? Was I better off before, or am I better off now with all of those tiny tax credits being eliminated and with just the childcare benefit? Or does that depend on my income?
Robert Demeter, Chief, Business Property and Personal Income, Tax Legislation Division, Tax Policy Branch, Department of Finance Canada: About nine out of ten families are better off. About one out of ten families won't be. It is related to income, low and middle.
It depends on your particular situation, but, once you reach family incomes of 120,000, 150,000, that's where you start to see it. In other words, if you looked at those with family incomes between 120 and 150,000, most would be better off, but some wouldn't be. If you look at family incomes between 150 and 200,000, that's where you'd start to see a majority of families receiving less as a result of the reforms proposed in the budget.
Senator Eaton: Because it is based on your income.
Mr. Demeter: Right. That's driven by the new Canada Child Benefit, which is income-tested. When we talk about the proposed elimination of the education and textbook tax credits, those are to finance and enhance student financial assistance. I think the government-stated objective is better targeting of support for students towards low- and middle- income families. It's part of a package.
Senator Eaton: Part of a package. So, as you say, the great majority will benefit, with more money in their pocket?
Mr. Leblanc: The nine-out-of-ten stat is for families with children. What's referred to there is the change in child benefits.
Senator Eaton: With incomes under 150,000.
Mr. Leblanc: Nine out of ten families is for all families. If you look at those with incomes less than 150,000, almost all are better off, and those families who will receive less are concentrated among families with 150,000 or more in family income.
Senator Eaton: I didn't put income splitting into that.
Mr. Leblanc: That's included there.
The Chair: We have a graph that we'll share with Senator Eaton and Senator Marshall.
Senator Marshall: Did I understand you right in responding to Senator Eaton? She asked you to define who falls within the middle class. Did you say it's not defined? What are the parameters? What is the bottom end of the middle class and the top end? Is it your net income, or what is it?
Mr. McGowan: Pierre can add, but within our tax legislation, there's no concept of middle class or not middle class. Rather, there are a series of tax brackets.
Senator Marshall: If you haven't defined middle class — the budget says, growing the middle class — how will you know if the middle class is getting bigger if you haven't set the parameters?
The Chair: Maybe I can help you, because we've done a little work with the PBO's office. The mean income in Canada, at this point in time, is $32,000. If you look —
Senator Marshall: Then the bottom end of the middle class should be somewhere below that, and the top end should be —
The Chair: If you look at Bill C-2, basically, the benefit starts for people earning $45,000 of taxable income, and it goes right up to around $200,000 of people benefiting from these tax changes.
Senator Marshall: The maximum $200,000 would be the top end?
The Chair: The top end is around $216,000, to be exact.
Senator Marshall: To be middle class.
The Chair: It's not that I know it. It's just that I asked the question, and this is the answer that we got back.
The issue, when we look at Bill C-2, will be: Is the actual program supporting middle class people, or is it supporting other folks? It's a very interesting issue because, at some point in time, someone is going to want to identify what middle class really does mean in our country. It's a bit fluid at this time. I think it's fair to say that. That's not a political statement; it's the truth.
Can we move on? Is there another question?
Senator Marshall: The only point I'd like to make is that the government is saying they're going to pursue evidence- based decision making, and if you don't define the parameters into which you want to see the majority of people, then they won't have the decision-making criteria that they're looking for.
The Chair: Right.
Can we move on, Mr. McGowan?
Mr. McGowan: I'm happy to do so. Probably the most technical and complicated one went first, unfortunately. Hopefully, it gets better.
The next clause, clause 7 in the bill, relates to an enhancement of what qualifies as Canadian exploration expenses. These are exploration expenses incurred to discover mineral or oil and gas resources.
This particular type of deduction is valuable for resource companies because it's currently deductible, so it can be deducted right now instead of over time as a capital asset or a depreciable capital asset property, or not at all if it's not depreciable.
Also, it can be renounced to flow through shareholders. If you have, say, a junior mining company that doesn't need all of these expenses, then it can renounce or transfer its deductions to its investors. That's very valuable for them and an important support for the resource sector.
As to the cost of environmental studies and community consultations that are required in order to obtain an exploration permit, the measure wouldn't include those as qualifying as Canadian exploration expenses when, otherwise, they would have been what are called Canadian development expenses. Only 30 per cent per year of those are deductible,so it's much more valuable to qualify as a Canadian exploration expense.
The Chair: Each year, for Senator Marshall and some of the folks, like me, who have been on the committee for quite a few years, we ask the same question and get the same answers. You renew it each year. We ask, "Why wouldn't this be in some form of not necessarily perpetuity but a fixed term?'' I guess the government's answer historically, whatever government has been in place, is that Finance likes to make sure they can make that decision on an ongoing basis.
Mr. McGowan: That's correct. That's a bit later in the bill. That's for the mineral exploration tax credit. It's a 15 per cent tax credit that is on, as you quite correctly suggest, Canadian exploration expenses. So they are tied.
This expands the class of what qualifies as a Canadian exploration expense, and the mineral exploration credit, which we'll see a little bit later, is going to be extended again for another year for the reason you mentioned as well.
Next in the bill we have clause 8, the Ontario Electricity Support Program. This measure would exempt payments received under Ontario's new Electricity Support Program from being included in their income so that it doesn't adversely affect any income-tested benefits that they receive.
Clause 9 deals with the small business tax rate. That's part of three different measures, all of which stem from the announcement in Budget 2016 that the current small business tax rate, at 10.5 per cent, will be maintained for taxation years after 2016. There are actually three components because of the operation of the tax system to that. You have the lower corporate tax rate; that's one component. When a dividend is paid out, individual shareholders get a credit for the amount of income tax paid or considered to have been paid by the corporation. That credit is based upon a grossed-up amount of the dividend.
Maybe an easy way to understand this system — it's usually your first three weeks of a university corporate tax class — is let's say you have $20 of tax in a corporation and that leaves you with $80 left over. You pay out an $80 dividend to a shareholder. Then the dividend gross-up rules — I'm changing the numbers for mathematical simplicity — would gross up the amount of the dividend to $100 to represent the amount of income you would have earned and would give you a credit in a perfect system of $20 to account for the corporate tax paid.
Those are the three components that are dealt with in the bill: The small business tax rate, the dividend gross-up and the tax credit mechanism.
The Chair: Historically, it would gross it up by a third, and it's going to go up to 38 per cent in the new legislation — that's what my accountant told me — for a small company participant.
Mr. McGowan: Right. I believe that is Bill C-2. The change from 33 per cent to 38.3 per cent — I don't want to go too far afield.
The Chair: I'm sorry, Mr. McGowan. I forgot about the extra third. When my accountant told me it was 33 to 38, after all the years of getting cash calls from the bank, I suddenly panicked and I got excited. I forgot the third.
Mr. McGowan: That is a change consequential to the introduction of the new top marginal rate of 33 per cent. It's part of a suite of rules dealt with in Bill C-2 that attempt to prevent the deferral of taxation on passive investment income through a corporation. It's intended to provide an extra tax at the corporate level to prevent any deferral opportunities for moving your investment portfolios to a corporation because corporations pay taxes at a lower rate than individuals.
The idea behind those rules is that whether you earn income directly and pay the tax, the 33 per cent, or you earn it through a corporation, then your passive investment income is going to be taxed at roughly the same rate. At least it's not going to be taxed at a lower rate by moving it to a corporation. That's in Bill C-2.
This is almost the other side of the coin because it deals with the active business income of a Canadian-controlled private corporation, and that is subject to a lower tax rate than the normal income. For 2016 currently, as I said, it's 10.5 per cent; then it has an appropriate gross-up in tax credit amounts.
Those are going to be maintained for years after 2016. They are currently scheduled to be reduced. In the act itself, the budget announced that these tax levels are going to be maintained.
Clause 9 deals with the gross-up, the amount that's added to a dividend received to account for the underlying corporate tax.
Senator Pratte: The reductions that have been announced in previous budgets had been put into the act, so this is why the act has changed since Budget 2016 announced that the rate will be maintained at 10.5. You have to go back and change the act so that the rate is maintained and all the other clauses are going back to 10.5; is that right?
Mr. McGowan: You're absolutely correct. To take the tax rate, the 10.5 per cent one — I wish it were simpler but it's actually expressed as 17.5 per cent because the general rate of 28 minus 17.5 gets you to your 10.5 per cent. That currently says for 2016 it's 17.5 per cent, and for 2017 it's going to be 18 per cent and so on until 2019.
Senator Pratte: That's already in the act?
Mr. McGowan: That's correct.
Senator Marshall: The gross-up has moved from 33 per cent to 38.3. What's the tax credit now?
Mr. McGowan: The current gross-up is at 17 per cent.
James Greene, Director, Business Income Tax Division, Tax Policy Branch, Department of Finance Canada: Mr. Chairman, the gross-up factor on small business dividends is currently 17 per cent, and absent the proposals in this legislation it would have dropped to 16 per cent in 2018 and then to 15 per cent in 2019. The bill would maintain it at the current 17 per cent level.
Senator Marshall: What about for individuals? We gross-up our dividends, but what's the credit?
Mr. Green: When an individual receives a dividend from a corporation, the amount of the dividend is grossed up, in a sense to represent the underlying pre-tax corporate income.
Senator Marshall: To make sure the government gets everybody's share of taxes, yes.
Mr. Green: Then there's the dividend tax credit.
Senator Marshall: What's that?
Mr. Green: Essentially, it's 10.5 per cent. The proposal is that it would be maintained at that level, so it basically mimics the corporate tax rate.
The Chair: If you are at a personal tax rate of 43 per cent and you get a dividend, which we were getting at 33 per cent historically from your corporation, basically your dividend percentage rate is getting closer to your personal income tax rate. It's a way of getting money for the government, which it is what it is.
Senator Marshall: I'm not surprised.
The Chair: Without the change of the election promise that was made to reduce the business tax for small business, how much does that mean in terms of dollars for the government each year? It is like a tax increase. How much money will the government get from that particular stance or position?
Mr. Green: Mr. Chairman, it's an amount, obviously, that increases over the next three years. If we go out to the end of the five-year budget forecast period to 2020-21, the change is estimated to have a net impact in that year of $825 million. Revenue is higher by that amount than it would have been if the small business deduction had been reduced down to —
The Chair: Is that 825 per year?
Mr. Green: Yes, 825 per year.
Senator Eaton: This is probably a very simple question for you. What is the cut-off that determines a small business from a corporation?
Mr. Green: Mr. Chairman, a small business for purposes of this low rate is essentially defined by the amount of its taxable capital, which is basically a mixture of assets, and businesses qualify as long as their taxable capital is less than 15 million. The low business rate is available on up to $500,000 per year of taxable income. It has a limited amount to it. Additional income above 500,000 is taxed at the general 15 per cent corporate rate.
Senator Eaton: I gather it would be 17 per cent now in the next year. There are provincial taxes which vary across the country that are put on top of that; is that correct?
Mr. Green: That's right. The federal small business rate is 10.5 per cent,and provincial corporate taxes are added on top. The average provincial corporate tax rate is in the neighbourhood of about 4 or 4.5 per cent.
Senator Eaton: How uncompetitive will that make us? Does it make any difference at all? Have you looked at that?
Mr. Green: Yes. Canada, in fact, is highly competitive in terms of our small business tax rates. We have one of the lowest tax burdens on small business of any country in the OECD. In the 34 countries of the OECD, there are only three, if memory serves me correct, that have a lower tax rate on small business.
Senator Eaton: Do you know which those are?
Mr. Green: They are Hungary, Ireland and Korea.
The Chair: Continue on, Mr. McGowan. We are at page 10 in our document here. Where are we now? We were on D in our document. Moving on to the northern residence deduction, is that next?
Mr. McGowan: Clause 10 of the bill is a consequential change to the section 55 or the measure that I initially described that deals with the conversion of capital gains and the dividends. That relates to the amount that is added to a corporation's capital dividend account on capital when it realizes, amongst other things, a capital gain. That is updated to reflect the revised rules in section 55, which we discussed initially.
It also has another consequential amendment dealing with the definition of "paid-up capital'' that is consequential to the Canadian Wheat Board rules. Essentially, the definition of "paid-up capital,'' which is your capital for tax purposes, is the amount you can think of, generally speaking, as the amount contributed by shareholders to a corporation that can be returned tax-free from the corporation to its shareholders.
It provides rules for how you determine the paid-up capital, subject to a number of specific provisions in the act that can change that; and it lists them. This amendment just adds the Wheat Board rules, saying that in the context of the Wheat Board, you look to those rules for computing paid-up capital of the shares of the Canadian Wheat Board.
I should introduce the Canadian Wheat Board measure itself now since this is the first occurrence in the bill. The Canadian Wheat Board was privatized, and the transaction closed last July. These measures, which we'll see in more detail later in proposed section 135.2, I believe, take you through the transaction. They deal with the tax consequences of the privatization transaction. In essence, they provide a tax deferral for the farmers who are involved and also for the trust that was set up to implement the structure. We'll be able to look in more detail at how that works when we get to proposed section 135.2.
The next amendment in clause 11 is again consequential to the Canadian Wheat Board changes. There's a set of rules dealing with non-resident trusts. That's where a Canadian contributes money, and typically the paradigm transaction is an offshore trust — I guess famously Panama or something like that. The Canadian tax rules say that any income earned in a non-resident trust should be properly taxed in Canada and that you can't ship profits offshore in that way. They do it by deeming the non-resident trusts received a contribution from a Canadian to be resident in Canada, and there are a number of exceptions to that deeming rule. We've added an exception that it doesn't apply to the Canadian Wheat Board Trust. That trust is completely irrelevant to the non-resident trust rules. This was just a consequential amendment to clarify that.
Next is clause 12, which is rules dealing with offshore captive insurance. The Canadian international tax system, as I briefly alluded to earlier, contains rules that prevent Canadian investors from moving passive investment income, such as income on bonds, share portfolios and the like, offshore to a non-resident corporation that's not going to be resident in Canada. Absent the foreign accrual property income rules that it might not be taxable in Canada, these rules say that if you have certain types of passive income, you can't move them offshore to a non-resident company, paradigmatically in a low-tax jurisdiction, and avoid Canadian tax. Of course, these passive investments are very easy to move around. They impute on an accrual basis that income to the Canadian taxpayer.
One type of income that our system has long said should be properly taxable in Canada is the insurance of Canadian risks. So a Canadian corporation like a Canadian insurance company can't move, for example, my mortgage insurance to an offshore company and avoid Canadian tax. That will continue to be taxable in Canada under the Foreign Accrual Property Income Rules.
Budget 2014 announced a set of proposed amendments that seek to prevent a sophisticated form of tax planning involving the effective transfer of economic exposure to Canadian risks to an offshore affiliate, where through a series of complex derivative arrangements they were legally transferred to an entity outside the group, such as a Swiss insurance company, but the economic exposure to them remained with the foreign affiliate of the Canadian company.
The set of amendments included in Budget 2014 and enacted in the second budget implementation bill of that year contained a gap. They prevented the use of certain derivatives, like swaps, to obtain economic exposure to the portfolio of Canadian risks that had been transferred to a foreign entity, but it was also possible, as was later discovered, to get the same economic exposure not in an instrument like a swap but on what's called the transfer or the seeding of the Canadian risk. So your proceeds for seeding the risk to the foreign entity would contain payments that would effectively track the economic exposure to the transfer of Canadian risks.
That's a long-winded way of saying that these rules prevent insurance companies from transferring Canadian risks offshore and keeping economic exposure to those risks through derivative products and make sure that the tax policy on the insurance of these Canadian risks is properly taxable in Canada.
Senator Marshall: How would you know of these transactions? Who detects them? Who identifies that these transactions are occurring? Can insurance companies do the transfer and nobody be aware of it? How are you aware that these transactions have happened?
Mr. McGowan: A few different ways. One, we have a self-reporting system in Canada, and, of course, Canadian taxpayers tend to report their transactions; and the Canada Revenue Agency audits them and can spot these transactions. In addition, and I don't recall for this specific measure, but sometimes you have practitioners or people from industry who join the Canada Revenue Agency who know about this type of tax planning; and you can tell them where to look. They'll say, "Hey, you might want to look at this.'' I've not seen the movie, but I read the book, The Big Short.
Senator Marshall: Yes.
Mr. McGowan: It's a good example of how these complex derivative arrangements can be difficult to wade through. It's very much the case here.
Senator Marshall: Is there a dollar value on that? How much will the federal treasury be in by this tax change?
Mr. McGowan: There is. It's in the budget documents.
Senator Marshall: Is it possible to estimate?
Mr. McGowan: It very much is. We have it in the charts. We're just looking it up.
Senator Marshall: You can get it for me later. I would think that if you don't detect it and there's no process in place to make sure you get all of the transactions, would you be able to get an estimate? I can get that number from you after.
Mr. McGowan: I don't have that handy.
Senator Marshall: We can get that later.
Senator Eaton: Do you have a supplementary question?
Senator Eaton: Yes. Do you have an estimate of how many non-resident employers here employ non-resident employees in Canada?
Mr. McGowan: That relates to the streamlined withholding requirements. We call it the regulation 102, and it's a separate measure. I don't know that we have that right now. We have a revenue estimate, which was in the neighbourhood of $2 million a year.
Senator Eaton: If you come across that number — you must have had numbers to come up with a certain revenue source — could you send it to us? It would be rather interesting to know how many non-resident employers employ non-resident employees in Canada.
Mr. McGowan: I know that this was a very significant measure in the tax community. I think every tax executive institute presentation or submission we have seen in the last several years mentioned this. It was a large concern, but I don't have the specific numbers. We'll take a look.
The Chair: We'll follow up with you to make sure we get it.
Mr. McGowan: Clause 13 increases the maximum amounts that can be paid under the Northern residents deduction. Each member of a household located in the Northern zone can currently claim $8.25 per day, but it's going up by a third to $11 per day. Where no other member of the household claims a residency deduction, the maximum is $22 per day. If you're living by yourself, it's $22; if there are two people, it's $22; if there are three people, it's $33, and so on. For residents of the Intermediate zone, they're entitled to a deduction of half of these amounts. That's increasing the amount of the existing Northern residents deduction.
Senator Eaton: They get $22 per person if they're living by themselves. I understand there are also subsidies for food, when they buy it. Do you have any idea of the total subsidization we give to our Northern neighbours?
Mr. Leblanc: No, not overall. Just a good sense of this measure, but not of the program you described.
Senator Eaton: You don't have any other reference point? It's strictly the tax? Thank you.
The Chair: Could you give us a definition, from a geographical perspective, of the Northern and Intermediate zones, to help us out?
Senator Neufeld: I'm in the Intermediate zone. I live in Fort St. John in British Columbia. If I went 400 kilometres north and west, I would be in the full zone.
Mr. Leblanc: By definition, the territories are in the Northern zone. If you look at the northern parts of some provinces — British Columbia, Alberta, the provinces in the West and also, I believe, some of Quebec — that would be the Northern zone. If you go north, but not quite as far, that's where the Intermediate zone is in certain provinces. Sorry; that's a very general explanation.
Mr. McGowan: I have a map.
The Chair: It would be great to get a copy of that map, Mr. McGowan. Could we do that? We could photocopy it. Would that be okay?
Mr. McGowan: Absolutely.
The Chair: Did we ask how many people are affected by this deduction?
Mr. Leblanc: We expect about 225,000 Canadians will see their taxes reduced as a result of this measure.
Senator Eaton: Their taxes are reduced. They don't get money?
Mr. Leblanc: That's right. It's a deduction, so it will affect tax payable.
The Chair: That includes the Northern and Intermediate zone?
Mr. Leblanc: That's correct, all those affected.
Senator Marshall: What would the dollar value be?
Mr. Leblanc: You're looking at something in the $50 million range in terms of foregone revenues. I believe it starts at $45 million in terms of the first full year, which would be 2016-17, and soon after that goes up to $50 million.
The Chair: How did you arrive at that number? Not the $50 million, but the $22 or whatever it is per person. Do you have any background? Was that an analytical number?
Mr. Leblanc: The background is that it was in the platform.
Senator Pratte: There's your answer.
The Chair: It was in the platform. That's a very different analytical answer. Continue on, Mr. McGowan.
Mr. McGowan: Clause 14 is another measure that the government announced in Budget 2016 and it is proceeding with. It relates to the use of derivatives to effectively generate artificial tax deductions. The transactions themselves are tremendously complex, but I think that, somewhat conceptually, they are — I don't want to say simple — not that bad.
As I said earlier, dividends paid between taxable Canadian corporations are, generally, effectively tax-free, but as I mentioned, they have the mechanism where you include an amount in income and you get a deduction, making them tax-free. The best way to describe it is probably to compare the two cases.
If a tax-exempt has shares of a taxable Canadian corporation, it receives the dividend, the tax-exempt doesn't pay tax on it, the corporation doesn't get a deduction and nothing terribly surprising happens. But say you interpose a financial institution between the tax-exempt and the Canadian corporation so that the financial institution owns the shares of the Canadian corporation and the financial institution itself is a corporation. It enters into a derivative, or, classically, a total-return swap. The transfers — all of the economic exposure to the share up to the tax-exempt — I gave the previous example of the $100 dividend declared by the corporation that goes to the pension fund. Nothing happens, really. But here you have a $100 dividend declared by the corporation that goes to the financial institution, and then, under the terms of the total-return swap, any economic exposure to the shares on which the dividend is paid are transferred to the tax-exempt. That $100 is passed on under the swap, and for tax purposes, the financial institution would include the amount of the dividend in its income but would take the intercorporate dividend deduction and then would take a second deduction when the $100 is paid off to the financial institution.
If you look at it economically, from a big-picture perspective, $100 has gone from the Canadian corporation into the financial institution and then been passed on to the tax-exempt. The tax exempt is still not paying tax, and the corporation is still not getting a deduction, but the financial institution, despite having $100 coming in and $100 coming out, has two $100 deductions and one inclusion. So net, they get a $100 deduction off their taxes. If I passed $100 from Rob to Pierre, I don't think Rob would be entitled to deduct $100 off of his tax bill.
The existing dividend rental arrangement rules, which were introduced decades ago to prevent similar types of planning, were introduced before the use of complex derivative financial arrangements became prevalent, and they clearly didn't contemplate those types of arrangements. They didn't cover them, so now we're extending or modernizing those rules to catch this type of arrangement.
Similar tax planning, where dividends were effectively rented and passed on, was denied the intercorporate dividend deduction, and this extends that when derivatives are used to pass on the economic exposure to what we call a "tax- indifferent investor,'' or tax-exempts. The measure it says, "You don't get an intercorporate dividend deduction.''
Going back to my example, $100 goes into the financial institution. That's included in income. The financial institution gets $100 deduction when it passes what's called the dividend compensation payment off to the financial institution. So 100 goes in; 100 comes out, 100 inclusion, 100 deduction. The financial institution is no richer, no poorer, and it doesn't have an inclusion or deduction on its taxes. In essence, that's how the rule works.
As I said, in clause 14, it effectively turns off the intercorporate dividend deduction where you have a synthetic equity arrangement. That's where you pass on the economic exposure to the share to a tax-exempt.
I'm reminded that, as I think I had said, the existing rules did not clearly contemplate this type of structure. I understand that the Canada Revenue Agency has looked at it. I don't know if they're in the process of challenging, but they may well challenge some of these structures in place, based upon the existing rules. But, as any such challenge could take 10 or 15 years to work its way through the system, this provides certainty and a clear set of rules now.
Next, we have, in clause 15, the children's arts tax credit. This is a non-refundable tax credit at 15 per cent on up to $500 of expenditures for children's arts programs. It's being reduced to $250 for the 2016 taxation year, and the credit is being repealed for the 2017 and subsequent taxation years.
The Chair: Senator Pratte, do you have a question?
Senator Pratte: I remember when those tax credits were introduced. You know how journalists they are. They were asking questions like: Do you know if these types of credits will actually encourage children to get more involved in arts programs and things like that? Of course, at the time, there were really no answers to those questions. Obviously, we know what they cost the government, but, besides that, were there any studies made as to the impact of those types of very pinpointed tax credits?
Mr. McGowan: I would defer to Pierre.
Mr. Leblanc: Since we're on the clause for the children's arts tax credit, I'm not familiar with any studies that specifically focused on this credit. It could be challenging to try to identify.
Senator Pratte: But there is another one for sports.
Mr. Leblanc: There have been certain studies that have looked at the children's fitness tax credit, but for arts, no.
Senator Pratte: For fitness? Not by the department, I guess.
Mr. Leblanc: There have been studies out there finding limited effectiveness, I think we could say.
Senator Eaton: Did you look at the figures that were claimed for children's art classes? Wouldn't that give you a good indication how many children benefited and how many parents claimed them?
Senator Pratte: You can claim them even if your kid already went to arts classes.
Senator Eaton: Oh, I see.
[Translation]
You wanted to know how much more.
[English]
Senator Pratte: That was one of the criticisms. Your kid already went to art classes, and you simply claimed the credit because it was there. It was suddenly available.
Mr. McGowan: Clause 16 relates to the education and textbook tax credits. We'll see throughout the bill that a number of measures based their eligibility for other credits or rules on whether or not you qualified for the education tax credit. When you see the phrase "entitled to a deduction under 118.6(2),'' that's what they're looking at. It's: Were you eligible for the Education Tax Credit? And they base eligibility for other rules on that.
With the repeal of the education tax credit, a new definition of "qualifying student'' is introduced that has the same general criteria as would have qualified you for the education tax credit before. Now those other provisions will refer to the definition of "qualifying student'' instead of eligibility for the education tax credit. So it's more mechanical in its operation, but it serves to ensure the continued effectiveness of other rules that relied on eligibility for the education tax credit, and that's what the new definition of "qualifying student'' does.
Clauses 17 through 21 all relate to the repeal of the education and textbook tax credits. Clauses 17, 18 and 19 remove references to the education and textbook tax credits from their respective provisions, leaving, of course, the references to the tuition tax credit, which remains. They deal with transfers to parents and grandparents.
The Chair: We're looking at 22 and 23.
Senator Mockler: When we have a transfer to grandparents, what are the changes in that compared to previous budgets?
Mr. McGowan: For the changes to grandparents, as I said, the education tax credit and the textbook tax credit are being repealed, and those previously could be transferred to a grandparent, as could the tuition tax credit. With the repeal of the education and textbook tax Credits for 2017 and subsequent years, of course, those will no longer be able to be transferred. Those are the changes that are being made.
Mr. Leblanc: Maybe I can follow up with a practical example. Take, for example, a student who is paying about $5,000 in tuition, and then there are also the education and textbook amounts. Let's say we're in 2017, so this measure has taken effect. Basically, because you can transfer up to $5,000, but let's say the student can't use any of those amounts in the year; their income is quite low. What the student would have done is transfer $5,000 and the rest they would carry forward. They would carry forward, say, eight months of an education amount — that's 3,200 — and eight months of the textbook amount, which is, say, roughly $500. That's just an approximation. So about 3,700. What would be different now — again, we're thinking about 2017 — is that the only amount that could be claimed under this proposal is the tuition tax credit. In this case, just by construction, it's $5,000, so they transfer the $5,000 to the grandparent or the parent. What's different here is that they will have used up all of those amounts in the transfer, and they won't be carrying forward any amounts. The effect won't be right away; the effect will probably likely be when they start working and start having income that they can use to use those amounts that have been carried forward. It will depend on the specific cases. The tuition tax credit will be left to be carried forward, and I guess that will depend on the amount of tuition a particular student pays.
[Translation]
Senator Mockler: That is exactly what I was trying to find out. What impact will this have on the grandfather's wallet?
Mr. Leblanc: It really depends on the example. In this example, there would be no effect on the grandparents or the parents, because the grandparents would receive the same transfer, that is to say a $5,000 transfer. However, it would have an impact on the students, not immediately, but in the future. So, it all depends, there may be other cases. For instance, if tuition fees are less than $5,000, currently, there are amounts granted for textbooks, for education. There may be a certain effect in 2017.
Senator Mockler: If the educational institution is outside of Canada, what impact will that have?
Mr. Leblanc: It all depends on the institution, but in the case of certain foreign institutions, tuition fees will be eligible. So, for the students as well, as of 2017, no amounts will be granted for education or for textbooks. However, there will always be a credit for tuition fees. Generally, tuition fees are quite high in those institutions.
[English]
Senator Mockler: Which institutions will qualify or not qualify outside of Canada? Give us an example so that we can comprehend what you're saying, sir.
[Translation]
Mr. Leblanc: A large university like Stanford, for instance, is on the list of institutions whose tuition fees are eligible.
Senator Mockler: Do you have that list?
Mr. Leblanc: Yes, we can provide it to you. I do not have it with me, but we can send it.
[English]
Senator Eaton: Why was Stanford University chosen or why were the institutions on the list chosen? There must be some reason.
Mr. Leblanc: Stanford because it came to my head, and the list —
Senator Eaton: Harvard? Are all the Ivy Leagues included?
Mr. Leblanc: Yes.
Senator Eaton: Why? It's an interesting question.
Mr. Leblanc: I think I could tell you in basic terms that it's considered to meet the criteria for a qualifying institution and it's considered that if that student continues to be a resident of Canada for tax purposes, and it's considered that that investment in education is considered to be a legitimate expense for the purposes of the credit, then under the current rules a credit can be claimed for that tuition.
Senator Eaton: If you think of Harvard and Stanford as universities, any university follows those criteria abroad?
Mr. Leblanc: We can follow up with more details about how the criteria work for foreign institutions. It would be better to make sure we give you the right information.
Senator Mockler: Could he also include, Mr. Chair, for the benefit of all the members, the definition of the criteria?
Mr. Leblanc: Yes, we'll do that.
The Chair: Thank you very much.
Mr. McGowan: I believe we're on clause 22 of the bill now. That is another consequential amendment, section 118.92 of the act. For individuals claiming non-refundable tax credits, they're claimed in a certain order, and this provision lists the order and lists all the different tax credits that can be claimed. It's being amended in this bill to remove the reference to the section that contains the Family Tax Cut, which is being repealed, and also removing references to the education and textbook tax credits, as well as the children's arts tax credit. These are being removed from the ordering rule.
Clauses 23 and 24 are being amended consequential to the repeal of the education and textbook tax credits to remove references to section 118.6.
Clause 25 is the Family Tax Cut, that is the income splitting tax credit for families with children, or children under the age of 18, so separate and apart from the pension income-splitting tax credit. This is just the Family Tax Cut. It approximates through a tax credit mechanism of up to $2,000 the effect of splitting income with a qualifying spouse, qualifying income up to $50,000, and that is being repealed for the 2016 and subsequent taxation years.
Senator Marshall: It says here in our notes that it's going to increase federal revenues by $1.9 billion in 2016-17, so it must have been popular. I don't know if this is a fair question to ask you, but why would that be eliminated? That seemed like a good program to me. What's the logic in eliminating that program?
Mr. Leblanc: If you think of it in the context of what the government is doing generally for families with children, the stated objective is to better target support towards low- and middle-income families with a very significant expansion of child benefits through the Canada Child Benefit. I think the elimination of income splitting for families with at least one child is seen in that spirit. It was seen as a measure that wasn't particularly well targeted. Those funds are being reinvested and enhanced and are a better targeted suite of benefits for families with children.
Senator Marshall: The way it was working is that it would benefit more well-to-do families, is what you're saying.
Mr. Leblanc: Just how it worked, it depended on the difference in incomes between spouses. Basically, you have to have spouses in different tax brackets. The greater the gap in tax brackets or in incomes between spouses, the greater the benefit, capped at $2,000, but there was some relationship there.
The Chair: Moving ahead to Canada Child Benefit, page 26; is that where we are?
Mr. McGowan: I think clause 26. This is another consequential amendment relating to the small business deduction or the small business tax rate. I mentioned it has three components: the small business tax rate, the gross-up on the receipt of a dividend, and then the amount of the dividend tax credit.
Clause 26 is the one that maintains the current gross-up level. Here it's expressed as a fraction of 21 over 29, but it's maintaining that gross-up after 2016.
Next we get to the Canada Child Benefit, which is in clauses 27 to 31. This replaces the Universal Child Care Benefit and the current Canada Child Tax Benefit, and it is part of the suite that Pierre just described. It provides a maximum tax-free annual benefit of $6,400 per child under the age of six and $5,400 per child aged six through seventeen. The amount of the benefits, of course, depends on the number of children and, as well, it's phased out depending upon the family income.
Senator Eaton: Are children in First Nations eligible for this Canada tax benefit?
Mr. McGowan: There is an amendment relating specifically to that, and that's in clause 28.
Mr. Leblanc: Basically it's a very targeted amendment. Generally speaking, yes, children who are living on and off reserve are certainly eligible for the Canada Child Benefit.
What was happening is that there's a requirement that the parent be either a citizen or a permanent resident or have a certain status under the Refugee Protection Act. Say you have a community that's straddles the border. They might be neither a citizen nor a permanent resident of Canada, but they're an Indian for the purposes of the Indian Act.
Senator Eaton: They reside in Canada even if the reserve straddles the border.
Mr. Leblanc: That's the idea. They might not have citizenship, and they might not have permanent residency.
Senator Eaton: Also, they're not American, or they don't have American citizenship.
Mr. Leblanc: How would it work for the Americans? I know they wouldn't be Canadian citizens. Even if they were, they wouldn't be residing in the U.S.
Senator Eaton: They wouldn't be residing in Canada either.
Mr. Leblanc: They are residing in Canada. They're allowed to reside in Canada, so they're considered residents of Canada for tax purposes.
Basically right now they are eligible for other benefits, such as Old Age Security and the Goods and Services Tax Credit. But given the way the rules were written, they weren't eligible for child benefits. This basically puts things in line with other benefits offered by the federal government by making them eligible for the new Canada Child Benefit.
Senator Eaton: A cheque is sent, so it's not tax relief, which might not apply to First Nations.
Mr. Leblanc: That's right.
Senator Marshall: How come the formula is so complicated? I went to the legislation, and the formula is three pages long. You almost have to be a mathematician to follow it. Who makes up the formulas?
Mr. Leblanc: It's closely related to the platform proposal. Right now, if you take the collection of child benefits we have, even if you take income-tested benefits, there are two. There is the National Child Benefit supplement, which is targeted at low- and modest-income families and is phased out at a fairly high rate between income of roughly $25,000 and $46,000; and there is the Canada Child Benefit, which reaches higher up the income scale and starts to phase out at around $45,000. Where it phases out depends on the number of children you have.
You could say that there's a general relationship. It doesn't move too far from what we have now in that it's targeted, provides the maximum benefit to families with net income of $30,000 or less, and then starts to phase out at rates that are lower than the current National Child Benefit supplement. The rates range from 7 percent for families with one child, 13.5 per cent for families with two children, to 19 per cent and 22 percent for families with three and four-plus kids respectively. The idea is that if you continued at those phase-out rates, it wouldn't reach all that far up the income scale. Starting at $65,000, it starts to phase out more slowly.
Senator Marshall: Could you tell us, for example, for a single parent with one child, at what adjusted income level would they be before they get nothing?
Mr. Leblanc: For a single parent with one child, I have those numbers. It will just depend on the income. Let's say they had one child aged zero to five. It would be $188,438.
Senator Marshall: Then you get nothing.
Mr. Leblanc: You get nothing. If you had a child aged 6 to 17, because the maximum benefit is lower for the age group, it would be $157,188.
Senator Marshall: What is the $157,000? Is it adjusted income or net income or taxable income?
Mr. Leblanc: It is adjusted net family income. Think of total income, at line 150 of your tax return. It's your different forms of income. It could be the total of earnings, self-employment income and different forms of investment income. Then you make certain deductions. There are two main groups of deductions in the income tax system. The first group of deductions is more commonly claimed, such as contributions to a registered retirement savings plans and registered pension plans, union dues, professional fees and child care expenses. Take away those deductions and arrive at family net income. It's called adjusted because under the current system it doesn't include the Universal Childcare Benefit. That's basically the measure.
Mr. McGowan: The Canada Child Benefit takes us up to clause 32, which relates to the Child Fitness Tax Credit, which is a refundable tax credit on an amount of eligible expenditures for qualifying child fitness programs of up to $1,000 and is at 15 per cent. It is being reduced. The maximum amount of qualifying expenses will be $500 for the 2016 taxation year and will be repealed for the 2017 and subsequent taxation years. We briefly discussed earlier the studies on that.
Senator Pratte: In the budget, it's not really clear. What is the amount for a full year that was spent on the Child Fitness Tax Credit?
Mr. Leblanc: You want to know in terms of the expected savings, since there's a bit of a phase-out. The expected revenue gain for the 2015-16 tax year is $20 million.
Senator Pratte: Does that include the arts?
Mr. Leblanc: For both together. Then it will be $120 million for the 2016-17 taxation year and $245 million for the 2017-18 taxation year. When you look at 2017-18, it will basically be a steady state from then on. The revenue gain would grow very modestly. That's basically your full effect.
Senator Pratte: For both.
Mr. Leblanc: For them together; that's correct.
The Chair: We're on page 31, for everyone's information going forward.
Mr. McGowan: The next is clause 33, which deals with the School Supplies Tax Credit. This is a new 15 per cent refundable tax credit relating to the cost of eligible school supplies purchased by teachers or early childhood educators for use in the classroom. The eligible expenditures would include consumable goods used in the course of teaching as well as certain prescribed durable goods like games, puzzles, containers and things like that that teachers and early childhood educators often purchase for their students out of their own pockets. It would apply for the 2016 taxation year.
The Chair: Is there a maximum amount that teachers can qualify for on this?
Mr. McGowan: The qualifying expenditures are capped at $1,000. The maximum amount of the credit would be 15 per cent of that, or $150.
Clause 34 is the third of the changes related to the small business deduction, and this maintains the corporate tax rate on the amount eligible for the small business deduction at its current 10.5 per cent rate after 2016. As I mentioned, you'll see in the legislation that it's 17.5 per cent because the general rate of 28 is reduced by 17.5 to get you that 10.5 per cent number.
Clause 35, as mentioned earlier, extends the mineral exploration tax credit by a year in respect of flow-through share agreements entered into up to the end of March 2017. This is a 15 per cent credit that applies to qualifying "grassroots'' exploration expenses for minerals. It applies to individual shareholders who have had Canadian exploration expenses renounced to them. As mentioned by the chair, this is the same credit that was extended previously.
The Chair: For the last 20 years?
Mr. McGowan: About 15 times.
Mr. Green: It was originally introduced in 2000 for a three-year period.
Mr. McGowan: Clause 37 deals with tax credits in the case of bankruptcy, and consequential amendments are made to remove references to the family tax credit and the education and textbook tax credits.
Clause 38 deals with the privatization of the Canadian Wheat Board. As I described earlier, the wheat board was privatized in a transaction that closed last July, I believe, and as part of that transaction a trust was established that holds shares of the wheat board corporation. Participating farmers, when they deliver grain, can receive units of the trust as part of their remuneration for that.
This measure effectively goes through the steps in the privatization transaction and dictates the tax consequences at each step, carrying through to the point where a farmer disposes of the units. It takes you through each step in the transaction from the beginning right up until the farmer sells —or the trust winds up — and prescribes the tax consequences. In general terms, it provides a deferral to the participating farmers.
When the trust was established, it was initially capitalized by issuing a promissory note, or a debt obligation, to it, which it used to subscribe for shares of the Canadian Wheat Board corporation. That transaction would ordinarily result in a fully-taxable benefit on the full value of the note, which would later approximate the value of the shares taken back. That would have been included in the income of the trust and generally taxed at the top marginal rate. Of course, that was not the intended tax outcome, so the rules override what would otherwise have happened and provide a deferral, so there's no income inclusion on the capitalization of the trust.
Likewise, when a participating farmer delivers wheat and takes back units of the trust as payment, it would ordinarily be included in the farmer's income, fully taxable immediately in the year that the trust units are received. The rules provide a deferral in that case, so they're not taxed on receipt by the farmers. Rather, they're taxed, generally speaking, on the disposition of the units. There's a tax deferral until the farmers actually dispose of the units and realize their proceeds for doing that.
Generally speaking, there's an income inclusion on the disposition of the units but, for example, the rules provide a tax deferral where a participating farmer dies and the units go to their estate and end up in the hands of their spouse or common law partner. There are exceptions, of course, but the general rule is that there is a deferral of taxation until the units are sold.
In addition, there are consequential rules. We've talked about the lower tax rate that applies to income of a Canadian-controlled private corporation eligible for the small business deduction. If the units are earned by a corporation that's eligible for the small business deduction, they would normally be eligible for this lower tax rate, so later on, when the trust units are sold, this is a special deeming rule saying they are entitled to the same treatment.
You can see it's kind of complex, but it takes you through every stage of the transaction and overrides what would ordinarily be the tax consequences that would occur in the other 260 some sections of the act to ensure that the participating farmers have a tax deferral with respect to the transaction.
Senator Mitchell: I'm interested in how those units work. For tax purposes, are they valued at the time that they take the units, or at the time they sell them? I think you're saying they're valued at the time they sell the units.
Mr. McGowan: That's correct. For tax purposes, the participating farmer will be deemed to have acquired them with a tax cost of nil and with a taxable income of nil. It's not until they sell them that the units are considered an amount of taxable income.
Senator Mitchell: If I understand, it's not one of those situations where they could get the unit, have a taxable value placed on it and then three years later sell it and find the market has collapsed and they have no money to pay the taxes.
Mr. McGowan: That's correct. When they initially receive it, they won't have any tax inclusion. It's later on, when they sell it, that they'll have that income inclusion equal to its value.
Senator Mitchell: What kind of market is there for that? How is that market structured? How do they sell it?
Mr. McGowan: I don't have as much information on the commercial operation of the trust. There is a mechanism whereby, reflected in the tax rules on redemption of the units, they get the income inclusion. That was contemplated as a source of liquidity or a way to sell it. In terms of the current market, I don't have that information beyond the tax amendments.
Senator Mitchell: Is the money essentially in a pool and they just redeem it when they choose to? Or can they go to their neighbour and sell it to them? Why would somebody buy one?
Mr. McGowan: In terms of the actual funding, my understanding is redemptions of trust units —
Senator Mitchell: Share value in what was the Canadian Wheat Board?
Mr. McGowan: The trust holds shares of the Canadian Wheat Board, and the issuance of units to participating farmers provides indirect economic exposure to the shares in that way.
There are rules relating to transferring it to your corporation but not your RRSP or to your spouse, as I mentioned previously, through an estate, but I don't have any information on the current market for these units.
Senator Marshall: How many participating farmers would this impact? It's specific to the Canadian Wheat Board, so it doesn't impact the general population of taxpayers. How many would be impacted by this?
Mr. McGowan: I'm just looking to see if I have that in my materials.
Senator Marshall: You can provide that to us. I haven't seen any articles on this aspect of the budget bill, so if you could just find out how many participating farmers, knowing that participating farmer could also be a corporation.
The Chair: Please do that.
Moving on.
Mr. McGowan: Clause 39 is another consequential amendment relating to the Education and Textbook Tax Credit repeals. It deals with the life-long learning plan and replaces the reference to someone who is entitled to an education tax credit with a qualifying student, which is just the new term for that type of person.
Clause 40 is a measure that was announced in Budget 2015 and was confirmed again in Budget 2016. It relates to investments by charities and registered Canadian amateur athletic associations and partnerships.
There are rules in the act that prohibit charities from carrying on a business other than a related business. A "related business'' would be something like a hospital cafeteria, a church bake sale or something like that. Generally speaking, a partnership is the relationship between persons carrying on business in common with a view of profit. So it's people carrying on a business by definition.
The Canada Revenue Agency had long taken the position that a partnership is carrying on the business of the partnership, which effectively precluded charities from investing in limited partnerships unless the limited partnership carried on a related business, like operating their cafeteria or something. This measure would allow a registered charity or registered Canadian amateur athletic association to make a portfolio investment in a limited partnership to expand its universe of potential investments to increase its return.
I had mentioned that these are portfolio investments. There would be a limit of up to 20 per cent of the interests in the partnership. The charity can't invest more than that, or they will start to be more controlling. Also, they have to deal at arm's length with the general partners of the partnership.
In effect, it allows registered charities to invest in partnerships for investment purposes; whereas, previously, that could have been cause for their deregistration as a charity.
The Chair: There are no questions. Moving forward.
Mr. McGowan: Clause 41 lists certain refunds and deemed payments of tax. It's in respect of refundable tax credits. It is being amended to add a reference to the new school supplies tax credit and remove a reference to the Children's Fitness Tax Credit, which is being repealed.
Senator Neufeld: I wonder if we can go back to the charities. Can you give me an example of what benefit that would be to a charity? Something must have driven this change, and I'm quite aware of them being delisted if they did the wrong thing before. Was that something that was happening all the time — that charities were investing in things that they shouldn't be, and this now just allows them to go ahead and do that? What would drive it? What would make you change it?
Mr. McGowan: It is something that I've heard of happening, but it's also something where somebody running a charity who is aware of their restrictions would avoid making certain investments. Sometimes charities could run afoul of the rules, maybe unknowingly, but it also provided a limit on the sorts of investment opportunities that a charity could take.
Some investment funds, for example, in Canada, are organized in a number of different ways. Sometimes they're organized as trusts — usually in the form of a mutual fund trust. Some of them are organized as mutual fund corporations. Others are organized as investment limited partnerships. Charities were not permitted to invest in those funds, which are classically passive, pooled investment vehicles. In looking at the world of investment opportunities available to it, it would have to set anything organized through a partnership aside, simply because of the organizational form that the fund happened to take.
The Chair: Is that okay, Senator Neufeld?
Senator Neufeld: Yes.
Mr. McGowan: Clause 42 is another measure that had been announced in Budget 2015 and was confirmed in Budget 2016. It deals with withholding obligations imposed on non-resident employers with non-resident employees performing services in Canada. Those employers are still required, as Canadian employers are, to withhold amounts on account of tax on the salary they pay to their employees. However, in many cases, generally because the employees are exempt from Canadian tax due to a tax treaty with Canada and their country of residence — again, most commonly the United States, being our largest trading partner — you would have non-resident employers having to withhold tax on amounts paid to their employees for services performed in Canada when the employees were not ultimately going to be liable for tax in Canada.
There were a couple of different procedures in place: One, the employee could just file a Canadian tax return and get the money back, or an employee-specific waiver could be obtained, but you have to get one of those for each employee and often in respect of each trip to Canada. That was identified by the business community as being tremendously cumbersome, in particular where Canada is not going to be taxing these employees, anyway. In many cases — for example, where the cost of hiring an accountant to fill out your Canadian tax return was more than the cost of the Canadian tax — you would hear perfectly reasonable stories about non-resident employees saying, "I'm not spending $1,000 to get a $400 refund,'' so they just leave the money on the table. This was creating friction in cross-border trade.
The rules provide an advanced certification system where qualified non-resident employers can apply to the Canada Revenue Agency to be certified as a qualifying non-resident employer. Then they don't have to withhold in respect of their qualifying non-resident employees. They get certified in advance, and the idea is to reduce their compliance burdens in situations where their employees were not subject to Canadian tax.
It doesn't change which employees are subject to Canadian tax. If they were before, they would be after. Rather, it's in situations where the employees are not subject to Canadian tax and so they qualify as qualifying non-resident employees. If they have a qualifying non-resident employer, they don't have to comply with the withholding obligations.
The Chair: One more. We have about two more minutes left, and then we're going to see you folks this afternoon as we continue the deliberations. So we are on a marathon. Let's close it up with one more, Mr. McGowan.
Mr. McGowan: The next one is clause 43, which relates to the repeat failure to report income penalty. This penalty is being revised to restrict when it will apply, particularly in situations where its application was not consistent with good tax policy and in particular in the case of low-income individuals. I should mention, as well, that this was a Budget 2015 measure that was confirmed in this Budget 2016.
An issue arose that there are two penalties for failure to report. There's the repeat failure to report income penalty, and there is what is intended to be the worse penalty of gross negligence. Because the repeat failure to report income penalty is based upon the amount of unreported income, and the gross-negligence penalty is based upon the understatement of tax, in situations where you had certain low-income individuals, you could actually have the gross negligence penalty, which is supposed to be the worse of the two, being less than the repeat failure to report income penalty. So you got into the strange situation where, if someone had behaved worse, they would have gotten the lower penalty.
These amendments will, first, put a cap of $500 of income — a de minimis threshold — but it will also say that the amount of the repeat failure to report income penalty will be the lesser of 10 per cent of unreported income and an amount generally based upon what the gross negligence penalty will be. The repeat failure to report income penalty won't be higher than the gross negligence penalty.
The Chair: That's the end of this morning's session. I'm pleased to remind members that we will resume this study of the subject matter of Bill C-15 at our 2:00 meeting, which will take place in 257 of the East Block. Let's make sure we get ourselves into the Senate and into our meeting quickly. I would ask all our members to check into the Senate so you're registered, please, for the session, and then come on over to 257. We'll start as expeditiously as possible.
Thank you, witnesses, for your time. I think we started to get a bit of momentum going. It was a bit of a rough start, but it's normal when we get into a subject like this, which is so analytical, that it takes time to get some momentum.
Thank you, and we look forward to seeing you later today. We really appreciate your involvement.
(The committee adjourned.)