THE STANDING SENATE COMMITTEE ON NATIONAL FINANCE
EVIDENCE
OTTAWA, Wednesday, November 1, 2017
The Standing Senate Committee on National Finance met this day at 3:30 p.m. to continue its study on the Minister of Finance’s proposed changes to the Income Tax Act respecting the taxation of private corporations.
[Translation]
Senator Mockler: Welcome to this meeting of the Standing Senate Committee on National Finance. Today, we begin the 12th public meeting on the study of the Minister of Finance’s proposed changes to the Income Tax Act respecting the taxation of private corporations.
Today, we have the honour of welcoming the Minister, Mr. Morneau, and his Deputy Minister, Mr. Rochon.
[English]
Welcome to this meeting of the Standing Senate Committee on National Finance. 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 to those watching, the committee hearings are open to the public and also available online on the Senate website at SenCanada.ca.
At this time would I like to ask all senators to introduce themselves, starting on my left.
Senator Black: Mr. Minister and Mr. Deputy Minister, I am Doug Black, from Alberta.
[Translation]
Senator Forest: Éric Forest from the Gulf region, in Quebec.
Senator Pratte: André Pratte from Quebec.
[English]
Senator Tannas: Scott Tannas, Alberta.
Senator Mercer: Terry Mercer, Nova Scotia.
[Translation]
Senator Moncion: Senator Lucie Moncion from Ontario.
Senator Maltais: Senator Ghislain Maltais from Quebec.
[English]
Senator Oh: Victor Oh, Ontario.
Senator Marshall: Elizabeth Marshall, Newfoundland and Labrador.
Senator Batters: Denise Batters, Saskatchewan.
Senator Cools: Anne Cools, Toronto, Ontario.
Senator Mockler: I would also like to recognize the clerk of the committee, Gaëtane Lemay, and our two analysts, Sylvain Fleury and Alex Smith, who team up to support the work of this committee.
[Translation]
Today, the committee is continuing its study on the proposed changes to the Income Tax Act respecting the taxation of private corporations, changes that the Minister of Finance of Canada proposed during the summer of 2017.
[English]
Today, honourable senators, we welcome the Honourable Bill Morneau, Minister of Finance of Canada.
He is accompanied by his deputy minister, Mr. Paul Rochon.
Honourable senators, every senator will have the chance to ask one question and a supplementary question, if there is a need, within a time frame of five minutes. I would also ask the minister to not run the clock and be short with his answers. I will intervene if I need to in order to give everyone an opportunity to participate.
Minister Morneau, can you please make your brief presentation? It will be followed by questions from the senators.
[Translation]
Once again, we thank you for being here, Mr. Morneau. The floor is yours.
The Honourable Bill Morneau, P.C., MP, Minister of Finance: Thank you.
[English]
Hon. Bill Morneau, P.C., M.P., Minister of Finance: Thank you. It’s a pleasure to be here today, honourable senators. I want to thank you for taking the time to study what the government is doing to support small businesses while improving tax fairness for the middle class and for all Canadians.
[Translation]
These changes are part of our efforts to strengthen the middle class and to secure strong economic growth.
[English]
The government believes that small business is indeed the backbone of our economy, which is why we recently announced our intention to lower the small-business rate to 10 per cent two months from now, and then again to 9 per cent a year later, on January 1, 2019.
We want to do everything we can to help small businesses to grow and create great jobs for Canadians, but we know at the same time that we have to ensure that our tax system is fair.
The system that we inherited, collectively, encourages those individuals who are already successful to incorporate simply to pay less personal tax. This situation, we know, is unfair, and our goal is to address it.
[Translation]
We need to make sure that the benefits of a tax rate of 9 per cent go to entrepreneurs and small businesses, not to the wealthiest in our country as a tax break.
[English]
Our proposed measures, which are discussed in our Fall Economic Statement, will ensure that Canadian-controlled private corporation status is not used just to reduce personal income tax obligations for high-income earners but rather is used to support small businesses.
It’s important to underline that the vast majority of private corporations in Canada will not be impacted by the government’s proposed measures. This summer and fall, as you may have heard, we undertook a consultation on tax planning strategies used by private corporations and heard from businesses, professionals and stakeholders from across the country. They asked us to make sure that there would be no unintended consequences from our proposed changes.
What I can tell you is that we listened.
[Translation]
The measures that we are proposing reflect comments from across the country.
[English]
I want to lay out for you the changes we’re making to our plan that are a direct result of what we heard from Canadians.
First, on income sprinkling, the government intends to simplify the proposal to limit the ability of owners of private corporations to lower their personal income taxes by sprinkling income to family members. But we’re going to make sure that changes won’t impact those family members who meaningfully contribute to small businesses.
Regarding passive investment income, we intend to move forward with measures to limit the tax deferral opportunities available to private corporations. But what we learned through the consultation is how much small-business owners rely on passive investments, not just for the business but, in many cases, for their families as well.
We’re going to ensure that as we move forward, we provide business owners with greater flexibility for their savings within their private corporation. This flexibility will allow them to build a cushion of savings to be used in a way that fits their personal situation, whether for future business expansion, personal needs like parental leave or, potentially, retirement.
During our consultation with Canadians, we also heard from investors who support entrepreneurs and innovators in our country. To address their concerns, our approach will ensure that Canada’s venture capital and angel investors continue to invest in the next generation of Canadian innovation.
Finally, we heard from farmers and fishers across our country. We want to make sure that we protect Canada’s farmers and Canada’s fishers. We want to move forward in a way that allows them to protect their ability to hand down their business to their children, so we’re not moving forward with the proposed changes regarding the conversion of income into capital gains.
[Translation]
I would like to thank Canadians for sharing their comments.
[English]
Our government’s plan — working to strengthen the middle class and ensuring Canadians have the support, resources and confidence they need to succeed, create jobs and grow our economy — is working. We’ve come a long way in the last couple of years.
The first time I appeared before this committee was in June 2016, when Canada was still, many years later, feeling the effects of the Great Recession of 2008 and 2009.
[Translation]
We currently have the fastest growing economy in the G7.
[English]
Growth this year is forecast to be 3.1 per cent in Canada. The unemployment rate we have in our country right now is the lowest we’ve had in a decade. Canada’s economy has created over 450,000 jobs since 2015, and the unemployment rate, as I said, is something that we should really be proud of.
Moreover, the Canada Child Benefit introduced by our government has helped lift about 300,000 Canadian children out of poverty. By the end of this year, child poverty will have been reduced by about 40 per cent from where it was in the year 2013.
[Translation]
Our government has made historic investments in infrastructure, has enhanced the Canada Pension Plan and has put more money into the pockets of low-income seniors.
[English]
We doubled the Canada Summer Jobs program and have taken action to promote a healthy housing market across our country. We know that the economy is growing and that our plan is working, but we know there’s still more to do.
As I announced in our Fall Economic Statement, our government will strengthen the Canada Child Benefit by making sure it keeps pace with the cost of living. Starting next July, two years ahead of schedule, tax-free Canada Child Benefit amounts will be increased each year with inflation. For the 2019-20 benefit year for a single parent with $35,000 of income and two children, the increase in the Canada Child Benefit will contribute about $560 towards the cost of raising his or her children.
We also said that we’re going to enhance the Working Income Tax Benefit to provide even more support and opportunities for those working hard to join the middle class. The government proposes to further enhance this benefit by an additional $500 million annually, starting in 2019.
We want to continue to work to create good jobs in this country, to lower our unemployment rate still further from where we are today.
This is in addition to the increase of about $250 million annually that’s already set to come into effect in 2019 as part of the enhancement of the Canada Pension Plan negotiated with provinces in 2016.
Taken together, these actions will boost the total amount the government spends on the Working Income Tax Benefit by about 65 per cent in 2019.
We also want to report to you and to Canadians that we’re making these investments responsibly. We have the lowest debt-to-GDP ratio among all G7 countries, and, according to the September 2017 survey of private sector economists, Canada’s net debt-to-GDP ratio could be, just five years from now, at the lowest level it’s been at since 1977.
The proposed changes you’re studying contribute to a fairer tax system.
[Translation]
In the interests of tax fairness for the middle class, our government plans to reduce the small business tax rate to 9 per cent from the 2015 rate of 11 per cent.
[English]
For the average small business, reducing the small-business rate to 9 per cent will leave an additional $1,600 per year for entrepreneurs and innovators to reinvest in their businesses, in jobs and in our country.
[Translation]
As parliamentarians, it is our duty to ensure that the benefits of a growing economy are shared with the middle class.
[English]
Again, I want to thank you for inviting me here today to speak to you about our plan. I’d be pleased to answer any questions.
[Translation]
Senator Mockler: Thank you, Mr. Minister.
[English]
Senator Marshall: Welcome, minister, today.
I wanted to start off with one of your opening remarks, where you say that small businesses are the backbone of the economy. The changes that you proposed are going to significantly affect these small businesses. Your officials testified before the Senate Finance Committee earlier, and they told us that your department hasn’t conducted any economic impact analysis on the proposed tax changes.
The original proposals that you tabled in July had to be significantly amended. I think two have been shelved now. This has really affected the credibility of the government and your department.
In addition, small-business owners, when they’ve testified, and also tax experts are saying now that small businesses are confronted with significant implications of the tax changes. They are also seeing the looming downturn of the economy. They’re looking at higher interest rates in the future, and there’s uncertainty over NAFTA. Those are just a few examples of some negative things lying on the horizon.
The passive income rules specifically are going to significantly affect small businesses, and it’s going to cause significant harm to the economy.
My question is this: Why didn’t the Department of Finance conduct a thorough analysis of the economic impact of these changes before they were released in July and then avoid this embarrassment of having to change the proposals and also shelving some of them?
Mr. Morneau: Thank you for your question. There were a number of things that you talked about in that question. Where I’d like to start is the situation that small businesses, indeed all businesses, find themselves in in Canada right now.
I know that when business owners start a year, they’re worried about getting customers, getting clients, growing their business. The idea that we have an economy that’s growing at the fastest rate among G7 countries is cause for optimism. The fact that we’ve created, in this country, more than 450,000 new jobs over the last couple of years is cause for optimism.
The measures that we put in place that we want to move forward with and that I know the Senate is studying will have a positive impact on small businesses. In terms of the first and most important impact, of course, every small business — and by that I mean every business that’s earning net profits of $500,000 or less in this country — will have a lower tax rate. By providing that lower tax rate, we see that they will have more money to invest in their business.
For every single business, that’s going to be their situation. Of course, as you, I know, understand, about 85 per cent of small businesses don’t have any passive investments at all. Those businesses, 85 per cent of businesses, will have the reduction in the small-business tax rate, and they will have no impact whatsoever on passive investment income. But it’s a bigger category than that that will find themselves in a very positive situation because it’s about 97 per cent of small businesses that won’t get to the threshold that we’re talking about.
We see that about 1.7 or 1.8 per cent of small businesses in this country are privately incorporated entities, so about 29,000 out of 1.8 million. They are the ones that actually have about 80 per cent of the passive investment income in this country. So for those businesses, we’re saying that the tax deferral opportunity they have is limited, limited to about $1 million in future or roughly $50,000 in investment income annually.
In terms of impact, we see an enormous positive impact on all of those small businesses and, of course, a situation where the tax system will be fairer because we won’t be providing significant advantages for that very small subset of businesses that have a big tax deferral opportunity not available to other Canadians.
Senator Marshall: The small-business owners that we’re talking to are not feeling optimistic. I appreciate the comment you just made, but it’s not just the tax changes that concern them but also the way it was rolled out and the fact that the Department of Finance didn’t do the upfront work before they rolled it out.
I also wanted to ask a question with regard to an interview that you did with The Globe and Mail earlier this year, when you said that the government was targeting billions. The term you used was “targeting billions in dead money.” In reading the article, what you’re talking about is a company’s retained earnings. When you look back in history, you referred to the 2008 downturn. Canadian companies weathered that because they had a cushion of money there to support them. Under your tax proposals, you’re forcing companies to pay additional taxes on passive income above a certain amount. But we’ve got to remember that these are retained earnings, and they serve a purpose. Business owners can expand their business. They can get cheaper credit. It’s a cushion for contingencies.
So why are you continually referring to it as dead money?
Mr. Morneau: We, of course, recognize the importance of making sure that we have a tax policy that incents businesses to do what I think all of us want, which is to invest in our economy, to create jobs and to allow us to grow over the long term.
Our observation was that the system right now creates an incentive for people to retain money in their small corporation. The reason for that, of course, is the difference between the small-business tax rate and the personal income tax rate.
We are very keen on encouraging people to keep money inside their private corporation if that money is being turned around and invested into their active business. So that’s actually the objective that we’re trying to achieve.
We see that lowering the small-business tax rate will allow for more money to be reinvested in the business. What we want to do, though, is to make sure that, at the same time, we don’t create particular advantages for those that are already successful that aren’t available to anyone else. So, for the person starting a small business, when they see that someone that already has a business is able to leave large amounts of money in that enterprise, not to be reinvested in the business but just to be there, potentially for retirement or for personal savings, we don’t want to encourage that behaviour.
So what we’ve found, we think, is a balance. We’ve lowered the small-business tax rate so that small businesses have the opportunity to invest more, but we’ve limited the amount of passive investment income to what will be needed for the overwhelming majority, 95 per cent plus of businesses. Those private corporations that have more than that will continue to be able to invest in their active business. But that’s the amount of passive investment savings they’ll be able to have in their business.
Senator Marshall: The only issue with that —
Senator Mockler: Thank you, senator. We have to move on to another senator, please.
[Translation]
Senator Forest: Minister, thank you for appearing before our committee. This topic is of great concern to the Canadian public. According to our information, you have received more than 21,000 submissions in response to the announcement of this reform. After more than 12 meetings, members of our committee have heard from many witnesses who are concerned about this reform, particularly with respect to the four major themes: passive investment income, income sprinkling and distribution, intergenerational transfer and capital gains.
As you know, our committee is preparing to tour the east and west of the country. Although the amendments you have made to your bill have brought some optimism, we think that interpreting guidelines and the rules of interpretation of the legislation will be of great concern. It’s what we have experienced so far in this committee. In order to produce a proper and accurate report and to help you improve the legislation, we would like to be able to provide some more specific rules of interpretation to the people we are going to meet. Can you give us more information on that?
As the saying goes, “the devil is in the details”. Many witnesses have expressed their concerns about the rules and guidelines for interpretation.
Mr. Morneau: Thank you for your question. It’s never easy to change the Income Tax Act. In our opinion, your meetings with Canadians are very important. They are absolutely necessary if we want our system to work well.
The overarching principles have been explained in our fall economic statement, but much remains to be done. We will be able to provide a little more information about income sprinkling over the next two months. People working in a family business will have all the information they need to benefit from income sprinkling. We want families to be able to work together.
I also understand that there are still very few explanations about passive investments. That’s why your study is important. We are counting on your report to help us improve the legislation. A draft bill will be tabled in January and you will be able to review it. We hope this will be part of our 2018 budget.
It takes a bit of time, but, with the help of Canadians, we believe we can improve the situation. That’s why I fully supported your decision to do this study.
Senator Forest: Let me reiterate my wish: if we had more details, our work would be even more relevant and realistic. Thank you.
[English]
Senator Black: Minister and deputy minister, thank you for being here. Minister, before I start my comment followed by a question, I do want to thank you — I don’t suspect you’re getting a lot of thanks these days — because when I wrote you in the summer requesting an extension of the consultation period and suggesting that the Senate might be an appropriate venue to study these matters, you were very quick to endorse and support that initiative. So, credit where credit is due.You’re sitting here today because you thought it was a good idea.
Mr. Morneau: We can all congratulate each other. Maybe we’ll have a cocktail later.
Senator Black: Minister, with regret, it’s become so obvious to us around this table that the intentions of the government, which I have no doubt are good intentions, have fallen short of the mark. The overwhelming evidence that we are hearing is that with respect to the passive income, it’s harmful to business, it has unprecedented complexity, it’s beyond complicated, it’s unmanageable and, in fact, it will lead to a loss of tax revenue and billions of dollars from the economy.
We’ve already heard from Jack Mintz, whom I know you have worked with before, that we have to factor this as well in the face of, perhaps, lower tax rates in the U.S., creating a situation where business in Canada becomes even less competitive.
On income sprinkling, you’ve indicated today that it’s your intention to simplify the system. But minister, with respect, you’re the only person we’ve heard from here that would lead us to think that your suggestions simplify. If I may, we’re even hearing from CRA yesterday that there’s a recognition that this is vastly complicated, on the verge of being difficult to conceive how you assess the value of family farms and the contribution of spouses.
So having said all of that, a consensus seems to be developing, minister, that these proposals, all goodwill, should be abandoned. There is no shame in trying; there is no shame in failing. A consensus is developing that these should be abandoned, and what we should actually be doing is reviewing the complete tax system in Canada now — it hasn’t been done in 20 years — to figure out how we tax a modern economy in a fair, equitable manner.
So if you could comment, please, on abandonment followed by an expedited review of the tax system.
Mr. Morneau: Thank you for your question. We clearly have come forward with some measures that we believe will enable our system to be fairer. We’ve said that we have some things in our system that are not creating fairness in the system, and we want to do that in a way that allows us to continue to enable people to invest and reinvest in our economy. That was the original intent.
We believe we found a balance that will enable that intent to move forward.
So taking a few of your specific questions or comments, when we get to the next stage of the proposals, we will be helping people to understand the positive revenue impact. So there will be a positive revenue impact from the approach that we’ve taken on income sprinkling. There will be a positive revenue impact on the approach we’ve taken with passive investment income.
Of course, as you’ve seen, our goal is to make sure that we balance those positive revenue impacts with what we can do for Canadians who are, in some cases, struggling to get by and people that are actually trying to invest in our economy. So we’ve said that we’re going to put that money back into the economy. Making sure that there’s a lower small-business tax rate allows for more investment in the economy. Moving forward with indexing the Canada Child Benefit means we can help families to keep up with the cost of living. Putting in place the Working Income Tax Benefit at a higher level means that working Canadians are going to find themselves getting more value out of work.
So this is entirely consistent with what our government is doing. We see that making any tax changes is, of course, fraught with challenges. People will not like those changes if they feel themselves personally impacted. Of course, our job is to listen, as we’ve done, make sure that we make changes as are appropriate and find a balance, and we think that’s what we have found. We believe that the $50,000 in annual passive investment income is quite an easy test to administer. That information is available. So while some people may argue otherwise, they aren’t in a position necessarily to fully understand the ability to administer that.
We know that the reasonableness test has been used for decades in this country, so we are proposing to make it simpler, but a reasonableness test for many parts of our tax code is already in place, so we will find a way to simplify that. There will be more rules that will be coming out in the not-too-distant future.
Finding a balance is challenging. We intend to move forward to make sure that the tax system is fairer, that we continue to encourage investment in this country, so that we continue on the pace of what’s actually happened.
A couple of years ago I faced similar questions when people said that if you’re going to lower taxes on middle-class Canadians and raise them on the top 1 per cent, Canadians would all leave the country and that increasing the Canada Child Benefit wouldn’t necessarily increase the impact.
Where are we two years later? We are in a situation where middle-class Canadians have more disposable income. It’s created a spark plug to our economy. We should be proud to tell people that our economy is doing very well. Now our goal is to keep that continued growth going, which is what we are trying to do by continuing to invest in middle-class Canadians.
Senator Mockler: I would like to introduce and recognize Senator Day who just joined us, from New Brunswick, and Senator Andreychuk from Saskatchewan.
Senator Tannas: Thank you minister for being here. I had an exchange with your folks when they came before this committee before that I would like to ask you about.
I come from Alberta. I spent my career building a business in financial services. I always wondered why it was that the large Canadian banks never seemed to pay the income tax rate that non-small businesses paid for corporate income tax.
I did a bit of research, and we had a back and forth about this, but I’m still perplexed. The big five Canadian banks on average pay around 19 per cent tax on their net income. The smaller banks and financial institutions that don’t have international operations pay the full rate of about 26 per cent.
So that led me to believe then that it must be a lower tax rate in the other jurisdiction, which is the United States for the big five banks. The vast majority of their operations outside of Canada are in the United States, and yet your government and previous governments talk about the tax rates in the United States being higher. How could that be? I looked at a number of the large U.S. domestic banks. They are in fact paying a higher rate. They are paying 32 per cent.
I’m not an accountant, but I’m having trouble reconciling that our domestic banks that don’t have operations globally pay 26 per cent in the U.S. The domestic U.S. banks pay 33 per cent, and yet our banks that have operations in both Canada and the U.S. and nowhere else to speak of, pay 19 per cent. I think there is a leak somewhere. If you do the math on that, it’s a leak that goes into the billions of dollars annually.
Now, when your officials came before us, they talked about this particular initiative in small business going after $250 million. So all of this attack on small-business people, the wealth and job creators, and all the angst and insecurity that is now baked into everyone’s psyche about what’s next, why wouldn’t you hunt where the ducks are, with the big banks? If we could get them to pay what should be a fairly reasonable average between their U.S. operations and Canadian, we’d be billions ahead. I don’t understand why year after year only Bay Street has a special rate.
You’re from Bay Street, so maybe you can help me with this.
Mr. Morneau: I’ve never actually lived on Bay Street. My corporate headquarters were not on Bay Street, but maybe I can identify a few things here.
We were looking at some things in our tax code which are creating a level of current unfairness and a dynamic that was going to make the challenge grow over time. The current unfairness is relatively easy to describe when we talk about the income sprinkling measure. For example, if a woman incorporates and she happens to have children that are 19 or 20, and another woman incorporates and she happens to have children that are 13 and 14, it doesn’t really seem like anyone would design a tax code to give the first woman a lower tax rate than the second woman. If there was a reason behind that, it strikes me as likely accidental. Certainly it is not one that makes sense for the long term.
There are additional advantages around passive investment. We are seeing a trend towards private incorporation. That means the size of that differential between those two women, or between people in those two situations, is growing because we saw a 300 per cent increase in incorporation among professionals over the last 15 years. That’s a situation that obviously we don’t want to have continue. So the idea that we will grow the size of a group that has a preferential tax treatment because they incorporate or because they are able to incorporate doesn’t necessarily make sense. That was what we were looking towards dealing with to make the system fairer.
In doing that, we looked at particular advantages. We saw this income sprinkling measure with a $250 million cost, but we haven’t yet informed you of the revenue around the passive investment income because the design has not yet been completed. So that will allow us to provide you with more information on the size of the cost of that deferral advantage given to already advantaged Canadians.
So I’d ask you to just suspend disbelief for a few months until we get to our budget. That’s something we think is important to get on because otherwise long term we will find ourselves in a more challenging situation. That issue is discrete from the issue around what our large corporations or what our banks should be paying in taxes. We do have a tax rate for large corporations that is significantly higher than for small corporations. I’m sure you’ve done the work to get to these numbers, and I will not dispute them.
We need to ensure all corporations pay their appropriate rate of tax. One of the reasons that we signed on to the OECD approach to base erosion and profit shifting is because we want to make sure that large companies aren’t inappropriately having expenses in high-tax jurisdictions and taking profits in low-tax jurisdictions. We don’t want to have that. We want to have rules that appropriately force people to pay taxes in jurisdictions where the business activity is actually happening.
We’re doing more than one thing at the same time. That’s what you would expect us to do.
On top of all that, we have significantly invested in the Canada Revenue Agency over the last two years, about $1 billion, to ensure that businesses and individuals are paying what they should be paying. That effort is what we think is fair. It continues to show us that there are opportunities for us to ensure that people are paying their appropriate rate. I don’t know whether they’re in the group of companies that you identified because I don’t have any personal knowledge of their situation, but we will continue to make sure that people pay their fair share and that they’re not doing things that are inappropriate.
Senator Mockler: I would like to recognize Senator Jaffer from British Columbia, who just came to join us. Thank you, senator.
Senator Pratte: I want to go back to this issue of complexity because it has been a common theme from all the witnesses that we’ve had before us and a lot of other people I have talked to.
Everyone has told us, be they tax professionals or small-business people, that they find that these proposals will render their compliance burden much too heavy. They found it already heavy before, so they find it’s going to be heavier. Tax practitioners say it will render their work unmanageable, and these people thrive on complexity. The CRA people said they would find it challenging, which is not reassuring. They did mention that the reasonableness test, for instance, already exists, but it seems that for income sprinkling it would be more complicated.
What kind of commitment can you give all those people who are convinced that it’s going to be terribly complicated? What commitment can you give them that it will be as simple as possible to administer and for small-business people to manage?
Mr. Morneau: I appreciate the question, and I just want to agree with both the underlying premise to your question and the comments from the people who must be coming to you that seeking to make our tax system less complex is a laudable goal. We would like to achieve that. It’s not an easy goal and, of course, there are people who earn their living, appropriately, working on thinking about ways that the tax system can be considered in a way to make sure that their clients are in as advantageous a situation as they can be legally. That’s the way the system works.
As we find challenges and problems that don’t meet up with the original intent, of course, you try to deal with those challenges and problems, which does create complexity. I understand.
In the proposals that will come forward, we are seeking to make sure that we simplify to the greatest extent possible. In terms of the three things that we had on the table through the consultation, one of the things we pulled back on is one that presented a fair degree of complexity.
We had a rather large number of intervenors who talked about tax planning that happened with things like the pipeline plan and other things that were going to be challenged because of our conversion from regular income to a capital gains approach. While still there are some people using that approach in a way that was not necessarily intended, we didn’t want to have unintended consequences, and that’s why we pulled back, and that obviously significantly reduced the complexity of what we’re doing right now.
On the income sprinkling to family members, we’ve laid out some themes around how we will move forward, which I suspect you’ve probably seen. As I said, we intend to move forward and try to simplify that as much as we possibly can. That will be coming shortly.
With respect to the passive investment income, we couldn’t come up with a rule that said you can arbitrarily have $1 million worth of investments inside your private corporation because we don’t track investments; we track investment income. So the passive investment income is something that can be tracked.
I appreciate that people will say that they’re concerned about complexity. We are too. We are going to try and get this right. By definition, when we introduce new rules and grandfather old rules, there is a level of complexity that people will deal with, and we’re going to try to minimize that to the greatest extent possible. We’re hopeful that once we bring out the draft legislation, your advice and the advice of the people at this table will help us get to that conclusion.
Senator Pratte: If I may give an example with income sprinkling, because that was given to us by a few small-business people. The CRA will look at past contributions of a spouse, for instance, in respect to previous labour, capital or risks. You can easily imagine what sort of work the business person will have to do to try to find proof of past contributions to previous labour, capital or risks where you will have to find documentation of work that your spouse did for the company 10 years ago, when you had no idea that this proposal would come through. That’s a complication I can understand small-business people being worried about.
Mr. Morneau: We’re specifically looking at that. We understand the issue. We’re not in any way dismissing it, but we have a larger goal at stake here. We have many people who are incorporating themselves in order to income split in a way that we don’t see as helping our economy over the long term — someone incorporating just so they can get a tax advantage not available to other people is something we don’t think is conducive to having a fair situation. That is the goal. Getting at that goal requires us to consider how best to do it. We’re working on it, and we appreciate the fact that people are concerned that we do it as simply as we can. We’ll have more to say soon.
Senator Batters: Minister Morneau, for months Canadians have been perplexed at how Prime Minister Trudeau and you, as Minister of Finance, could even propose these draconian tax changes that you set forth in July. Reports indicate that the same unfair tax changes were twice proposed by finance bureaucrats to Conservative Finance Minister Jim Flaherty, and he turned them down flat. Yet you had a much more receptive ear.
Your July discussion paper contained some measures which were very quickly shown by accountants to be completely unreasonable. Two glaring examples were, number one, intergenerational transfers where a farmer or small-business owner would pay a 45 per cent tax rate to transfer their legacy farm or business to their own children yet only 25 per cent for selling it to a stranger, and number two, making the massive passive investment changes retroactive to July 2017 when your proposals were released.
So after much pressure was brought to bear on you and your government by the Conservative opposition and Canadians across the country, you’re now saying you’re backing down on those two unreasonable measures, but you climbed down only after you forced farmers and small-business owners across Canada to endure three months of considerable stress, worry and anguish about their very livelihoods, and during harvest no less.
You, your finance officials and your government should have realized that those two measures in particular were completely unreasonable right off the bat, before they were even proposed.
So Minister Morneau, who takes responsibility and who bears accountability for even including those measures in the first place, you, your finance officials or the Prime Minister? If those proposals came from your department, who will lose their jobs for that?
Mr. Morneau: We will continue to move forward with approaches that we see will ensure the tax system is fair. We believe that Canadians elected us to make sure that we could grow the economy and ensure that the benefits of that growth were not going disproportionately to those who are already advantaged.
We were clear when we ran for office. We didn’t disguise anything. We said that we would raise taxes on the top 1 per cent so that we could lower them on the middle class. We said that we would take the Canada Child Benefit which was going to families like mine and we would instead means test it so that we could actually send more money to families that were in a greater challenge of moving forward to successfully raise their children.
We identified the fact that we saw advantages in privately incorporating and that we wanted to deal with those advantages, and by dealing with those advantages it would also give us the opportunity to lower small-business tax rates.
So we believe that following through on commitments is exactly what Canadians would expect of us. The fact that we move forward with a consultation process in order to reach an outcome that will allow us to achieve the goals, while recognizing that we don’t want to have unintended consequences, we think is what democracy is all about. If your question is that we should have instead just announced measures and not had consultation, we don’t agree with that approach. We decided — I think appropriately — that hearing from Canadians was the right way to go. It has brought us to a situation where we will, as I said, achieve the goals of having a fairer tax system, and it will allow us to encourage small businesses to continue to invest, create jobs and grow our economy.
Senator Batters: Minister, my question was actually on those two particular measures — the intergenerational transfer, the significant difference between 45 per cent to your own kids or 25 per cent to a stranger, and the retroactivity of the application of the passive investment changes back to when you proposed those particular changes in July — who takes responsibility for that? Those are two things that I think everyone would now concede were completely unreasonable.
Mr. Morneau: Certainly, we don’t see the world the way that you’re suggesting. We’ve moved forward with proposals that we think will have a positive impact. We know that in getting at changes to our tax code, people will have strongly held points of view, and that’s the way it should be. Arriving at the appropriate conclusion requires us to listen, and that is what we did.
We’re now at a stage where we’re keen to hear what the Senate has to say, and we’re keen to hear what you will have to say once we put our proposals into proposed legislation. That will allow us to move forward appropriately.
[Translation]
Senator Moncion: Mr. Minister, thank you for being here to answer our questions.
[English]
Over the past 12 public meetings we have had, we have heard about problems related to the proposed changes. We heard that the consultation was too short, that the changes are too complex, and that our tax system is too complex and should be reviewed. On this last point, yesterday Jack Mintz mentioned that in the U.S. they’re doing an overhaul of their tax system.
My question is related to the review of the Canadian tax system -- whether it’s something in your plan, whether the changes you are proposing are to correct pressing problems, and whether the federal government will be looking into an overall review of this 41-year-old act.
Mr. Morneau: Thank you. There are a number of issues there. We know that throughout the process some people have suggested that this period was short. I have reminded people that on page 80 of our campaign document from 2015, we identified that this was what we were going to do. I have reminded people that in Budget 2016, in March 2016, we had an advisory council look at how we could deal with parts of our tax code that we didn’t think were operating as we wanted.
In Budget 2017, which was in March of this year, we identified the three places where we were looking to make changes, and then the specific rules that we put out in two cases, with proposed legislation, in July, to allow people to offer commentary. As I’ve said, we still have proposed legislation to come forward on passive investment income.
Different people will have different points of view on process. Our view is that we’ve repeatedly identified what we’re going to do. We came forward in a way that allowed people to have their point of view heard, and there will still be time through the legislative process, which will include parliamentarians, to further state their points of view.
Throughout the course of our time in government, we will remain focused on how we can ensure the tax code is operating effectively and that it’s fair. Every year during our budget process, we look at tax measures to make sure they're working appropriately. That is part of the responsibility, so that will be our approach on an ongoing basis.
With respect to the United States, our goal is to remain competitive. We will always watch the United States jurisdiction — as a jurisdiction that’s so important for Canadians and Canadian businesses — and consider their direction. Of course, we don’t have anything to say in that regard because we don’t have information from which to draw conclusions, but I would like to assure you that we actively pay attention to what’s going on with U.S. taxes and we review, at every stage of their deliberations, what they’re proposing to do and what might actually happen, and consider the impacts, positive or negative, on our economy.
Senator Moncion: So you’re not looking at doing an overall review of the act, which is 46 years old?
Mr. Morneau: Like governments before us, we will continue to focus on how we can ensure the system meets the objectives we set out for Canadians. We believe Canadians expect us to make sure the tax system doesn’t advantage only the wealthy few, so we will remain focused on that. We will also consider efficiency measures every year. We don’t have any plans for a major overhaul of the tax system at this stage.
[Translation]
Senator Maltais: Senator Mockler, thank you for giving us the opportunity to meet with the minister, even though I am not a member of your committee.
Mr. Minister, Senator Mercer and I are members of the agriculture committee, and we would have liked to invite you, but we understood that you could not do the rounds of every committee.
The Standing Senate Committee on Agriculture and Forestry has conducted consultations on the future carbon tax, not on taxation. Unfortunately, we have been caught by the other issue involving a new tax on agriculture. On October 16, you announced some good news nonetheless. Farmers are aware of it. However, farmers have asked us how the government is planning to work with family businesses. They want to know how you are going to work with them for the transfer of family farms. You are fully aware that farms, big and small, are taxed when they are transferred to a family member. This is a major concern and reality in the farming community.
Mr. Morneau: Two weeks ago, we explained that we wanted to ensure that farmers face no problems or no new problems when transferring their farms to their families. That’s important to us. That’s why we decided to replace the regular offset system with capital gains offsets. You want something more. I know. There are always requests to make changes to our tax system. Ideas come up constantly, everywhere. That’s why we will continue to review the effectiveness of our system every year. I have no explanation right now. Of course, we are aware that it is always important to have a good system for farmers, for fishers. We will continue to make sure the situation benefits everyone.
Senator Maltais: Thank you, Mr. Minister.
[English]
Senator Jaffer: Thank you very much, minister, for being here and for your answers. If everyone has learned a lesson, it was the loopholes you talked about.
It was doctors against nurses. In my province of B.C. there is still a lot of division. I regret that the conversation went the way it did. When I listened to you today it’s very different, but there’s a lot of divisiveness caused by this discussion.
I have two very specific, short questions. It appears that your proposed passive income rules are attempting to compare private corporations to individuals in the name of tax fairness. Do you think it is fair for public corporations to continue to enjoy the tax benefits that are now being denied to private corporations? Is there any concern that public corporations will use this tax advantage to swallow private corporations?
Mr. Morneau: We’re trying to make sure that we don’t have both an incentive for people to privately incorporate to gain an advantage and an advantage that only goes to those that are already successful within that environment.
That’s why we’ve put a threshold under which we restrict the total amount of investments that someone can have in the private corporation.
The situation for small businesses and large businesses is quite different, as Senator Black, I believe, who left, identified. Large businesses, on average, in Canada have about a 27 per cent tax rate; 26.7. That’s why you have deputy ministers, because he has 26.7 and I thought it was just 27 per cent.
That’s a big difference from what a small business has. We have advantages for small businesses. We have different and higher tax rates for large businesses. We will constantly be working to make sure that there are opportunities for people to be entrepreneurial in this country. That’s what we think we’re encouraging. We think that’s even more important in the face of challenges that we will likely face with different kinds of jobs in the future.
So it does remain important. There will always be a balance to make sure we create a competitive situation for large corporations and don’t create incentives that aren’t there with that goal in mind. But they do have to pay a much higher tax rate than those small businesses do.
Senator Jaffer: In the discussion you haven’t brought public corporations together, but I just have a minute to ask you about private corporations owned by multiple shareholders. The model that I see you having is $50,000 in a company. I see that as one owner. However, if it’s multiple shareholders like, for example, four brothers, it appears the company would be limited to $50,000. The rules have not come down, but this is how it looks.
Is it appropriate to then expect the shareholders to have to incur significant professional fees, both upfront and ongoing, for setting up individual holding companies to transfer out the passive assets, especially considering the present butterfly rules that would preclude the tax-deferred transfer of assets that have already appreciated in value? I think this would create such complex structures so that people could take advantage of the $50,000 exemption.
Mr. Morneau: We recognize that there’s more work to do before we have the passive investment legislation prepared. We have dealt with this in the past because, of course, in the past people have tried to have multiple people have the small-business rate, or multiple corporations underneath effectively one corporation in order to multiply the small-business advantage. So it’s not a new challenge. We do need to get it right. We’re working on it, and we’ll have some further information in the not-too-distant future.
Senator Andreychuk: Thank you, minister, for coming back to continue the dialogue. One of the issues is you said you rolled it out in your consultations, but it’s created a lot of uncertainty. That, I think, is not good for business, particularly in today’s climate. We don’t know where NAFTA is going; we don’t know how much income we are really trapping on all these new transfers over borders that are now online. You have a lot of problems in your tax system.
You’re back to saying that you want the tax to be fair. You’re using someone who incorporates and doesn’t incorporate in small business and you’re trying to make them equal. Fairness doesn’t necessarily mean equality. The system is all over the map. You’re trying to say that equality is the issue between one sector, but my colleagues have pointed out where it’s not equal for private corporations, public corporations, large ones, partnerships, et cetera. That continues to trouble me. Perhaps it’s the language that’s troubling me. It’s the tone that, somehow or another, incorporating is a bad thing, when in fact it’s not.
The small businesses don’t incorporate just to take advantage of tax breaks; they incorporate for a whole host of other reasons, like liability. I could go on with the other reasons. They’ve come to us to say that’s only one factor in incorporating.
I don’t know how we get over that to get into a dialogue of tax fairness. I would urge you to look at small business and medium-sized businesses. They need money, and they need to retain money to grow. If you’re talking about farms, we don’t know what the crops will be like next year. We don’t know what the prices are. If you’re biblical, it’s seven good years, seven bad years. So you do retain that.
Equally, what do you do if you’re a doctor in a small town and the province closes the hospital and you’re there? You want to continue to struggle? Retained earnings mean a lot more than “tax dodge,” because that’s what you’re making it sound like. We’re still back to the rhetoric.
My final point that you may want to rebut is the test of reasonableness. Yes, the Income Tax Act has reasonableness. I’ve dealt with it. But you can compare companies to see how much hospitality they use, how many educational trips they take, and so on. We can go on to that. However, with the reasonableness test, I thought we put into the tax something to recognize that small businesses are grown out of families. We’ve purposely not tried to define the family. The family can be in many forms. Therefore, how can we talk about farmers and doctors and put a reasonableness test in the hands of CRA? It’s unfair of them to make social comment on how we conduct small business, and we want to grow that for our economy.
I still feel that you haven’t gotten the message. These people want you to hear them, and we have time to do so by January.
Senator Mockler: Do you have any comment, Mr. Minister?
Mr. Morneau: I would point out that this comment around uncertainty will always present a challenge. Of course, it’s important to consider the facts of where we’re at. We’re in a very good economic situation. We created a great deal of certainty for Canadian families by improving their situation. We found ourselves in the best economic situation we have found ourselves in in a decade. We have found a way, we believe, to continue the benefits of small businesses incorporating, or individuals incorporating, to a certain threshold so that we don’t have people just using private corporations to advantage themselves from a tax standpoint.
It’s about balance. We think the balance we have found is one that will allow us to continue to have investment in our country, creating growth, and not one that creates an incentive for people to take tax advantages once they’re already successful.
I’d like to thank you, Mr. Chair, for having me here today. I hope that you’ll invite me back another time. I’ve now run 10 minutes into my next meeting. But I’d be happy to come back another time to talk to the committee.
Senator Mockler: Minister, we have three more senators. Would you mind giving us another five minutes? If not, I will respect your decision.
Mr. Morneau: Yes.
Senator Mockler: You’ve given us more time than your office had told the clerk, and we appreciate that. Could we do that, minister, please?
Mr. Morneau: Sure.
Senator Oh: Thank you, minister, for extending your time. You said many times that small businesses are the backbone of the Canadian economy. Also, many big businesses actually grow from small businesses.
Your proposed tax reform is causing alarm for small businesses. Today I have with us here the owner of a small helicopter business just down the road in Casselman, Ontario. Earlier he told me that he has asked his accountant to make plans for him to stay in Canada but also to start preparing an exit strategy. This is very concerning.
Entrepreneurs like him drive innovation and growth in small towns across Canada. Younger entrepreneurs, in particular, are becoming more educated, motivated and more mobile. Are you concerned that there is so much discussion about exit strategies?
Mr. Morneau: Could we take all three questions?
Senator Mockler: I appreciate that.
Senator Mercer: Minister, I’ve been a member of the Standing Senate Committee on Agriculture and Forestry for 14 years, half of them as deputy chair. One of the consistent messages that we’ve heard from farmers, particularly young farmers, is the intergenerational transfer of farms from mom and dad to daughter or son. This is a constant problem.
During our recent study on farmland acquisition, the issue continued to come up. The musing of you and your department over the summer has set a little panic in that sector. I’ve from Nova Scotia, so I know that it’s also caused some problems in the fisheries.
Minister, as a new member of Parliament, like a lot of your other colleagues, you’re getting a lesson in perception in this business quickly becomes reality. We need to calm the waters a bit.
In the study on farmland acquisition, the committee learned about farmland value increases and challenges. These increases were posed to new farmers in the sector. In 2011, a census of agriculture and the total land value of buildings was estimated at $276 billion. Do you think that the lifetime limit on capital gains should be raised to overcome challenges associated with farmland value increases?
Senator Cools: I have one question and one suggestion. I wonder if you could tell us what you meant when you said the government has invested $1.2 billion in the CRA. Could you explain that?
My suggestion is something that has niggled at me for many years. I was thinking that you and the government should consider making CRA a department of government again. There was a time when it was a department of national revenue headed by a minister. It is now an agency. I would submit to you, minister, that the business of tax collection and tax regulation is better done by a department of government than by an agency.
Senator Mockler: Minister, you’ve been overly generous with your time. Do you want to answer?
Mr. Morneau: I would be pleased to answer. There were three questions from Senator Oh about a concern around businesses exiting.
The best way I can answer that is that we have a great country. I have the immense honour in my role of travelling around the world on behalf of Canada. All I can say is that people are looking to Canada for examples on how to successfully balance ensuring that a country is growing and that the advantages are going to a broad cross-section of your people.
We’ll continue to move forward with the lowest small-business tax rate among G7 countries, which certainly advantages small businesses, and a fantastic standard of living. I certainly hope that business owners, like other Canadians, are encouraged to make investments in our country. I think we’re seeing the fruits of that right now.
In terms of intergenerational transfer on farms, I would point out the already very advantageous situation. We do have the lowest small-business tax rate among G7 countries. That lifetime capital gains exemption that you asked about has been increased. It’s been increased over the years to $1 million, which, for farmers, is significantly higher than it is for other small businesses.
We know that there are people who would like us to consider other tax changes. We’re not ruling anything out, but we will continue to review issues on an ongoing basis.
Finally, I think I said $1 billion is what we’ve invested in the Canada Revenue Agency over the last couple of years in our first and second budgets. We continue to see that there’s opportunity for us to make sure that people are actually paying what they’re expected to pay, and that’s why we’re doing that. The CRA does report through to the minister, and I will ask her the question that you’ve asked of me, but it’s not something that we’re currently considering.
So again, Mr. Chair and all senators, thank you very much for having me here today. We will continue to work on your behalf and on behalf of Canadians to try and continue with this very positive economic success which we’ve seen over the last couple of years. Thank you.
Senator Mockler: Thank you very much for your time. We may invite you later if we need additional information.
(The committee adjourned.)