THE STANDING SENATE COMMITTEE ON NATIONAL FINANCE
EVIDENCE
OTTAWA, Wednesday, October 18, 2017
The Standing Senate Committee on National Finance met this day at 6:45 p.m., to continue its study of the Minister of Finance’s proposed changes to the Income Tax Act respecting the taxation of private corporations and the tax planning strategies involved.
Senator Percy Mockler (Chair) in the chair.
The Chair: Honourable senators, welcome to this meeting of the Standing Senate Committee on National Finance.
[English]
My name is Percy Mockler, senator from New Brunswick and chair of the committee.
I wish to welcome all of those who are with us in the room and viewers across the country who may be watching on television or online.
As a reminder of those watching, the committee hearings are open to the public and also available online on the Senate website sencanada.ca.
Now I would like to ask the senators to introduce themselves, starting on my left.
Senator Oh: Victor Oh, Ontario.
[Translation]
Senator Pratte: André Pratte from Quebec.
[English]
Senator Black: Doug Black, Alberta.
Senator Andreychuk: Raynell Andreychuk, Saskatchewan.
Senator Eaton: Nicky Eaton, Ontario.
[Translation]
Senator Forest: Éric Forest from the Gulf region of Quebec.
[English]
Senator Cools: Anne Cools from Toronto, Ontario, Canada, and the deputy chair of the committee.
The Chair: I would now like to recognize the clerk of the committee, Gaëtane Lemay, and our two analysts, Sylvain Fleury and Alex Smith, who team up with the support of their team to work for this committee.
This evening our committee continues its special study on the proposed changes to the Income Tax Act respecting the taxation of private corporations and the tax planning strategies involved, changes that the Minister of Finance proposed during the summer of 2017.
[Translation]
Today, we have before us three business-oriented national organizations. They were asked to give their opinions on the impacts of the proposed changes.
[English]
First, from CPA Canada, the Chartered Professional Accountants of Canada, we welcome Mr. Bruce Ball, Vice-President, Taxation. Then we invited the president and CEO of the Business Council of Canada, The Honourable John Manley, who delegated Mr. Brian Kingston, Vice President, International and Fiscal Issues.
Finally, from the Canadian Federation of Independent Business, or CFIW, we welcome Corinne Pohlmann, Senior Vice President, National Affairs and Partnerships.
Thank you, witnesses, for accepting our invitation to be here to share your opinions, your comments and even your recommendations to the Senate Committee of National Finance that has the order of reference to make this study.
I have been informed by our clerk that the first witness will be Mr. Ball, followed by Mr. Kingston and concluded by Ms. Pohlmann.
Bruce Ball, Vice-President, Taxation, Chartered Professional Accountants of Canada: Thank you. CPA Canada is one of the largest and most respected national accounting and business organizations in the world, representing more than 210,000 Canadian chartered professional accountants at home and abroad.
Collectively, CPA Canada and the profession enable, champion and safeguard the Canadian ideal of good business that values inclusion, sustainable growth and social development in cultivating a healthy and thriving economy. We are committed to acting in the public interest, contributing to Canada’s economic and social development, and to helping Canadian’s businesses and the economy to succeed and prosper over the long term.
CPA Canada is pleased to be here today to speak on the federal government’s tax proposals involving private corporations. We also wanted to acknowledge that there have been changes made this week.
CPA Canada believes that tax policy is an essential lever to achieve key economic and social objectives in Canada. That is why CPA Canada is a strong and long-time advocate of tax reform.
We’ve consistently called for a top to bottom review of Canada’s tax system. Many other national organizations, leading think tanks, economists and academics have joined the chorus.
With the government’s proposed tax changes to the taxation of private corporations, the call for a comprehensive tax review has grown even louder and more urgent. There has not been a thorough review of Canada’s tax system in 50 years. We believe there is no better time than now to do such a review.
The proposals in many respects run counter to the public interests and the basic principles of sound tax policy, in particular concepts such as fairness, simplicity, competitiveness and efficiency. The latest set of measures announced this week in relation to private corporations may represent some initial steps forward but fundamentally these proposals continue to raise many questions and concerns.
I have some examples on each of the three areas. On income sprinting, we continue to believe that the reasonableness test will be complicated to apply. It will raise the cost of compliance, the overall costs of doing business and the government’s costs to administer the tax system. Given the announcement earlier this week, we are anxiously awaiting to hear further clarity on these proposals.
On passive investments, I will make three points. First, we need to ensure that the proposals around passive investment income are needed. These proposals will add complexity to the tax system. We still don’t believe that the government has made a good case for the changes.
Second, given the announcement today, further consultation going forward is crucial between now and the next budget. The government must ensure that affected stakeholders, including the tax community, have the opportunity to actively participate in any discussions between now and the next budget.
The third point we wanted to make is that the government did discuss a de minimis rule to exclude certain small businesses from the application of the new passive investment rules. This is something we recommended in our submission to Finance Canada.
Assuming the proposals do go forward, though, because we still believe there are broader issues, we look forward to discussing these issues further with the government and other stakeholders to make sure the de minimis proposal announced today is effective. I would also like to say that our organization along with the joint tax committee are ready and able to help with that.
On capital gains, the playing field was already uneven when comparing an arm’s-length sale to intergenerational transfers. The proposals have added more inequity with a strong bias to sell a business to third parties rather than family members. We are hoping that the finance minister will address the unfairness this week.
We would be pleased to further discuss our concerns that we’ve been hearing from the tax community, other stakeholders and CPA Canada’s recommendations as well.
I wish to emphasize, however, that this week’s measure in relation to private companies doesn’t really change CPA Canada’s overall position. Our central recommendation to Finance Canada on the proposals was that they really shouldn’t be enacted in isolation. They need to be reviewed as part of a comprehensive review of Canada’s tax system. Ad hoc incremental changes to the tax system are not a long-term solution. In fact, they create further complexities, inefficiencies and unintended consequences down the road.
The July 18 proposals and this week’s announcements are a case in point. There have been more changes and more changes on the changes. Over the last few decades, Canada has added layer upon layer of complex tax changes without proper consideration to the impact on the tax system as a whole. CPA Canada believes it is time to focus our attention on the entire tax system.
I did want to mention a few things about the bigger picture so I will set aside the proposals for a moment. It’s our belief that our tax system has not kept pace with Canada’s changing economic and social realities, including a slowing labour force growth, an ever-increasing competition for top talent globally and rising income inequality.
I would also like to take a look at what is happening around us and what Canada needs to do to stay competitive because other countries are taking action. As an example, the U.K. has simplified its tax system which also greatly reduces compliance costs. They have actually combined business tax rates into one single corporate rate. The U.S., as everyone has heard, is poised to introduce its tax plan for major corporate and personal tax cuts, which will also include tax simplification. Should these reforms proceed, they would significantly change the competitive landscape.
In the face of all these challenges, we believe it's time for Canada to build a best-in-class tax system. This is something we believe that every politician, no matter what political stripe, and all Canadians should support because it’s in the public’s best interests.
Does the country simply want to continue to plow ahead with incremental tax changes that only complicate a beleaguered tax system, or do we want to demonstrate leadership by charting a new and determined course to build a fairer tax system for the 21st century?
If we are truly committed to a fair tax system that supports inclusive growth and benefits all Canadians, then let’s take the time to get it right. Let’s launch a comprehensive tax review. CPA Canada stands ready to participate in this exercise.
Thank you, senators, for initiating your important study. I look forward to answering your questions.
Brian Kingston, Vice President, International and Fiscal Issues, Business Council of Canada: I thank you for your invitation to take part in your study on the proposed changes to the Income Tax Act.
The Business Council of Canada represents the chief executives and entrepreneurs of 150 leading Canadian companies in all sectors and regions of the country. Our member companies employ 1.7 million Canadians, account for more than half the value of the Toronto Stock Exchange; contribute the largest share of federal corporate taxes; and are responsible for most of Canada’s exports, corporate philanthropy and private sector investments in research and development.
First, I want to say thank you for launching this study. We are very concerned that not enough time was given to consultation on these very complicated proposals. We are very appreciative of the committee taking the time to review this important legislation.
The Business Council strongly supports efforts to improve the fairness and efficiency of Canada’s tax system. Unfortunately, the measures under consideration would make the tax system even more complicated than it already is. While we appreciate the government has been willing to listen to some of the concerns raised by Canadians, the proposed changes continue to have significant unintended consequences that we believe would discourage investment and job creation in Canada.
The proposed measures are far too broad and have created significant uncertainty for entrepreneurs, large private corporations and subsidiaries of multinational corporations. There are three areas I will go through where we have specific concerns and then I will talk about some of our broader views on tax reform.
The first area has to do with succession planning. While I understand the minister intends on addressing this tomorrow, it’s very important to note some of the concerns we’ve heard. The proposed tax changes would make it impractical in the event of a death to transfer a large, private family business to the next generation without triggering an external sale. As framed in the consultation paper, a child could be subject to double taxation if he or she purchases shares from a parent shareholder before that shareholder dies, uses a pipeline plan to receive cash on the parent’s death or sells to an external party.
The second area of concern has to do with passive investments in large private corporations. Large privately held companies, many of which we represent, have many legitimate reasons for holding passive investments. Those examples include a company wishing to keep liquid resources on hand to seize new opportunities and, as a diversification strategy, to invest in technology start-ups; companies in the real estate sector keeping easily liquidated investments on hand to assist with mortgage renewals in a time where credit conditions are unfavourable; and many companies holding passive investments because it allows them to borrow funds at a lower rate.
If the government discourages such activities, companies will be forced to re-evaluate such diversification strategy. This would have significant implications for some of Canada’s largest, most successful private corporations. It could restrict their ability to invest in start-ups in the communities in which they operate.
Moreover, we are concerned with the compliance burden associated with these passive investment proposals. A recent survey of 87 of our members found that on average they spend $3.73 million to comply with Canadian tax legislation and employed 18 full-time tax professionals. We believe this compliance burden will only increase under these proposals. Tax fairness will only be achieved by reducing complexity, not by further complicating the system.
The third area of concern has to do with passive investment and multinational subsidiaries. Applying the proposals to private corporations other than Canadian controlled private corporations could have serious implications for Canadian subs of foreign investors. Increasing the tax burden on multinational subsidiaries would erode Canada’s already weak tax competitiveness position. Multinational enterprises would be motivated to actually move operations and investors outside of Canada, depriving the country of jobs and growth while doing nothing to promote tax fairness.
The government’s plan to rewrite the tax rules for private corporations will not help achieve Canadian tax competitiveness. We fear they are driving investors and entrepreneurs away from the country. Canada does not have a highly competitive business environment as claimed in the consultation paper. In fact, our country’s tax competitiveness is slipping. Our combined federal corporate rate is above the OECD average, and we have the thirteenth highest tax burden on investments among the 34 OECD countries.
According to a recent survey of our members, two-thirds or 64 per cent said that Canada’s investment environment has actually worsened over the past five years. Only 20 per cent said the investment environment has improved. We, of course, asked why they thought the investment environment had worsened, and the most frequently cited reasons were an uncompetitiveness tax system, an unwieldy and uncertain regulatory process, and increasing costs of doing business.
To reverse this very worrying trend, we have repeatedly called on the government to adopt a competitiveness agenda that includes simplifying the tax system. Rather than making incremental changes to an already complicated system, we believe now is the time for a comprehensive review aimed at strengthening fairness and efficiency. Both of these objectives could be achieved by broadening the tax base and lowering rates.
Of equal importance is the need to ensure the tax system does not favour certain kinds of businesses over others. Lowering small business tax rates further as announced on Monday works against this objective while doing nothing to boost Canadian competitiveness. We need a tax system that rewards the attainment of scale and growth, not one that encourages companies to stay small.
With that, I conclude my remarks and I look forward to any questions.
Corinne Pohlmann, Senior Vice President, National Affairs and Partnerships, Canadian Federation of Independent Business: I thank you for the opportunity to be here to talk about this important issue. You should have a slide presentation in front of you that I’m hoping to walk you through over the next few minutes.
First, CFIB is a not for profit, non-partisan organization that represents 109,000 small and medium size companies across Canada. Our members come from every sector of the economy and are found in every region of the country.
When the tax changes were first announced on July 18, we took the time to try to understand what the complicated tax measures actually meant. However, we did know that small business owners were already highly concerned with total tax burden, which is a chart you can see on slide 3. We knew we had to do our homework and learn more about income sprinkling, the use of passive investments in business and converting income into capital gains among the smaller firms.
From early August until the close of consultations, we received hundreds of phone calls and emails and heard from dozens of other organizations. We also reached out to many tax professionals to better understand their perspective.
In addition, we sent out a survey in September to gather feedback which formed the basis of our submission. It is some of these results that I will share here today.
The survey received more than 8,500 responses from small business owners across Canada and had more than 700 pages of comments. We also did a similar survey of tax professional members to which there were over 400 responses.
What did our members say? As you can see on slide 4, most felt the changes would have somewhat or very significant impact on their business. Why? First, when it comes to income sprinkling, we found that 68 per cent of small business members do provide compensation to family members from the business, primarily to the spouse, as you can see on slide 5. Introducing restrictions by imposing a reasonableness test on whether family members should be receiving income from the business seemed unnecessarily complicated. We felt it would impose a heavy red tape burden on small business owners.
We were also concerned that these new rules would not necessarily recognize all the formal and informal ways family members are involved in the business, like taking a shift when an employee gets sick or helping to stuff envelopes for a marketing campaign in the evenings.
Also important is that the financial risk is not usually borne only by the business owner but also family assets are put at risk such as remortgaging the home. These are all conditions unique to small business owners and families.
Early this week, though, some adjustments were proposed to the income sprinkling provisions. We are pleased to see that the government abandoned the proposed rules to limit access to the lifetime capital gains exemption. However, it’s our understanding that the onus would still be on the business owner to prove that family member is making a meaningful contribution to the business. Our concern continues to be on how this will work, what the paperwork will look like, and how CRA will ultimately interpret these rules, despite the government’s claim that they will keep it simple and not let it be open to interpretation.
This latest announcement improves on some aspects of the original proposals, but we remain concerned about how it will work in practice. We eagerly await more details on these aspects of the changes.
Let’s talk about how businesses tend to finance growth in their business. As you can see on slide 6, they most likely use business equity funds or assets, which makes sense when you realize that obtaining for external financing is not easy for a small company. When they do get it, it can be expensive. This is why the use of passive investments is important for many of them.
When we asked our members about whether they have passive investments in their business, almost 70 per cent claim they did, as you can see on slide 7. Many invested in property or land as well as business shares or stocks. We also know that business owners use these investments for a variety of reasons including savings for a piece of equipment or expansion of the business, for retirement purposes, as a savings account to get through slow periods, for parental leave and other types of leave, et cetera. Any restrictions or increases in tax rates could have serious consequences.
As mentioned earlier today, the government announced they would allow small businesses a $50,000 annual threshold on passive income investment. This may be a step in the right direction as the government is starting to recognize the many important roles passive income can play in the life of a business and its owners. If administered properly, this change will be helpful in allowing many small firms to use passive income to ride out challenging times, save for investments or set aside money for leave or retirement.
However, while the $50,000 annual threshold will help small firms remain small, it’s unclear whether this will be enough for small firms saving to grow and create more opportunities. Canada has a dearth of medium size businesses. The size of the threshold may be too low to help those businesses looking to get to the next level. We need more clarity on how this change will be implemented, including whether the threshold will be indexed to inflation, for example. We hope we can get some of these answers between now and the 2018 budget when they plan to introduce the draft legislation.
These tax proposals represent one of the biggest changes to the tax system in over 40 years. Rather than achieving the goal of fairness, we felt the original proposals would make the tax system even more complex, result in middle class business owners being worse off than other taxpayers, and add to the many uncertainties small business owners already face. It’s not surprising that 94 per cent of small business owners and 95 per cent of tax practitioners did not support the government’s proposed changes to the tax system, as you can see on slide 8.
To be fair, the government did say they would make changes that could be brought to these proposals. We did ask the government to take the proposals off the table and launch meaningful consultations with the business community; to address any shortcomings in tax policy; to consider a comprehensive review of the Canadian tax system with a view toward fairness and simplification for all taxpayers; to ensure that in any changes to the tax treatment of businesses there’s no impact on the middle income small business owners from any measures, that there’s no scenario under which a business taxpayer ends up paying more in effective taxes than a personal taxpayer, and that there will be no retroactivity of any kind.
Earlier this week the government did start announcing some of the tweaks to the proposed tax changes. I’ve already commented on a couple of those in regard to income sprinkling and passive investments. We have one more to come tomorrow on converting income to capital gains.
I would also mention that we were pleased to hear about the reinstatement of the reduction in the small business tax rate to 9 per cent by 2019. This is important, as it has been cited by most small businesses as one of the more effective measures to help strengthen their business performance, as you can see on slide 10.
This will become even more important as small business owners start to face a number of new costs, such as higher employment insurance premiums starting in 2018, higher Canada Pension Plan premiums starting in 2019, and the introduction of much higher minimum wages across Ontario and other provinces. This lower small business tax rate will hopefully help mitigate some of the additional costs that are coming.
In summary, we’re pleased to see a reduction in the small business tax rate and that the government will no longer be moving forward with measures that limit access to the lifetime capital gains exemption, but we do remain concerned that income sprinkling changes may not reflect the many formal and informal ways family members participate in the business.
We’re also pleased that the government is recognizing the important role passive income can play in a business, but we remain unsure what the impacts will be on small firms saving to grow to the next level. We are anxiously awaiting details on the treatment of capital gains related to business succession.
Finally, I want to point out that these are incredibly complicated tax changes with many potential unintended consequences. Once the entire package of revised proposals is out later this week, we will review them with tax professionals and hope to be able to provide an overall assessment on the net impact for Canada’s small business owners.
There is more to come.
The Chair: Thank you very much.
Senator Pratte: I thank all of you for being here tonight. All three of you have mentioned that you are favourable to a comprehensive review of our tax system. You’ve each mentioned that you would like to be part of that comprehensive review. One major point is simplification of our tax system.
Could you elaborate on what should be simplified, how it should be simplified and whether it’s feasible? I know we always say that the Income Tax Act is 3,000 pages long, but the world is complicated. Is it really feasible to simplify our tax system?
Mr. Ball: Maybe I will talk about the process a bit first, because that will help frame my comments around the more specific parts.
We would like to see a process that would involve an independent expert panel. The main thrust would be going through the tax system as it exists now, identifying areas that are too complicated or cause issues in terms of compliance and that sort of thing, and then looking at options.
To answer the more specific question, I think it’s possible to simplify the tax system. You have to go into the process with an open mind as well. Everything should be on the table and you should have a look at it to see how it works.
One thing that occurs to me with the proposed changes is there are potentially four different types of income in a corporation that might be taxed at different rates: a general rate business, small business income, passive investment income subject to the old rules and passive investment income subject to the new rules. Part of the exercise would be to try to limit the amount of complexity and then look at the system to see if you can actually make things simpler as well.
Mr. Kingston: I absolutely think simplification is achievable. Your point is very good, though, that we live in a highly complex global economy. The idea that we could go to a single flat tax, for example, is very challenging in this environment, but I don’t think that should stop us from at least trying to clean up the system.
I look to the U.K. as a fantastic example. They launched a review in 2010. They had an independent organization launch what was called the Mirrlees Review. They published a series of papers on tax reform that eventually led to a very comprehensive tax reform exercise by the government moving to a unified rate. For example, they created an Office of Tax Simplification. The objective there was to look at the existing legislation to see if there was any duplication and for ways to clean it up. We can absolutely achieve it and should at least attempt to instead of doing what we’re doing right now, which is making the system even more burdensome.
Ms. Pohlmann: I don’t know if I have much more to add other than to say that complexity means it makes it much more difficult to be compliant. If we can find ways to reduce the compliance burden, we can end up simplifying the system. That’s where you have to start. Potentially, you have to start with the areas where people are having the most struggle complying with.
I don’t think it’s an easy exercise to go through either. There will be lots of different stakeholders wanting to hold on to their specific tax measures, but it is worth the exercise to discuss and to start moving in a direction. Rather than taking away, we just keep adding more complexity. We need to start thinking about how we take some of that complexity away before we start adding more.
Senator Eaton: Earlier today Minister Morneau announced changes to the passive investment that would exempt $50,000 a year. I don’t know if that’s cumulative or not or every year. Are you allowed to amass it up?
Ms. Pohlmann: No.
Senator Eaton: No, you’re not, so it’s cumulative. Could you comment on whether this addresses the concern? I can’t see how it would. Perhaps as tax accountants you see a brighter horizon than I do, with only $50,000 for a large corporation, for a small business that’s buying new machinery or is putting away a rainy day fund. Who is he hoping to appeal to with the $50,000, especially if it’s cumulative?
Mr. Kingston: Maybe I’ll start from the large company perspective. It absolutely does nothing to help large private corporations. For some of the companies in our membership $50,000 is a drop in the bucket, frankly. These companies have significant passive investment holdings to take advantage of new business opportunities to weather downturns. These are large diversified companies with investments throughout the region they’re in and in most cases throughout the Canadian economy.
Frankly, $50,000 makes no difference to the concerns that we’ve raised with the minister.
Mr. Ball: One of our concerns is with the $50,000. That’s for sure. The other concern would be that they are still talking about changing the tax system overall. They’re just going to provide an exemption for companies on the smaller end of it. I’d agree it’s not going to cover all the situations that might come up.
Another issue is the tax rules in general will still be really complicated in terms of having all these details. Corporations may fade in and out of the rules. Sometimes they have to take account for it and sometimes they don’t.
We would really like the government to take a step back and make two things absolutely sure: whether you need to do this and if there is a problem, is there a better way to do it? I don’t think the $50,000 really speaks to that issue.
Ms. Pohlmann: We would agree. It’s not the preferred method. Most of our members make far less than $500,000 a year, for example, so for many of them that may be enough to cover off any interest.
Senator Eaton: You did say it was cumulative if they have two good years in a row.
Ms. Pohlmann: No, it’s not. It’s only $50,000 per year.
Senator Eaton: What if I have two good years? I have $50,000 and then the following year I have another good year and I put in another $50,000.
Ms. Pohlmann: No, no. The $50,000 is the investment income off of your passive investment. Your passive investment could be up to a million dollars and if you’re making 5 per cent off of that, then you can pull out $50,000 of that. That’s the piece. You can have up to a million dollars in passive investments
Senator Eaton: That’s what I didn’t understand.
Ms. Pohlmann: For many smaller companies that’s probably enough, but I think that is exactly the problem: There’s a lot of misunderstanding about how it would actually work. I think it hasn’t been thought through. I feel there will be lots of unintended consequences, even for those potentially under that threshold, for not understanding how it works, when the threshold hits and that kind of thing.
Senator Eaton: Picking up on Senator Pratte’s question about revamping, relooking or reorganizing our tax system, I look at how often President Trump talks about repatriating American capital that has flown the coop and at the competitiveness of countries like India and Brazil. Do you think the flight of capital is a worry unless some of these things are changed or dropped?
Mr. Kingston: It absolutely is. I mentioned some of the survey results around the capital investment environment in Canada and CEOs thinking that it has worsened. When you combine changes like this with what we’re witnessing in the global trade arena right now, the NAFTA renegotiation and perhaps a NAFTA withdrawal, as a business owner it’s a very volatile environment to be making long-term investment decisions. When you combine all of those factors, I fear it will actually be a disincentive to be investing in Canada at this moment.
Senator Eaton: Do you have something to add, Mr. Ball?
Mr. Ball: No. I agree with that. I would say that people are more mobile these days as well. In terms of the passive capital that the finance people talked about in the backgrounder today, that might be at risk too, if someone is considering whether or not they’re going to stay in Canada. I think that’s a concern.
Another thing that bothers us is that we’re still unclear, in terms of the capital they talk about in corporations, to what extent it’s a problem under the rules. They seem to be able to measure it, but there isn’t a really good measure in terms of how it has been accumulated. It would be important to see that and to take a look at what other uses it could be put to as well.
They seem to be taking a negative approach to things you can’t do without incenting positive things that corporations could do.
[Translation]
Senator Forest: I think the tax system should have two main objectives. The first is to be fair to all persons and firms in Canada. The second is to be competitive. I share your concern about a broader overhaul of Canada’s entire tax system because our economy is increasingly open and global. It is opening its market to competition around the globe.
Returning to the reform under discussion, since Monday, there has been a kind of striptease or softening of what was announced. So it is a gradual reveal. A possible $50,000 tax exemption was just announced. A 9 per cent cut was just announced. In the reform that was just announced, what would penalize your companies the most?
[English]
Mr. Ball: It’s hard to pick because there are a number of things that we think are problematic. In terms of the intergenerational transfer, that’s the one that I find the most problematic because it could involve rather large dollars. The issue has been discussed. We all alluded to it.
Essentially, if you sell outside the family and you get a capital gain rate which is a fair bit lower than the dividend rate, there are two issues around it. It’s very complex and they have to deal with that. Another issue is that it is a higher rate. A third issue is possibly double taxation.
It is a very complicated exercise to deal with a corporation that is passed on from one generation to the next in terms of trying to make sure you get an equitable result. In my mind that’s probably still the biggest one for a lot of businesses because it could potentially involve a lot of money when they sell.
Mr. Kingston: From my perspective the most problematic proposal has to do with passive investments, particularly the concerns that I highlighted briefly around private subsidiaries of multinational corporations. This is a real unintended consequence that finance hasn’t fully considered.
We have companies in the membership that have a number of private corporations which operate certain elements of their business. Under their proposal, as we understand and read it, those private subs and the income they generate for the overarching multinational corporate entity could be considered passive investments. If you have a private corporation in Canada that is now paying a tax rate in excess of 70 per cent. There is no competitiveness. It’s totally gone. Our concern is that multinationals may not view Canada as an attractive investment destination anymore. That’s very concerning.
Ms. Pohlmann: I would echo the intergenerational transfers. We don’t know the details yet. That’s coming tomorrow. We have been raising that issue for years. The fact that it costs more to sell a business to your own children than it is to sell to a third party makes no sense whatsoever.
We know other jurisdictions like Quebec have taken steps to change that, but the federal government has not. Hopefully, we’ll see good news tomorrow on that front because that’s one of the most problematic.
I’m the only one that talked about income sprinkling. We believe the issue there will be the interpretation by CRA on how these tests will look. It could potentially be very problematic from a small business perspective to have to prove every single time that somebody is making a meaningful contribution to the business and where is that line. That’s another area that could potentially cause lots of complications in the future.
Mr. Ball: I have one quick point on that as well. The thing about income sprinkling that I find troublesome is that aspect of it. A lot of the numbers quoted by the government talk about people who are actually doing income sprinkling and getting an advantage from it.
Ms. Pohlmann is bang on. We’ll have to see what happens with what they announce on Monday, but based on the original proposals every company paying to a related party a dividend has to justify whether or not it’s reasonable. There’s a lot of work there, even if you’re not subject to extra tax.
[Translation]
Senator Forest: It is worrisome to see that about 1.6 per cent of Canadian companies hold more than 80 per cent to 85 per cent of all passive capital. In my opinion, a significant proportion of that capital is used either for planning the renewal of an industrial park, or as prospective working capital. Some of that amount might also be tax exempt. My question is for you, Mr. Kingston. For your members, would it be possible to establish guidelines to identify the purpose or motivation of that funding since it is highly concentrated in 1.6 per cent of all the 1.8 million businesses in Canada? Could some guidelines be established to address our concern about these amounts not be subject to taxation?
[English]
Mr. Kingston: I think that’s the key question in this whole proposal and what we’ve had difficulty getting a clear answer from the government on. The proposal clearly wants to go after high income individuals who are purportedly using a private corporation to lower their personal tax rate. We see companies within our membership that aren't doing this for personal tax reasons. These are just large private corporations. Because they’re so large, of course, at times they will have significant holdings to deal with downturns in the business cycle, for example. There needs to be a clear definition between those two objectives the government is going after.
We’re very concerned, for example, that a large private corporation will no longer be on the same footing as a public corporation which has ever right, in response to its shareholders, to hold assets as it sees fit, to either reinvest in the company or to distribute to shareholders. If private shareholders are suddenly not allowed to do that, you’re creating an uneven playing field between private and public companies.
There needs to be more thinking there. I won’t claim to be a tax legislation expert. I will leave that to finance to figure out, but it’s not clear to us from the proposals how they intend to do that.
Senator Neufeld: It has been interesting since July, anyhow, and getting a lot more interesting lately. You talked about how the government says they are now going to reduce the small business rate to 9 per cent. That was already a plan from the previous government. This government just changed that when they came in. They said they were going to reduce it to 9 per cent but decided to change the legislation and say, “No, you are not going to get it.”
Would you say that saying, just the other day, that they were going to reduce it to 9 per cent, which was already in the financial plan of Canada by the previous government, was a move to appease the small business folk and the large businesses that really are feeling pinched by some of these tax changes? Would you agree with me?
Ms. Pohlmann: Yes, I would agree with you. Still, we will take what we can get. It was also an election campaign promise by the Liberal government to reduce the small business tax rate, so when it didn’t happen in 2016 it was a surprise.
I agree it’s partly a means of softening the changes they are putting forward in this community, but it is something that’s really important. There is a good reason why we have a small business tax rate in Canada. For smaller businesses it’s harder and more expensive to get financing, so this helps them to retain more of that equity in their business.
They also spend a lot more money in dealing with regulations and paperwork. We have evidence showing they spend five times more than large companies in dealing with the paperwork. These are ways to offset those costs and the small business tax rate was put in place to recognize those things.
For us, it’s really important. We saw the large business rate go down quite extensively from 28 per cent to 15 per cent over the course of about 10 years. The small business rate went from 12 per cent to 11 per cent in that period.
It was time to lower the small business rate as well. We were pleased that was part of the package. It might have been better if they have done it at the beginning of this whole process, when they started their initial proposed tax changes or when they came into power. It might have gone over a bit differently then.
Senator Neufeld: Another one is passive income. We had some numbers given to us. I believe they came from Finance, I believe. Some 29,000 companies hold about $200 billion to $300 billion in passive income. A colleague of mine divided that up and it works out to about an average of $8 million per company.
That money in passive income must be invested some place. Is that correct? It’s not just sitting in some bank account waiting for someone to flee in another 10 years, to take it and run away with it. Is that correct?
Mr. Kingston: That is absolutely correct and that is what has concerned us about some of the comments the minister made regarding dead money. The idea that conjures up is that this money is taken out of the business and put into a safe for some other time or purpose. That’s absolutely not the case. It may be invested in ETFs or passively invested in the stock market, but that doesn’t mean the money doesn’t do anything. It is now invested in public corporations that are using it to grow their business or do whatever they see fit. We are concerned with some of the language, frankly, around dead money and passive investments and the suggestion it is not doing anything.
Senator Neufeld: I would think people who have that kind of money actually know where to invest it. I would also think the stock market is probably a place where a lot of it would be invested. If you were to pull all of that out of stock market, what would happen?
Mr. Kingston: We wouldn’t want to see what happens.
Senator Neufeld: We wouldn’t want to see what happens.
We have a government that really wants to tax passive income up to as high as 73 per cent because they want it invested some place else. I mean it’s a process that is so grey to me I can’t quite understand it. When you said to leave it up to the Finance officials, I thought to myself, “My goodness, I think that’s what got us here today, obviously.” I’m assuming Mr. Morneau didn’t do this on the back of a piece of paper. I’m sure that somebody did some work in the Ministry of Finance to say this is what we’re going to do. I’m afraid to leave anything to them because of the mess this has created.
Would you agree with me?
Mr. Kingston: On passive investments, absolutely. We’ve not been remotely pleased with the way the proposal has been tabled and communicated. It has left us with huge, huge concerns, yes.
Mr. Ball: The biggest concern we’ve seen with that is it’s a fairly one dimensional analysis. They were really comparing what happens if an individual invests personally versus what happens if he invests in a corporation and pays it out over 10 years. If you look through the paper, there’s a calculation on that. The 73 per cent is designed to bring the result of strict equality under both scenarios without looking at things like what corporations do with money, how they invest it, whether they need it for expansion, or that sort of thing. The biggest concern was that they were focused on this particular issue without taking a bunch of other important things into account.
Senator Neufeld: We have been hearing in the news about trusts too. They were not touched. Is it correct that trusts won’t be affected at all, if all of the changes the government has proposed go into place?
Mr. Ball: There are different corporate issues but, by and large, it was really all about the income sprinkling. It involved trusts but it didn’t need to, so it dealt more with the sprinkling part and not trusts. They were largely unaffected for that. There were to be capital gains exemption changes for trusts and they have withdrawn those, so that was a good development.
In terms of the passive income part, the issue was that corporations don’t pay as much tax on the original business income and you have more to invest. That’s the issue that Finance saw. Again, that doesn’t affect trusts either.
I don’t know if there were really any big picture issues with trusts resulting from all this, apart from pulling back the capital gain exemption. I don’t think there were any changes affecting trusts.
Senator Neufeld: I wanted to be sure about that because we know of two people with relatively large trusts who are in control of what is going on that won’t be affected by what you say. It actually bothers me a whole bunch if you are saying that all these wealthy, rich people are hoarding all this money, that they are going to run to their basement, shovel it in the corner and run away with it at some point in time. It almost sounded like that when you talked about dead money, but we’re going to leave trusts alone. Maybe it had to do something to do with their own purposes.
Mr. Ball: I have a really quick comment on that. In our view a comprehensive tax review actually deals with issues like that. It would be to go through it to see if any aspects of the tax system are not operating properly and take a look at them. These proposals were aimed at three particular issues without looking at the broader issues and the complications in the tax system.
Senator Black: I thank all of you for being here and for your support on this extraordinarily important matter. I also want to identify myself with the questioning of my colleague Senator Pratte. I’m very grateful that all of you have independently said that it’s possibly time in our history for a comprehensive tax review. We can take that away and discuss that.
Perhaps you know from my public statements on this particular matter that I have a view, but as a preamble to my question, I’m also a senator from Alberta which has been hard hit over the last two or three years. These particular proposals are extraordinarily negative for Alberta business, both large and small. Of course we have to give the benefit of the doubt, and I’m watching with interest this week as we roll out, I would put generously stated, tweaks. I liken it to being hit by a truck and then the driver offering you a Band-Aid. That’s how I see these proposals. They are just de minimis.
My question is in terms of competition, which you’ve now talked about; in terms of innovation, which you haven’t talked about but I would like to talk about; and in terms of running the risk of losing Canadians to a non-resident status because of these tax proposals, all of which I’m seeing in my province. Do you think these tweaks do anything to assist that?
Mr. Ball: Yes, the issues could be marginally better, I suppose, but it goes past what we see as the big picture because it is dancing around the big issues. We see that the tax system as too complicated. It needs to be simplified. We need to make sure it is working effectively.
We’ve described this as layering complexity on complexity. In some ways layering the tweaks on top of it is yet another layer of complexity potentially as well because you have to determine whether you are going to qualify for an exemption from rules that were already complicated.
We would like to see the government go back and take a look at everything to make sure it’s working properly. Do you need three layers of complication on top of each other, or is there a simpler way to deal with things?
Mr. Kingston: Thank you, senator, for raising innovation, in particular. It’s a very important element that I haven’t brought up yet. We were very concerned once this proposal went out because of the rhetoric around it, particularly around going after wealthy Canadians that are using loopholes. We found some of the language to be problematic and almost trying to pit Canadians against each other. We weren’t happy with the way that was being phrased.
My CEO spoke publicly about this, but we were made aware of Canadian entrepreneurs and investors who are actively considering leaving Canada as a result of these changes because of a lack of clarity around whether or not they would be retroactively applied and what it would mean for passing on your family intergenerational business and wealth to your children.
Instead of addressing this issue upfront and providing clarity, the government continued to remain silent mostly on some of the questions and concerns being raised. That led people to take pretty divisive actions in terms of arranging their assets. That, to me, is extremely concerning particularly when you have a government talking about an innovation agenda. We have a real opportunity to attract investors and entrepreneurs to Canada, and this type of language does not create an attractive investment for those people. We’re very concerned about it, and I hope that the damage has not already been done, frankly.
Ms. Pohlmann: I would agree that a lot of the language used early on in this discussion was damaging. It was part of the reason that we saw such a backlash right across Canada. It was quite astounding, I have to say. I have never seen that kind of backlash from small business owners in my many years here in Ottawa. It was clearly something that touched a nerve.
As Mr. Ball said, I think these tweaks are marginally better than what was there before. It is improvement, but the word we have is that there are still many details we don’t know and we don’t understand. We remain very cautious around what this will actually look like at the end of day. There are a lot of details still to come. We need to see those details to understand.
We believe unintended consequences may result, but we don’t know what they are yet until they are implemented. That’s where our concern still lies. We think it is a slight improvement over what we had before, and I think tomorrow will be interesting.
On the innovation side, the piece we have not talked about that much is the impact it has had on angel investors and those people who invest in other businesses. They claim they will address that as well. We don’t know what that will look like or how it will work, but I am also aware of many who are looking toward those types of investors right now who have been told that everything is on hold until they understand what the implications will be.
There are businesses out there hoping to get capital now but are not because everything is sort of “let’s just wait to see what happens,” and that’s unfortunate.
Senator Andreychuk: I will try to be brief and not cover the same ground that others have. I was around when western Canadian farms were smaller. They weren’t competitive internationally. You had to grow a larger business, but when you wanted to pass it on you either had to gift it in some manner to your children, which means you didn’t get as much because that was basically your pension and your future, and your children had to go find the money somewhere. Well, they couldn’t, so you were in a Catch-22 constantly.
This intergenerational passing doesn’t take into account the difficulty of some of the backbone of Canada, that is, agriculture, small business and women. We’ve spent a lot of time trying to get women into entrepreneurship. It starts in a basement office.
We were doing a study in Foreign Affairs and International Trade on why we don’t take more risks? Why don’t we grow businesses into the next step? Why do they sometimes leave and go offshore? We were told that small businesses couldn’t get financing. The other point was that to grow a small business to the next step, you have to have some capability to move at the right time. That’s what passive investment is for a lot of women.
Have you been hearing some of that? Perhaps I wasn’t listening in July. I was reading the papers, I will admit, at that time. I was off on medical leave. The government was saying they wanted to make the tax system fair between those who are employed and those who are self-employed. Then they went off that.
How do we judge fairness? I have heard from the government, “Oh, we’re going to make it fair.” You’re now saying you would like a total review to get a fair tax system. I would like a definition of “fair.” How do we get at fairness?
Because everyone knows their problems and the others don’t. Then the government is compounding that by, as you say, pitting one class against another. The next thing we heard was that it was not fair between the employed and the self-employed. This word middle class gets kicked around. I won’t go into it because I think we have covered that fairly on many other occasions.
Those are the two things that people are struggling with. They say, “It’s not fair to me,” and what is the rebuttal? I might as well get it all out tonight. The government is saying, “Oh, no, we’ll take care of all that,” and it will be handled by the bureaucracy somewhere. Right in the middle of that debate, we get these interpretive things on discounts.
I think it’s a lack of trust now, not so much fairness, et cetera. Do we really know what we’re doing in Canada? How do we attack that? How do we explain it to people? What is the public policy throughout all this? What is the net benefit to me as a Canadian? That is what people are saying, even if they’re not small businesses.
Mr. Ball: Fairness is difficult. In terms of employee versus business person, it’s actually probably easier to say what isn’t fair. The idea that you are going to tax an employee and a business person in exactly the same way is actually not fair because a business person is taking more risk and there should be a reward for taking risks. I think that has been part of the concern. It was a simplistic sort of comparison of one to the other.
In fairness, it is a broad issue. It should be fair to the country as well. It should also achieve a lot of other goals like increasing productivity and that sort of thing. There is a reason to reward business people and provide them with incentives.
You made a really good point about how it will be handled by the Canada Revenue Agency in particular in terms of when these proposals are moved over to them. It is key to remember that if a law says something, the CRA is actually required to enforce the law. If it says a dividend to a family member in excess of a reasonable amount, the CRA’s mandate is to actually determine that and then apply the higher rate tax to the excess amount.
I don’t think it’s appropriate, actually, to sort of pass the issue on to the CRA to let them deal with it and somehow decide what is fair and what is not. I think the law needs to be clear.
Mr. Kingston: I’ll make a couple of points regarding fairness. The first is that what has been missing from this debate is the fact that we have a progressive tax system. I’ve found it to be somewhat concerning that is rarely mentioned in this whole debate. We have a system that ensures high income earners pay more tax. Of course, no one is ever going to agree, necessarily, on how much each group of income earners should pay. The system is already designed to do that. It would have been nice to see at least some recognition of the fact that is how our tax system works.
The second point is that reducing complexity is the best way to ensure you can actually have an open and knowledgeable debate about fairness. One of problems with all of these proposals is that they are so highly complex it’s difficult to understand the various strategies being used and how to address those. By reducing complexity you can actually have a more fulsome and informed discussion around fairness and what kind of tax system you need in Canada.
Ms. Pohlmann: The only other thing I would add is that we talked about trust. Can people still trust? That’s an important element of all of this that has been eroded in a big way. Again, it goes back to how it was positioned and the government’s idea of fairness. It showed that they didn’t understand how small businesses work and what goes into being a small business owner. They were doing comparisons in the consultation paper. The employee was making $220,000 a year and so was the self-employed person. They neglected to talk about the fact that the self-employed person had no paid vacations. They don’t have access to Employment Insurance. They usually don’t have the same benefits and have to figure out how they are going to get them for themselves.
When we talk about fairness, it can’t just be on this one piece of it. It has to be on the overall influence that is going on around those individuals. I think that’s what gets sort of lost. As a result, the trust has been eroded mostly through the language. The employee discount issue that sort of came out in the middle of all this didn’t help things either because it seemed to sort of show another disconnect from what the reality is of people who work in the retail sector or in the restaurant sector.
There is some work to be done, both at the political level and within the finance area. We run into another challenge a lot. It’s a good point that Finance makes the rules and then CRA is to apply those rules. Sometimes they are at odds with each other. They often end up pointing fingers at each other. It’s very difficult, sometimes, to resolve issues because they each will point the finger at the other for being the problem. That’s another area where we have to think about how to resolve that when it happens. We’ve certainly run into it as an organization on behalf of our members a number of times.
[Translation]
Senator Moncion: Can you define the size of a SME? What are the guidelines? What is the limit for a medium-sized enterprise?
[English]
Mr. Ball: Under the tax system definition itself, the small business deduction is on active business income up to $500,000. That number has increased over the years. I think that is at least the benchmark the tax system uses.
From a practical perspective, you see a wide range of income levels. It depends on where the business is located and other factors as well. I’d have trouble putting an exact number on it, but in terms of tax system, anyway, business income up to 500 is sort of the definition.
Senator Moncion: Would that be small or small/medium?
Mr. Ball: That might be small to medium anyway.
Senator Moncion: Is the active income of half a million dollars considered small/medium?
Mr. Ball: It’s small for sure, anyway.
Senator Moncion: Yes. What about medium?
Mr. Ball: Medium is a little harder to say in terms of exactly what that would mean.
Senator Moncion: Most of these SMEs are probably your customers. How would you rate their knowledge of the tax system?
Mr. Ball: I can certainly say that business people rely heavily on professional advisers to help them through it. Actually, Ms. Pohlmann might know better than I would in terms of her membership, but I don’t think there are that many who are able to navigate everything on their own.
Ms. Pohlmann: Absolutely not. I would agree. I think that their knowledge of the tax system is pretty superficial: “I need to pay my taxes. Okay, Mr. or Ms. Accountant, tell me how much and I’ll just do it.”
They need to have at least a rudimentary understanding because they have to pay income tax. They have to pay GST. They have to pay payroll taxes. There are a lot of things they have to do, and they have to be done at the right time; but they would not have an in-depth knowledge, for sure.
Senator Moncion: Keeping that in mind, you’ve been talking about the backlash from the small business owners. With what you just said about their knowledge, I’m not sure that the backlash is necessarily coming from them. I think it’s coming more from CPAs and lawyers, tax lawyers, who work in this area.
I’m just nuancing some of the things we hear about small business owners being versed on the tax rules. Would you agree or disagree with me?
Mr. Ball: The discussion around the implications of these rules is actually quite similar to the discussion that happens around complying with tax generally. What happened when these changes hit was that a lot of Ms. Pohlmann’s members started talking to my members and combined they asked, “What is this going to do to me?” They started having discussions between the two of them.
I actually believe that there was a backlash from business people for sure. Once they were informed about how the changes were to affect them, they became worried.
Ms. Pohlmann: I would add to that. We’ve asked often of our members, “Who do you trust to give you advice for your business?” Their professional accountant tends to be among the top one or two. Their accountant is coming to them and saying that they need to prepare because these tax changes are coming and this is how they are going to affect you. They trust that advice. You’re right that part of it is that the CPAs or the accountants inform their clients, as they should because that’s their job, and educated their clients on what’s happening. Then, in turn, that started to get small business owners more upset about what was coming.
Senator Moncion: My next question is about the intergenerational transfer of these small businesses.
When did the fair market value come into force in the income tax for small and medium size business?
Mr. Ball: I’m not sure I quite understand the question.
Senator Moncion: When you do transfers now you do them at the fair market value of today. When did that income tax measure come into play with intergenerational transfers? It has been there for a while.
Mr. Ball: I understand. That helps. The farm sector is different because there are rules that allow a transfer at something other than fair market value. In terms of related parties and family members, the tax system has pretty much always worked that way.
There were intergenerational transfers back in the 1980s, perhaps for small businesses corporations as well up to a limit, but that was quite a while ago. The current rules have operated the way they have for quite a while.
Senator Moncion: When we look at these transfers for the fair market value, you would have a tax that would be much higher and it is anticipated because of the way the accounting is being done now.
Mr. Ball: There are two issues with intergenerational transfers. One is around the capital gains exemptions. It’s a lot more restrictive. Even on tax rates generally the big concern is that if you sell to a third party you get the capital gain rate, which is quite a bit lower than the dividend rate. Whereas, say I sell my business to my son. If you sell between family members there’s a strange quirk in the tax system that you have a high cost from the transfer but you still have low paid-up capital in the company.
What will happen if the company is wound up is that you can have double tax. Unless you’re absolutely sure that the next person who gets the company in the family will sell to a third party, you need to take steps to make sure you’re not double taxed. Unfortunately, that often means you will be taxed on the value of the company as a dividend rather than as a capital gain. That is really causing a lot of concern that a lot of families are doing commercial transfers of the business.
In my example, my son has to actually pay me for the corporation. I’m not gifting it to him or anything. He will buy it at fair market value and run it, the same way he would if I sold it to a third party. Yet the tax results are a lot worse for that kind of transfer than they are if I sell it to a third party. That’s really the concern.
Senator Moncion: Could you provide an example of that? I have an example that shows it is exactly the same, whether you sell to a third party or you do an intergenerational transfer. Could you give us a numbered example that we can use?
This is something that you could provide in writing so that I can compare what I have right now as opposed to what you’re saying about double tax.
Mr. Ball: Absolutely. I think it would be helpful. We could write up an example to walk you through why there’s a concern. Unfortunately, it’s extremely difficult to explain this. That’s part of the problem. The tax system is very difficult in terms of dealing with these transfers and dealing with the death of a shareholder of a private company too. It’s extremely complex.
Senator Moncion: I agree with you. The comprehension of most people about tax issues is that it is very complex, and it is. That’s why you are hired to do this work for your customers. The complexity belongs to professionals who work with the complexity of taxation.
In my case I’ve worked over the years with a lot of small and medium size businesses. I was in the lending business and I was in the banking business. A lot of things that I see here, or things that are being said, are accurate, but there are nuances that we also have to bring to the table when we are looking at these issues. This is not necessarily part of all that I’ve heard or seen with the witnesses we’ve heard so far.
Mr. Ball: We would be happy to give you an example.
The Chair: Could provide the information through the clerk, please?
Mr. Ball: Sure.
The Chair: Mr. Kingston or Ms. Pohlmann, do you have any comments to add to the question asked by Senator Moncion?
Ms. Pohlmann: No.
Senator Oh: Today, Minister Morneau announced changes to the promoted tax on passive investments. While this is a positive announcement, some have noted that it is unclear how future gains on currently held investments will be treated.
In your opinion, what would be the impact of not taxing the current investment at a higher rate but applying the higher rate tax on future income earned from these investments? Can you comment on that?
Mr. Ball: Yes. I think it would be a difficult number to quantify. The government, I believe, would have to get more information.
I want to mention, though, that one of the key things in our submission was that the tax system needed to be fair in terms of application of changes in tax policy. Although the rules would be very complex for passive investments, it’s crucial that people who have accumulated money in corporations aren’t adversely affected by the changes. That’s part of the reason why we’d like the government to go back and take a really good look, because we think it’s fundamental that existing investments have to be protected.
At the same time that’s going to be one of the biggest complications around these new rules as well. That’s one of the big reasons why we’d like them to go back, reconsider them and take a look at the issues they’re worried about, to see if there’s another way to deal with it.
Mr. Kingston: I completely agree with what Mr. Ball has said. We’re happy that the proposals are on a go-forward basis so that existing passive investments won’t be affected. One of the immediate reactions that we heard from some of our large member companies is related to the complexity.
Now you will have pools of passive investments that are under the old rules and now you have new passive investments and a new set of rules. You will have to track those pools. That will be highly complicated. That’s an area we’re quite concerned about.
Ms. Pohlmann: I’m not sure I have anything further to add. For me, it’s about the complexity that it will add and the fact it will add not just complexity in how it works but also complexity in how you manage all these different pools if you have that.
I agree that’s part of the issue that still has to be determined.
Senator Black: This is supplementary to the excellent question that our colleague Senator Moncion asked. She raised the issue around the taxation that would apply to family owners who transferred their assets within their family as opposed to outside. I’ve heard circumstances that the rates could be as high as 91 per cent to 93 per cent. That may be on the outside, but I’ve heard that; I’ve more than heard that.
Senator Moncion raised something that I hadn’t heard before. That’s why I’m very interested in hearing what you have to present. More important, I wouldn’t mind a comment before you leave today. Is there a way or are there possibilities to structure your affairs whereby you could pass your company to your family at regular tax rates, not being double or triple taxed?
Mr. Ball: It is possible, again using the example if I sell to my son. The 90 per cent rate you talk about is the concept of being double taxed on it. The concern is I could pass it on to him. I have a gain. Then, for whatever reason he can’t sell the company to someone and just winds it up, the only way now, with the rules the way they’ve done it, is that it will be taxed as a dividend if you get money out of a corporation. This will be part of the example we will write up.
What happens when you wind up the company? Say he can’t sell it to someone and he has to wind it up. He will have a large dividend, assuming the value doesn’t change between when he has it and I have it. He will have a dividend equal to the capital gain I had. He will have this big capital loss, and there’s no offset in the system right now.
That’s why you get the 90 per cent in excess tax rates. If my son is stuck with the company and he can’t sell it to someone else, then the only way to get the money is a dividend because they’ve blocked off planning that people were using to essentially access the cost base developed on that sale from me to him. It is very complicated, but that’s why the concerns are being raised about the 90 per cent.
I’m worried that people will walk into that 90 per cent situation without understanding it.
Senator Moncion: Again, if he can’t sell the company, the fair market value should be going down, shouldn’t it?
Mr. Ball: It depends on how you’ve accumulated the value. If it is accumulated business earnings, the company could actually keep its value. Even if it goes down a bit, you will still have an element of double tax.
The problem is how a subsequent transaction is treated. There’s just a mismatch in terms of the tax attributes when it comes down to it.
Senator Moncion: Don’t they have access to the loss?
Mr. Ball: Capital losses can only be claimed against capital gains. If you don’t have anything that’s generating capital gains you do have a capital loss, but it’s of no use to you unless you have a capital gain. They can utilize it when the person passes away, but that’s not really of much help to them. You do have to pay that second layer of tax a second time, and maybe one day you’ll get to claim a capital loss, maybe.
Senator Cools: I would like to thank you, gentlemen and lady, for what I thought were very interesting presentations. I have been sitting here for the last many days, and I have been grappling trying to understand how it is possible that a government, in the name of tax reform, could create so much instability in people and tremendous unease and anxiety. I would think that an unstable or destabilized environment of opinion is not a healthy place to propose tax reform and to get maximum support for it.
This has been worrying me for quite some time. A couple of weeks ago I was in Alberta, in Senator Black’s terrain, and I was hearing of the misfortune that has been happening there for the longest time. I was told that 100,000 people were out of jobs, and that sort of thing.
I wonder if you have any ideas of how the current government will rescue its tax reforms in this atmosphere of great uneasiness and destabilized public opinion. Have you given this any thought?
Mr. Ball: That’s a difficult issue. Frankly, it is an issue that we’ve talked about: How does the government move forward from that?
One thing I’ll mention is what I’d like to see the next time something like this happens. I’m not quite sure whether they will back this thing up completely or try to patch it up. Like I said, we want them to do a comprehensive review. What I’d really like to see going forward is to have the government reach out to each of our organizations, like the three of us here, and do a review of the particular issue. I think all of us would be willing to have members participate on a confidential basis. We could have discussions around what concerns them and how to fix it.
I find in working with our committees that volunteers are very willing to put on the government hat and try to figure out a way around it. A result like this is really not what you wanted. It would have been better to have a cooperative process and discuss the issues. There are legitimate issues in all three areas, but it was not handled well. I don't think so.
Mr. Kingston: We would like to see the government start talking about Canadian competitiveness more frequently. We find that has been missing from the narrative. When we go out and speak to our members and survey companies, we continually hear that they’re concerned about tax competitiveness. There is huge regulatory uncertainty regarding large projects. We see that particularly in the pipeline space but elsewhere as well. Then, of course, there are rising costs.
If you’re a business owner in this environment, it’s a very concerning time. We would like to see the narrative change a bit from the government around creating a positive investment environment for Canada and Canadian businesses. I think that would help.
Ms. Pohlmann: I would say that for me it’s also a bit about changing the narrative. They started this, I felt, in a more negative way. It was really about the loopholes and about almost implying that small business owners were tax cheats. They have to completely change how they were. They started to, as they realized the backlash was happening. In fact these are hard-working individuals who are doing the best they can. They contribute to their communities. Part of this is changing the narrative and changing how they talk about business owners, what they bring to Canada and so forth.
In addition, I agree with Mr. Ball. The consultation process was short. A lot of people felt it wasn’t enough time to really provide meaningful contributions to it. Working more closely with the accountants, the tax professionals, and organizations like ours that actually have people with good ideas, would probably go a long way in starting to mend some of the issues that are happening.
Even now, while they’re coming out with tweaks, I guess that is based on the consultation documents they got. Did they get through 21,000 consultation documents in just two weeks? I don’t know. Hopefully, the dialogue will continue and they will be open to feedback even after the second round. That will help if they continue to take the feedback and incorporate it into what they’re planning to do going forward.
Senator Pratte: One of the major concerns about the reform when it came out that people started realizing was that it would affect a large number of CCPCs, including many of the smaller CCPCs. According to government numbers as far as income sprinkling is concerned, somewhere around 50,000 companies will be affected. With today’s announcement on passive investment, according to their numbers, and they should know, somewhere around 50,000 companies would be affected. There could be overlaps, but at most, if we add both numbers, it would be something like 100,000, which is around 5 per cent of the total number of companies. It would be a small minority of companies affected. In most cases the larger companies, with probably the means of dealing with the compliance complexity, would be affected.
Should that not diminish a lot of the concerns that many had at the beginning of the whole process that the smaller companies would have to deal with a lot of the compliance burden and so on? Maybe now we could all calm down. Am I correct in my assessment?
Mr. Ball: That’s a good question around the 50,000. I am not totally sure exactly what they mean by that. I think they mean that 50,000 companies are benefiting from income sprinkling, but I’m not sure how they get the number.
My concern has been all along that it is only part of the issue. I have to believe there are more than 50,000 companies that pay dividends to family members. Maybe they’re all participating in the company and there wouldn’t have issues at the end of day around the income sprinkling rules. The issue is that each of those companies still need to take steps to decide how they will deal with the rules. The way it was drafted is essentially that you have to be able to justify that the dividend you paid the family members is reasonable.
We believe a lot of companies and their shareholders wouldn’t be subject to the rules, but we’re greatly concerned around the documentation standards and what they have to do in terms of recordkeeping. I think that was the significant concern.
Quickly on the passive changes, it appears that lots of companies might be practically taken away from the rules, but I still have significant concerns about a tax system that has that complication built into it potentially for a smaller number of companies. It’s still going to be extremely complex. I still believe that we need to do more work to make sure we really need to add all that complication.
There are other situations as well where it’s not fair, specifically.
Mr. Kingston: On the passive investment side of things, large companies will have the resources and the expertise to deal with these changes and the additional complexity, although I wouldn’t dismiss the fact that it’s still problematic given the amount of time they spend on dealing with Canadian tax legislation.
The fact that it’s a smaller group of companies doesn’t diminish the scale of the problem. These companies are extremely large. They invest in their communities. They have a number of subsidiaries. It may be a smaller absolute number, but the impact will still be quite significant if they’re faced with this 70 per cent-plus tax rate on passive investments.
Ms. Pohlmann: Our numbers are a little different from the government’s numbers. I am also curious as to where they got these numbers from. We went out and asked our members. We did get over 8,000 responses, which is a good sample size. It is probably pretty indicative of the business population out there. We found that almost 70 per cent are providing compensation to family members from the business. Every one of those, as Mr. Ball pointed out, will still have to prove that these people are making a meaningful contribution, so there will be an impact on those business owners.
As for the passive investment side, again, we have almost 70 per cent of our members saying they have some sort of passive investments in their business. They may not be big. They may be fairly small, but they’re still there. Depending on what this will look like in practice from a compliance point of view, they may also have to fill out paperwork or do something in order to prove it even if they’re under the threshold.
To argue that it will not have an impact, necessarily, I don’t know how true that is. I also question whether it’s really that small a number they’re talking about at the end of the day.
Senator Andreychuk: A few of the questions I was going to pose have been answered. You made the comment that it was the pushback from your businesses about the language or the rhetoric from the owners as opposed to the accountants. Then you started digging in with the accountants to find out what it means to you. You didn’t like the suggestion that you were taking advantage of loopholes and that type of thing.
On this reasonableness test and the income sprinkling, when you’re running a small business, whether it’s a confectionery or a small farm, everyone is contributing. It’s not a business plan that you can put out. A lot of it is crisis intervention by whomever is in the family. The stress of being part of a family business needs to be factored in.
What are the rules now in that area? Have they caused difficulties and therefore the new rules are just another layer? Or, is it a completely new way that we will have to document and prove that there was actual activity?
Ms. Pohlmann: I’ll start, but Mr. Ball will probably be better at answering. My understanding right now is that there is some reasonableness test over salaries. If, for example, somebody is being paid an extreme salary that doesn’t make sense in regard to the work they’re doing, CRA does have the right now to say that is not good.
It’s when it comes to dividends that I don’t believe there’s much of a test at the moment. That’s the new layer. They’re adding the dividends and shareholders as part of this entire process. This is where it will become quite problematic because government is basically telling you who your shareholders can be and how much you can pay them when it’s to do with your family. That is something I don’t think we’ve seen before, but Mr. Ball is the expert on this.
Senator Andreychuk: We heard another witness say that part of the tax problem is that sometimes it’s an individual responsibility or benefit and in some cases it’s the family unit. That is really where my question is coming from. There is nothing to take into account to understand family units in a small business.
Mr. Ball: You summarized that well. I would add one thing about the dividends. We’ll have to see how Monday’s announcement affects all this, but it was a broader rule too. It was looking at contribution in terms of labour, which you would look at when you’re paying salaries, but it also included capital and was cumulative as well.
The idea was that you would add up your contribution over time, deduct what you were paid and that was the difference, which is exceedingly complicated. Part of the reason why people used dividends often, actually, was just the effort that it would take to determine what is reasonable. For the example of working on a farm, potentially you would have to keep time sheets in terms of how long each person was working and things like that, to justify how much is being paid as a dividend.
Part of the reason people used dividends was to get around that issue. I say around it from a practical compliance point of view. It was just to find an easy way to pay family members as opposed to having all the complication.
[Translation]
Senator Forest: Thank you for your very informative testimony this evening. To continue on the topic of income sprinkling, what I am concerned about, as you said, is that the rule is set forth by the Department of Finance, but enforced by the Canada Revenue Agency.
A senior government official told us, for instance, that in the case of a firm or enterprise, it is a personal choice when a spouse decides to stay at home to fulfill responsibilities and give the other spouse time to work. That is nonetheless a rather drastic, ex cathedra interpretation.
I am struck by one thing in particular right now, and that is the criterion of reasonableness, which is more or less subjective. In other words, we will start keeping time sheets. When a son takes the tractor into the field, we will ask if he talked to his neighbour and whether we should deduct 15 minutes from his time sheet. In terms of its operation, there is something about this that is very difficult to apply. How can this aspect of reasonableness be defined so that it can be effective? This seems impossibly complex for small firms, which usually have few staff and which would find it difficult to apply, that is, to keep all the receipts and check each time period when the spouse, son or daughter contributes to the firm by keeping the business open or what have you. Is there some way to simplify this criterion of reasonableness?
[English]
Mr. Ball: The one thing I wanted to comment on quickly was the initial part with spouses. In our submission we didn’t have a recommendation per se, other than to take a good look at the tax system, before imposing this reasonability test on spouses, to make sure it’s working properly in terms of how spouses are taxed.
Again, that’s a broad issue. It brings in a lot of different things. The tax system is inconsistent right now. It allows pension income splitting between spouses, spousal RRSPs, and that sort of thing. One of our main recommendations was to go back and look at the taxation of the family unit to make sure it makes sense before you start imposing different rules on different people.
Second, maybe it depends on how you handle spouses. There are alternatives in terms of the reasonability test. This wasn’t one of our specific recommendations, but one idea to investigate more would be just raising the cutoff rate for the tax on split income, for example. One suggestion was that if you take university children out of the mix that might change things. If they are working in the business, maybe you pay them a salary.
Again, the big issue was to go back and take a look to see if there is a better way to do it.
Ms. Pohlmann: I agree. We need to keep it as simple as possible because it will become too complex for them to deal with. In the paper it will only earn them $250 million per year. It seems to me it will cost business owners a lot more to administer this and for the government to audit it and make sure it’s working properly.
I’m not sure that the cost benefit is there for what they claim would be a savings of $250 million. That’s the big question for us in terms of adding this.
I agree. I don’t know how they will ever define what’s reasonable because there are so many formal and informal ways that family members participate in the business, as I mentioned. It’s those informal ways that I don’t see how CRA could ever properly manage. It will take many years of tax courts to eventually determine what that looks like.
I think it’s going to create more complexity than is necessary for a savings of $250 million.
[Translation]
Senator Forest: I would like to make a final comment. Our Income Tax Act is highly complex and is over 3,000 pages long. If this makes you feel any better, the American act has 74,000 pages. Our law is complicated, but it must be worse in the United States. I just wanted to say that to help you sleep better tonight.
[English]
Senator Neufeld: Just further to the sprinkling issue, I owned a business for about 15 years a long time ago. I went through two CRA audits, and I can tell you it’s not fun. You do a lot of arguing at the end of it when they say, “This is what you owe,” because they are not going to leave without having you owe something to make the trip worthwhile, I guess.
It is difficult, so I certainly feel for the folks. I can imagine coming to a farm, as my colleague says. Can you imagine when you have all kinds of work to do and there you are arguing with the CRA person to apply the law in one way or another way? Let me tell you that I know from experience they can change their mind. It’s interesting. That was a long time ago.
I’m certainly not a tax person. When I had my business I did my books for the things I had to pay monthly, but when it came time to do the final, it went to an accountant and that person did it. I don’t pretend to know a whole ton of things about taxes, but intergenerational transfers really caught my attention. You folks have actually shed a lot of light on that also.
I don’t know if you are familiar with trusts. Is there an intergenerational transfer where the government comes in and scoops a bunch of money when somebody starts a trust? I was never lucky to be in a world where my parents could start a trust. They could hardly feed themselves, let alone build a trust for me.
When that’s done, is that always pouring money out to someone forever, or how does that work?
Mr. Ball: Trusts can’t last forever. There is a sunset by way of a disposition of the property. Basically a trust is deemed to dispose of what it has at fair market value at a certain time. Some trusts are based on the death of the beneficiary and for other trusts it’s every 21 years. Trusts are often sort of a parking spot for assets. They sit in the trust.
Senator Neufeld: Would that be called dead money?
Mr. Ball: No. In terms of family trusts often shares of the family business are in there.
What happens is once a trust starts approaching this twenty-first anniversary and the reckoning of accrued gains, you can transfer the assets out. Trusts are not permanent in the same way as a corporation. Generally they have to be dealt with at some point. Whether it’s something like a spousal trust, the death of the beneficiary, or if it’s a more general trust, every 21 years there is a reckoning.
The government did recognize that without such a rule you could actually defer gains indefinitely. There is something that either makes you transfer it out or actually recognizes the gain.
Senator Neufeld: You have 21 years to reconcile.
Mr. Ball: Yes. If it’s a family trust, you either have to transfer it out or you will be taxed on a gain inside the trust.
Senator Neufeld: Thank you.
Senator Eaton: I listened to the problems of sprinkling income on the farm. I used to work on my uncle’s farm, so I know exactly what that’s all about and small businesses for families.
One of our witnesses yesterday from Montreal, Mr. Coderre, talked about how the tax system in Canada is not aligned to our industrial policies. I think that went to something you said too, Mr. Kingston, in terms of what we want from our farms. We want to keep them healthy. We want small businesses to create more jobs. We want big business to invest in innovation, research and productivity.
Can you comment on that? Do you feel the same way?
Mr. Kingston: Absolutely, and that’s why we have been talking about the need for comprehensive reform. A really good recent example is the fact that we don’t have a tax on cross-border services. We’re in the digital age now where consumers are consuming products that aren’t necessarily produced right here in Canada and are transmitted digitally, and we don’t have a tax on those. That is one distinct example where our tax system is not keeping pace with the changes that we are witnessing in the economy.
We are also wanting to see more businesses grow into global champions. That’s something the Business Council is constantly speaking about. We represent large companies. We want more large Canadian companies out there representing Canada around the world. We don’t think our tax system is geared to do that at this time, so it’s time for a refresh of the tax system.
Senator Eaton: To match it up to our industrial policy or industrial ambitions.
Mr. Kingston: Exactly, to match up with the way the global economy is changing and how we want the Canadian economy to look 10, 15 or 20 years from now.
Mr. Ball: That’s a good point because the last review was a long time ago and things have changed significantly since then. The economy is a lot more dependent on service-related businesses now in terms of what’s growing as opposed to what we had back in, I guess, the early 1970s when they did the last review. Things have changed a lot, and digital is a huge part of that.
The Chair: There is one question that hasn’t been asked. Believe you me, I have heard previous witnesses being asked this question. You don’t need to answer it now. If you think the answer will be short, it’s okay. If not, you can provide the information to the clerk.
It’s very difficult to try to determine how we define the middle class. With the experience that you people have, how would you define the middle class? Mr. Ball, I will hear from you first.
Mr. Ball: Actually, we were talking about this before we came over because I think the last time I appeared here we were talking about the middle class then. I’m not sure I’m any closer to having an answer for you, to be honest with you.
We can have a look at our end to see if we can find something. We can look it over with our chief economist to see if he thinks we might be able to provide something. I’m not sure we can make any promises, but we’ll see what we can do anyway.
The Chair: Thank you. Mr. Kingston.
Mr. Kingston: There is no perfect definition, unfortunately. From a statistical perspective, we usually look at median incomes as a track for what the middle class is and how income growth has tracked over the years, but it’s absolutely not the perfect measure.
The Chair: Ms. Pohlmann.
Ms. Pohlmann: We can certainly share with you some work we have been doing on that, but it will also change depending on where you live. In Vancouver, $150,000 might be middle class, but it’s wealthy in another part of the country. It is very much dependent on location.
The Chair: Thank you very much to the witnesses for your professionalism.
(The committee adjourned.)