Proceedings of the Standing Senate Committee on
National Finance
Issue No. 53 - Evidence - November 28, 2017 (afternoon meeting)
OTTAWA, Tuesday, November 28, 2017
The Standing Senate Committee on National Finance met this day at 2:15 p.m. to examine the Supplementary Estimates (B) for the fiscal year ending March 31, 2018; and to study the Minister of Finance’s proposed changes to the Income Tax Act respecting the taxation of private corporations and the tax planning strategies involved (topic: taxation of corporate passive investment income).
Senator Percy Mockler (Chair) in the chair.
[English]
The Chair: I declare this meeting of the Standing Senate Committee on National Finance in session.
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.
[Translation]
I want to remind our listeners that the meetings of the Standing Senate Committee on National Finance are open to the public and available online at sencanada.ca, the Senate of Canada website.
[English]
Now, I would like to ask the senators to introduce themselves, starting on my left.
Senator Neufeld: Richard Neufeld, British Columbia.
Senator Marshall: Elizabeth Marshall, Newfoundland and Labrador.
[Translation]
Senator Forest: Éric Forest from the Gulf region of Quebec.
Senator Eaton: Nicole Eaton from Ontario.
Senator Pratte: André Pratte from Quebec.
[English]
The Chair: Thank you.
Today our committee continues its study on the expenditures set out in the Supplementary Estimates (B) for the fiscal year ending March 31, 2018.
[Translation]
To discuss financial requests, joining us is Janique Caron, Acting Assistant Commissioner, Finance and Administration Branch, and Agency Comptroller at Canada Revenue Agency.
[English]
We also have Mr. Ted Gallivan, Assistant Commissioner, International, Large Business and Investigations Branch, Canada Revenue Agency.
Ms. Caron, I gather that you have a short statement to present. Following your presentation, senators will ask questions.
[Translation]
Ms. Caron, go ahead.
[English]
Janique Caron, Acting Assistant Commissioner, Finance and Administration Branch, and Agency Comptroller, Canada Revenue Agency: Good afternoon, Mr. Chair, and thank you for the invitation to present the Canada Revenue Agency’s 2017-18 Supplementary Estimates (B) and to answer any questions that you may have on our new funding requests. I am here with my colleague, Mr. Ted Gallivan, Assistant Commissioner, International, Large Business and Investigations Branch, Canada Revenue Agency.
[Translation]
Mr. Chair, as you are aware, the Canada Revenue Agency is a client-focused agency that serves Canadians and is responsible for the administration of federal and certain provincial and territorial tax programs, as well as the delivery of a number of benefit programs. Through Supplementary Estimates (B), the Canada Revenue Agency is seeking an increase of $44.9 million in its voted authorities for the following two items:
[English]
First, the agency is requesting $43.9 million to implement and administer various measures to continue its efforts to crack down on tax evasion and combat tax avoidance as announced in Budget 2017.
This includes new funding totalling $13 million for GST/HST measures aimed at preventing tax evasion and improving tax compliance to increase the number of audits of high-risk large businesses.
It also includes $29 million towards hiring additional auditors to review electronic funds transfers and to increase the number of large business audit income tax teams to eight this fiscal year, and up to sixteen next fiscal year, targeting additional high-risk taxpayers, including multinationals.
We are also requesting $1.9 million for the expansion of business intelligence activities.
Funding is also being sought for one-time costs associated with establishing processes in response to legislative changes that have been made to the timing of recognition of gains and losses on derivatives.
The $43.9 million we are requesting represents the first of five years under the proposed 2017 Budget funding of $523 million to crack down on tax evasion and aggressive tax planning.
[Translation]
The second item for which the agency is seeking incremental funding is $1 million related to the government advertising campaign on the new Canada Caregiver Credit. The objectives of this campaign are to generate awareness of the new credit, which replaces the Caregiver Credit, Infirm Dependent Credit, and Family Caregiver Tax Credit, and to increase the number of eligible Canadians who claim it on their income tax return. The intention is also to promote the tax and the benefit related resources available on the Canada.ca website, which will include information on the Canada Caregiver Credit.
[English]
Also included in these supplementary estimates is a statutory increase of $7 million associated with adjustments to employee benefit plans for new salary funding being sought through these estimates. Following the approval of these supplementary estimates, the agency’s revised 2017-18 authorities will total $4.4 billion.
In summary, the resources sought through these estimates will allow the Canada Revenue Agency to continue to deliver on its mission to administer tax, benefits and related programs to ensure compliance on behalf of the governments across Canada. It will also make it easier for the vast majority of taxpayers who want to pay their taxes and more difficult for the small minority who do not, as well as ensuring that Canadians have ready access to the information they need about taxes and benefits.
[Translation]
Mr. Chair, we will be pleased to respond to any questions that members of the committee may have. Thank you.
The Chair: Thank you very much, Ms. Caron.
[English]
Senator Eaton: Thank you both for being here. I have two questions. The Auditor General was less than flattering last week. When we had our hearings in the Maritimes, several people and small businesses brought up the fact that you were very difficult to get hold of, and very often they got the wrong answers.
I think the Auditor General said only 36 per cent of calls are answered. The agency also found that the claims had an error rate of 6.5 per cent, but the AG found an error rate of nearly 30 per cent.
Did I see any money in Supplementary Estimates (B) to correct this? After all, it’s very misleading if you’re a small business person and you get the wrong answer, or if you can’t get a hold of someone. You are a service agency, basically, aren’t you?
Ms. Caron: Thank you for your question. We are absolutely a service agency. We received the Auditor General’s report. We accept the recommendations, and we have developed a three-point action plan where we will invest in technology, we will invest in training, and we will also change our performance measures to improve the situation.
This year we also introduced additional resources to the call centres. Those resources are not part of what you’re asked to approve today in Supplementary Estimates (B). These were resources that we redirected from within the agency. Budget 2016 also provided $50 million of resources over four years last year. So some of the results will start to show as well.
The technology will allow us to redirect the calls in a more seamless way, allow us to redirect the calls to the specialists with regard to the questions at hand and also allow us to have the methodology to monitor the quality of the answers better, take action and provide focused training.
Senator Eaton: If Minister Morneau’s new tax measures do go into effect on January 1, 2018, I would imagine from the people we’ve heard across Canada that there’s a great deal of confusion with passive investment and various other things. I would get as many details as possible, because there’s great confusion out there as to how exactly they work.
My next question for you is that you’ve allotted money, $13 million, to increase the number of audits of high-risk large businesses. Could you give me some definition of what a high-risk large business looks like?
Ms. Caron: I’ll ask my colleague.
Ted Gallivan, Assistant Commissioner, International, Large Business and Investigations Branch, Canada Revenue Agency: First, our definition of a large business is $250 million Canadian in annual revenue.
Senator Eaton: But what does high-risk look like?
Mr. Gallivan: That’s the first tranche. We have an automated system that has more than 100 algorithms in terms of the schedules, the information taxpayers provide us, information from third parties like Dun and Bradstreet, our own research, intelligence from other parties. That all goes into this database, and then literally we risk rank the businesses across Canada. We then spend 400 hours in a deeper dive.
The challenge with the multinationals isn’t whether we are going to audit the multinationals or not, it’s what part. They often have 200 different legal entities, so we know from our work that the next 50 audits we don’t do, because we’re focused on the ones we choose to do as we see greater inconsistencies between the posted tax rate and the effective tax rate, between the information reported on the tax returns and the information we get from third parties. This year we’re also starting to get country-by-country reports from multinationals that show their worldwide activity. If we see a lot of aggressive transfer pricing taking place, that puts them up the risk radar to the extent that their effective tax rate is below the posted rate, to the extent that there is a lot of aggressive transfer pricing or that we notice certain trends. Fractioning of accounts receivable, basically selling off your accounts receivable to a non-arm’s-length party at a discount, can be a legitimate need for a business that’s cash strapped, but when it’s done for the purposes of minimizing a tax bill, that’s an issue. We would go horizontally to look at that.
I think once you’re big enough, the consequence of non-compliance becomes high risk. Then we look for indicators of the likelihood that non-compliance is taking place.
[Translation]
Senator Pratte: I want to come back to the Auditor General’s report because, Ms. Caron, in your presentation, you said it was important to ensure that Canadians have easy access to the information they need on taxes and benefits. I understand that the Canada Revenue Agency has accepted the recommendations and that a large part of the problem is the outdatedness of your telephone system. I would still like to understand the issue a bit better. I see in the Auditor General’s report that the issue of calls not reaching an agent has persisted for a few years. The Auditor General’s data goes back to 2012 and 2013, and the issue already existed. However, in 2014-15, an agent responded to 22 per cent of calls, 19 per cent the following year, and 32 per cent this fiscal year. In any case, the issue has persisted for several years. Why has it taken so long for you to take steps to address it?
Second, I am astonished by the examples of questions that have been provided in the Auditor General’s report. They may not necessarily be very complex questions. In some cases, the rate of inaccurate responses was over 80 per cent, which is frankly quite surprising. So there really is a major issue. Perhaps it is a training-related issue, and not simply a problem with the telephone system. Could you tell us about steps that could be taken, aside from replacing the telephone system, that would help resolve this issue?
Mr. Gallivan: For starters, I think that part of the issue was figuring out how we ended up in this situation as an agency. The electronic portal, which is very similar to banking systems, was an important issue. The agency felt that it would help reduce the number of telephone calls. With online services available every day, 24/7, we thought we would see a drop in call volume, which did not happen.
Second, we tried to clarify correspondence and reviewed all paper documents the agency sends to Canadians in order to clarify them, so that Canadians would no longer have to call us. That also failed to resolve the situation. So investments had to be made. The initial decision was to invest in technology that will be implemented in May 2018, but it took time to acquire that technology and then make it compatible with the agency’s other systems. So it took some time to acquire the new technology and implement it.
As my colleague mentioned, last year, we had a budget of $150 million over four years. This year, new votes were created. The strategy aims to reduce the call volume, improve the technology and disseminate information. I have not talked about the quality of responses provided by our agents, who are excellent. They are under pressure because they are torn between the need to take the time to respond to various calls and to handle as many calls as possible. So those are two problems facing us. With the new technology that will provide better call tracking, we expect to be able to ensure the accuracy of responses provided to Canadians.
Senator Pratte: Thank you for the answer. Given the expected evolution of technological changes for the upcoming tax returns, can the taxpayers who will call the Canada Revenue Agency in March and April expect to get better service or should we expect another year for the impact of the changes to be felt?
Mr. Gallivan: The agency will not wait for the new technology to be implemented to make improvements. It is planning to reinvest internally. We have noted an improvement over last year. We are committed to making improvements without waiting for the new technology to be implemented. However, the new technology will really make a significant difference for Canadians.
Senator Pratte: I would like to ask one last question to ensure I understand. With the new telephone system in place, when I call the agency, will I be told, for example, that I will have to wait 12 minutes — which would be very useful information? When will that technology be implemented?
Mr. Gallivan: I don’t have the exact date, but I did mention mid-June 2018. We certainly don’t want to make the situation worse. It is not the right time to try new technology while the tax season is in full swing. My colleague may have the exact date, but we will have to wait for the peak tax return period to pass before we implement the new technology.
Ms. Caron: Starting in April, one of the centres for businesses will be moved to the new platform and, later in the fiscal year, that will become the call centre for taxpayers. We are currently investing in agent training to ensure the quality of responses that will be provided.
[English]
Senator Neufeld: To follow up on those questions: When did you start looking at making the system better? Was it while the auditor was auditing; was it after the audit came through, which was a bit embarrassing; or was it way ahead of the auditor?
Ms. Caron: We started to discuss the need to improve the technology in our system — not the full platform modification but improve our system — so that we could have the technology to monitor the quality of the answers; it was so that we could have the technology to understand the reasons why taxpayers are calling and be able to respond better. Those discussions started as early as 2011 in terms of identifying what could be done.
At the same time, Shared Services Canada was also created and acknowledged the outdated nature of the telephony platform. That’s why that project became a bigger project. Now we’re a partner in that project.
Senator Neufeld: So in 2011 you identified that there was a problem. In 2017 an audit actually made it public, and you’re starting to do something about it. Why such a stretch?
Ms. Caron: We’d started doing something about it before 2017. We received additional funding through Budget 2016 to be able to increase the number of agents in the call centres. That year, in the Auditor General’s report, you see that the results are better. Before that year, Canadians, I think, took probably seven attempts before they could talk to an agent. That year, we were able to reduce it to 2.3 attempts. That was last fiscal year. We took action.
Those projects and the big platforms are quite complex. We want to make sure we plan carefully, so we don’t disrupt the services to Canadians.
Senator Neufeld: I also understand that the CRA has said they are investing $1 billion to fight tax evasion and tax avoidance. You have a number in here — $523 million. Is it just because there’s something else happening with the other $500 million?
Ms. Caron: The big picture is that, in Budget 2016, $444 million was provided for tax evasion and tax avoidance, with a further $523 million in Budget 2017. The sum of those is $1 billion.
Senator Neufeld: Okay, thank you for that.
Quite a while ago my wife and I were on a holiday, and we went to Grand Cayman. It was the first and last time I was there. I was astounded that every Canadian bank that I knew of at the time had a huge office tower there. I don’t have the money that some people have to open an account, but it kind of shocked me.
Can you tell me why all Canadian banks, or all the major Canadian banks — maybe you don’t know why — have huge office buildings in Grand Cayman, which is known as a tax haven? Can you explain that to me, at least what your thoughts are on that?
Mr. Gallivan: Those jurisdictions would describe themselves as financial centres. Over time, legitimately, the stockbroking, the advice and the governance over those arrangements have certainly sprouted up.
There has been an issue with transparency. The G20 and G7, with Canada participating, have worked through the Global Forum, which is a body of the OECD that has worked on transparency. Transparency and low tax rates have attracted people to structure their affairs to maximize how much economic value could be attributed to those low-tax jurisdictions.
That one you mentioned in particular would be the combination of the tax rate and the transparency laws. There is increased pressure on those jurisdictions to share information. Starting in 2018, for example, the CRA will begin exchanging the worldwide banking information of all Canadians. Starting in 2018, we will have better line-of-sight on Canadian citizens who do what you just discussed, which is actually opening a bank account in these jurisdictions. That will permit us to decide whether we need to audit those Canadians.
We also have line of sight on the money movement back and forth. For any electronic funds transfer over $10,000, we receive a record of that every month. We are at the beginning of our process of learning how to mine that, but we have started to go jurisdiction by jurisdiction. We started with the Isle of Man. We’ve talked about Panama, Belize and other countries to look at every single transaction and say, “Okay, that’s not-for-profits, so we’re not so worried. That’s for multinationals, and we have another program. This individual over here — who are they and why are they moving so much money back and forth?”
I can’t really speak to the motivation of those particular institutions, but generally, it was the secrecy and the low tax rate that drove people there. Increasingly, we have the tools to pry that open and get a better line of sight on what’s going on.
Senator Neufeld: A good friend of mine posed a question a while ago about the banks in Canada using places like Grand Cayman, I assume. He didn’t really say that, but he said, “We’re able to reduce their corporate tax by a number of percentage points,” which for that particular bank would have meant that they would have had to pay about $4 billion in the first three quarters of the year to Canada. Do they actually run money through the Grand Caymans and back again to be able to lower their tax rate in Canada somehow in money management? I’ve never been around this, so I’m just asking for your expertise. You apparently know a fair amount about taxes.
Mr. Gallivan: I think it’s a matter of public record, through their financial statements, that the Canadian financial institutions are regular clients of the large and international branch of the CRA. You would see, in those financial statements, disclosures of hundreds of millions of dollars in either reserves or tax adjustments. Some of those cases are before the courts. In the recent Paradise Papers coverage, you would have seen one of the financial institutions with a $200 million dispute for one year. I think it’s true. Canadian financial institutions are very sophisticated, and they do pursue the acceptable limits of tax planning. We’re aware of that. With the submission you have in front of you today, it is to give us the horsepower to not only find the issues that we’re finding today but also increase the pressure so that we modify behaviour. When you look at these investments, there is the direct ROI, which varies from 6 to 1 to 10 to 1. But where we’re trying to be as an organization is to have a deterrent impact and to get coverage so that there’s a deterrent. In the financial sector in Canada, we traditionally have had one audit team assigned to those institutions. We are considering assigning two audit teams to some of those institutions. If the behaviour continues to be high risk, then we’ll assign a third team. As an agency, we’re trying to play at the level where we deter certain behaviour through our compliance work.
Senator Neufeld: When the Panama Papers came out, I think you folks said you had 123 audits under way. Was that prior to the release of that information or after?
Mr. Gallivan: We had a number of audits under way prior to the public release of that information. From international partners, from our paid informant program, from our own intelligence, we had a number of audits. Around the time of the Panama Papers, through exchange with our partners, we got very detailed information that let us jump to 123.
Senator Neufeld: How many would there have been to start with compared to the 123?
Mr. Gallivan: I wouldn’t want to mislead you, but there were dozens of audits and a few criminal investigations under way. So it was not a surprise that Panama was a jurisdiction with significant tax avoidance and, likely, evasion. Efforts are well under way. I don’t want to mislead you with a false answer, but there were a number under way.
Senator Neufeld: If you could provide to the clerk the number that were under way prior to the release of that information, that would be great. I appreciate that you don’t want to say it without knowing for sure.
Senator Marshall: Thank you for being here today.
I wanted to talk about privacy breaches. I have an article here from the summer that says that the CRA’s largest privacy breach happened in Western Canada. Have there been other privacy breaches?
Ms. Caron: We take the protection of taxpayer information very seriously. We have strong controls to prevent such situations, but, unfortunately, such situations do occur. If you give me a minute, I have brought a few statistics. Last calendar year, we had 162 breaches from security incidents; that number has been fairly stable over the years.
Senator Marshall: Would that be from exterior sources, or would that be with regard to your own internal people?
Ms. Caron: More likely our own internal people. Sometimes misplacing information, misplacing a briefcase perhaps.
Senator Marshall: Has there ever been anything from the outside? We hear that systems are being hacked. Has that been an issue for the agency?
Ms. Caron: I’m not a specialist in the IT security, but there were incidents — the name escapes me now — where the government systems were attacked by external hackers. We were very quick to react to close that gap.
Senator Marshall: Was your system accessed during that matter?
Ms. Caron: Very briefly, and we closed it immediately. But I’m not the expert on IT security, and I need to come back to you with more information.
Senator Marshall: In a case of a privacy breach, who gets informed? Is there a public press release, or are individual taxpayers whose files have been accessed informed? Could you comment on those two questions?
Ms. Caron: Absolutely. As soon as we have enough information to understand the circumstances and it is confirmed that it is a serious privacy breach, we inform the Privacy Commissioner. We give an informal acknowledgement, and then we follow up with formal information. We also inform the taxpayers, and we provide them with information in order for them to protect their information. We inform them of the situation. Then we do lessons learned and look at whether there is anything that we need to learn from the incident in particular.
Senator Marshall: If my tax file was accessed improperly, I would be notified?
Ms. Caron: Yes, you would.
Senator Marshall: Is Shared Services involved in your systems, or are your systems internal just to the Canada Revenue Agency?
Ms. Caron: Our systems operate in the larger platform that Shared Services Canada provides to all departments, and so they provide us services in terms of our mainframe systems, in terms of the external perimeter. They own our servers, for example, as well, so we work very much in partnership with Shared Services.
Senator Marshall: When you responded to a question from Senator Neufeld about new technology, this would be done in conjunction with Shared Services?
Ms. Caron: Absolutely, yes.
Senator Marshall: With regard to employees having unauthorized access to files, how are your systems set up? I would have thought that the system could be set up so that you could designate that this person, that person and that person could access certain files. Why is the system not set up so that it’s restricted to just certain employees for certain files?
Ms. Caron: I’m pleased to answer that. Starting April 1, 2017, we implemented a new system, called enterprise fraud management, that actually reads all of the transactions that our employees are performing on the system. To date, since April 1, 2 billion transactions have been read. We have embedded in that system indicators of risk with regard to unauthorized access.
If I were to look at my own information in the tax system, it would raise a flag, and it goes directly to our internal investigators in security, who would then do an investigation. That system is very robust. It’s amongst the best practices in tax administration.
Senator Marshall: So this is like an exception report?
Ms. Caron: It is an actual, real-life monitoring of situations, and it’s real-life flags that are identified.
Mr. Gallivan: That’s a fail-safe in addition to job-specific profiles that limit people’s access based on the nature of their duties. So there are definitely restrictions on what you could even try to do. Then the system that Janique has is such that, even within those narrow parameters, if you set a foot out of bounds, the new system detects it.
Senator Marshall: What is the Canada Revenue Agency doing about the calls that taxpayers are receiving from somebody who is impersonating Canada Revenue Agency? I’ve actually received a number of the calls myself. What are you doing in regard to that?
Ms. Caron: We have information on our website that provides pointers and guidance to taxpayers about how to identify those potentially fraudulent calls, and the way to address them is really to refer them to the RCMP. They have a specific line to receive those fraud cases, those fraudulent calls, and to investigate further.
Senator Marshall: The phone number actually comes up. It’s a 1-800 number. Is that something where people should take the number and give it to the police, or they take the number and report it to the Canada Revenue Agency?
Ms. Caron: To give it to the police is the instruction, but they can come to our website to find out what to do when they find themselves in that situation.
Senator Marshall: With the Disability Tax Credit for individuals who have been diagnosed with diabetes, I’m looking for the number of taxpayers who claimed the Disability Tax Credit for diabetes in 2016 and how many of those have now been informed that their tax credit has been cancelled. Would you have that information?
Mr. Gallivan: This is a very similar question to one posed by your colleagues in the House of Commons. Our response to them can also be provided to you. One of the reasons we don’t have it proactively is that our claims aren’t necessarily broken down by the nature of the disability. So people with responsibility for that program are going back to the files to manually compute the statistic.
Senator Marshall: It’s not coded?
Mr. Gallivan: We don’t break it down by the nature of —
Senator Marshall: By the nature of the disability?
Mr. Gallivan: With the specific case of diabetes, that isn’t a specific category that we have ready. So manual work is required to get that statistic.
Senator Marshall: Could you provide that? I wanted it for the 2016 calendar year, and then I wanted to know the number of taxpayers that applied in 2017 and how many of them got approved, how many were not approved and how many are still outstanding.
I have more questions.
The Chair: Second round, senator.
[Translation]
Senator Forest: Considering the setbacks with various computer systems, I assume that robust test beds will be implemented prior to the change planned during an initial phase at the business call centre. Right?
Ms. Caron: Absolutely. The planning of that transition is already well under way. Trainers are ready to provide training. We have planned tests for the platform’s functionality to ensure that the transition will go off without a hitch by April.
Mr. Gallivan: That is not a peak period for businesses. We are keeping our old online system in case of disaster.
Senator Forest: Was that platform developed after a call for tenders?
Ms. Caron: I don’t have the details of the process. Our colleagues from Shared Services Canada were in charge of the procurement process. The system has a proven track record. It’s the kind of platform that is used to support call centres. It is not something that is developed from scratch.
Senator Forest: In your presentation, you talked about $1.9 million for adjustments to business intelligence activities. Could you tell us a bit about the types of activities that will be developed that are not currently available?
Ms. Caron: Perhaps my colleague could add something further, but it’s a matter of being familiar with the information we currently have to help expand the research that will be done, data mining, in-depth data analysis and the segmenting of information. That will help us see whether we can understand the taxpayer’s data and come up with predictive models to enable a more targeted response. This has to do with collection. So that will be targeted by those who are collectors, who seek out client accounts.
Senator Forest: We have heard from over 130 witnesses on Minister Morneau’s tax reform project. The four main components of the reform are a major source of concern for Canadians. However, another source of deep concern was the agency’s interpretation criteria. The government would like the reform to be implemented on January 1, 2018. I assume that the agency has considered the issue from all angles and has already defined the interpretation criteria — for example, when it comes to income sharing, passive capital and intergenerational transfers. Can the agency let Canadians know what the interpretation criteria are?
Mr. Gallivan: Yes. The agency is working closely with the Department of Finance prior to public announcements to ensure that this kind of information is ready on the day it is announced.
In addition, when a major change is being made, we work with accounting firms and attend conferences to better educate and listen to stakeholders on the ground. It is not uncommon for changes to be made during this process. The agency has a lot of experience with processing and transition measures, as well as with the way to handle a file in transition.
Moreover, we want the test to be reasonable, and that is a test we already have. Our auditors are accountants, and applying this type of situation is part of their professional training. The work has already begun. We are sure that the information will be ready from day one, and we are open to working with the community during a transition period to ensure that everything is going well.
Senator Forest: A test by an accountant does not automatically demonstrate that it is “reasonable.” At this point, has the agency anticipated a certain amount of time to raise awareness and communicate information, in the case of the major accounting firms, among others? People are genuinely worried, and I would say that came across in the comments we heard from nearly every witness. In other words, they want to know what that “reasonability” test is going to look like. It’s a real concern.
Mr. Gallivan: The agency relies heavily on its relationships with such organizations as the Association de la planification fiscale et financière, in Quebec, and the Chartered Professional Accountants of Canada, in English-speaking Canada. We work closely with associations that represent tax professionals and lawyers. We are able to solicit their feedback on draft procedures and policies before they are finalized. I would say that the agency does not work on the matter alone, given that we have partnerships with organizations that represent accountants and lawyers, which play a part in the clarification process.
Senator Forest: Have you launched that consultation process yet?
Mr. Gallivan: I’m not sure. Given the secrecy around the budget, the external consultations may not have begun yet. At least a few accountants have signed confidentiality agreements; in terms of the Finance Department, then, some consultations may be taking place. At the agency level, though, I’m not sure whether we consulted prior to the budget decisions being finalized.
[English]
Senator Neufeld: I have a couple of quick questions. What’s your definition of a tax haven?
Mr. Gallivan: There’s a struggle with drawing a line, because I think some people would point to very large G7 countries and say those are tax havens because of the volume of transactions. So we go by risk, and for us the risk is either the dollar value back and forth, where you would see a country like the United States figuring fairly high, or the degree of lack of transparency, in which case the Cayman Islands and other jurisdictions you mentioned would be fairly high. So having the worldwide banking information and having the electronic funds transfer lets us go to where the money is. Sometimes that’s just the sheer volume, and sometimes it’s the sheer aggressivity.
Senator Neufeld: I was watching the news last night, and they talked about how the CRA is going to go out and review tax files by postal code. After you explained that you have all this equipment, you have people who tell you all kinds of things and you have ways of finding that out, help me a little bit: Do all the rich people in Canada live in these five or six different postal codes?What would drive you to use a postal code?
Mr. Gallivan: Sophisticated taxpayers understand how to arrange their affairs to avoid detection. They understand how we would risk assess their tax return, so they arrange their tax return so that it looks very vanilla to the tax authority.
They would understand that we would look at a jurisdiction like the Cayman Islands. They would never move their money from the Caymans Islands to Canada; they would send it from the Cayman Islands to Bolivia, from Bolivia to Hong Kong,Hong Kong to the U.S. and then bury it in the haystack of transactions from Canada to the U.S.
We have very sophisticated ways to identify taxpayers, but we’re sure we’re not perfect. By going to these neighbourhoods and going home by home, we’re able to say, “That taxpayer was on our radar. That taxpayer was on our radar. A company owns this house. What’s that company? Who is that really?”
For us it’s a way to test whether all these other measures I mentioned really are working. If they are, great. If they’re not, then it’s a learning opportunity for us to say that simply looking at electronic funds transfers, tax returns, and information from other partners and paid informants isn’t enough. There are still people who understand all of that and arrange their affairs to avoid detection.
Senator Neufeld: I’m still confused by the postal codes. I don’t know how many postal codes there are in Canada. There must be a tremendous number of postal codes. To pick six of them...
Unless, like I say, all the people cheating the system live in certain postal codes. Is that what we’re saying? That’s probably targeting some people we shouldn’t be targeting.
Mr. Gallivan: I understand your question better. I’ll try to reframe the answer.
The wealth management industry sees people with net worth above $50 million as their clients. At that price point, it becomes attractive to practise aggressive tax planning. We have had something for many years called the related party initiative where we seek to identify and have a standing brief on all Canadians who have an estimated net worth of about $50 million. Are we auditing them every year? No. But we’re trying to understand if they are aggressive or not, and whether we should audit them.
We’re moving that $50 million down. We might get to $30 million or $20 million. Those neighbourhoods where the average home price is $4 million or $5 million might suggest a net worth where it starts to become interesting to engage in aggressive tax planning. We want to understand who is doing so and whether our systems today are detecting those who are doing the aggressive tax planning.
Senator Neufeld: I’ll go by Vancouver. There are a lot of people in Vancouver who have lived in their homes for a long time, and those homes might be worth $4 million or $5 million today, or even $10 million today, but they sure weren’t worth that 30 years ago when those people purchased them. All of sudden, those people become a suspect in this, not through their own making.
Mr. Gallivan: I wouldn’t describe them as a suspect. I think we would have a responsibility in the neighbourhood where there are $5 million homes to look at the date the home was acquired, the age of the occupants, the residency of the occupants, whether they own a business, are they salaried employees, et cetera, to satisfy ourselves that, yes, that’s low-risk or high-risk.
One of the outcomes of this project might be to reassure Canadians that in neighbourhoods like that, 90 per cent of those taxpayers are relatively vanilla and happy beneficiaries of escalating real estate prices. But I think our responsibility is to check.
You’re right: The media portrayal that those people are suspects or have done something wrong is erroneous, and that isn’t something we’ve tried to feed. We’ve tried to feed the opposite, namely, that it’s a risk assessment, and it’s about us doing our due diligence.
Senator Neufeld: Thank you. Just talking about those measures you use alleviates my concern a certain amount. Thank you.
Senator Eaton: To follow up on Senator Forest’s point, the minister has not released final details of how these proposed tax loopholes will work. Certainly, all the small businesses we heard from in the Maritimes and in the West have no idea how the passive income thing will work or how the dividing of income will work. They’re really at a loss for details.
So if the minister hasn’t released those details, how will you be prepared on January 1 or 2 when your phones start ringing and the changes go into effect?
Mr. Gallivan: The CRA receives embargoed copies of proposed legislative changes prior to the budget every year.
Senator Eaton: Thank you. That’s a good answer. That answers my question.
I’d like to follow up on Senator Neufeld’s question about postal codes. Is there a country that collects taxes well? In other words, there’s not a huge gap between what they expect in revenue and what they actually get. I think our gap last year was $1.5 million. Is that correct? And Ontario’s was $2 billion? Is there somewhere we can take best practices from, or several countries we can take best practices from?
Mr. Gallivan: There are several countries we can take best practices from. There’s a group called the Forum on Tax Administration. It’s the tax commissioners from 56 countries worldwide, and we mentioned the OECD, which has about 37 members.
Canada is a member, vice-chair or leader of the committees in those bodies where we look at things from service to the underground economy to criminal investigations to multinationals, where we’re all trying to learn from each other.
Yes, there are countries that are farther ahead than us on measuring the tax gap, which is going to be much more than the $1 billion or $2 billion. The CRA has a tax gap estimate out on personal income tax. It’s $8.8 billion or $8.9 billion. There’s a GST number that’s higher. Once we get to corporations, it’s going to be in the billions. We in the CRA audit functions find $12 billion or $13 billion a year, so we know there’s a significant gap.
It’s an ongoing effort to learn from each other and to take best practices from other countries.
Countries tend to excel where they put their effort. If they make tax gap a priority, they tend to do well there. If they make multinationals a priority, they tend to do well there.
These supplementary estimates let us make progress on a number of fronts at the same time. We’re investing in the underground economy, we’re increasing the coverage of multinationals, and we’re going at people who have money in tax havens, all at the same time. Previously, we had to make choices and reduce funding in one.
Senator Eaton: The postal code idea — did that come up from a best-practice country?
Mr. Gallivan: Focusing on real estate value is a long-standing practice within the CRA. We’ve often looked at people’s real property and their declared income and selected them for audit. When news of the Vancouver real estate market and the Toronto real estate market becoming societal issues and not just tax issues started to flare up, the CRA started to expand its efforts there. We did so not because it had the largest ROI but because it was starting to become a societal issue, and we saw an opportunity to make a contribution to normalizing the situation.
In that real property focus in Vancouver, we started looking at hundreds of taxpayers all at once. We saw, first, a strong ROI coming out of that work, and second, we saw a strong deterrent message within the Lower Mainland around not paying your taxes on real estate.
It kind of grew out of that — to take it a step further and look more systematically at neighbourhoods across Canada.
Senator Marshall: Regarding the $29 million for the additional auditors, your speaking notes say it’s going to increase the number of tax teams to eight. How many were there initially? It’s going to increase it to eight, and then next year it’s going to increase it up to 16 teams. How many teams were there before we got the funding?
Mr. Gallivan: In those specific teams, you would be talking about 75. It varies year to year, and it varies on the composition. Again, it would be 50 or 75.
Senator Marshall: Teams? How many would be on a team? Two?
Mr. Gallivan: Correct — teams. Traditionally, we had five auditors on a large case-file team. You have to understand that with the complexity of multinationals, we have large-business auditors, international auditors and aggressive-tax-planning auditors. Each of those is a specialty. With a large multinational like the financial sector you mentioned, you can have 15 CRA auditors assigned to that one company.
Senator Marshall: When the Auditor General issued his report last week, it mentioned that staff who were answering the telephone gave incorrect answers in 30 per cent of the cases, I think.
What do you do in the case of these auditing teams? Do they come fully trained, or are they trained by the CRA so that you don’t have the same problem that you have with the people who answer the telephone?
Mr. Gallivan: Within that investment, the type of auditor who looks after a multinational typically has two decades of experience. So unlike the phone agents, they would be accountants with designations. They would have started with desk audits. They would have moved up to small and medium enterprises. We’ve tested them. They also need to have continuing education as part of their professional designations. The agency also provides additional training and education. We provide legal support, and so those teams often have a Justice Department counsel assigned.
As I mentioned, we actually have specialties between aggressive tax planning, international and large business. These are our most technically competent employees.
Senator Marshall: Thank you. My final question goes back to the Disability Tax Credit again. For individuals who now have their Disability Tax Credit cancelled, the diabetes group, what happens to their disability savings plans? There would be money in those plans both from grants and from bonds. I think the Senate Banking Committee did a study on that a couple of years ago.
Mr. Gallivan: The CRA is aware of that looming issue because of the year end. There’s always recourse available to people. So through the recourse, if they find a change in the decision, they could unwind that savings plan. I think right now the agency is trying to figure out what information we can give to the people who are in that situation. We’ve reconvened a consultative committee that existed, which provided us with advice and a sounding board of external experts. So we’ve reconvened that committee. That kind of conversation, what do we tell people who have these savings plans —
Senator Marshall: Who gets the money? Is there a possibility that the money could go back to government as opposed to the individuals?Because some of the money came from the government originally.
Mr. Gallivan: There is a provision under the legislation around how that would be unwound and what those steps are, but what I was trying to convey is that the agency is trying to think through that scenario so that it can give guidance to Canadians before the Canadians have to face it on their own.
Senator Marshall: That would be under your purview, the CRA’s purview, or is it another government department?
Mr. Gallivan: There is legislation that governs how these plans would be unwound; and what the agency has committed to do, given the number of people who are concerned about losing their benefits, is to think through the implication on the savings plan before January 1, before people start being impacted.
Senator Marshall: So no decision has been made?
Mr. Gallivan: We’re trying to figure out what the ramifications are under the legislation, and is that what needs to happen or not. I don’t want to commit the agency —
Senator Marshall: Do you know how much is in those plans now in total? I would think there would be millions and millions of dollars.
Mr. Gallivan: I think the amount in play would depend on how many beneficiaries have been denied their benefits.
Senator Marshall: Would you have that information? Could you add that to the list of information I’m looking for?
Mr. Gallivan: I can certainly commit to trying to get the information.
Senator Marshall: Or tell me who we should go to.
Mr. Gallivan: As part of the response, when we talked about how many people have received benefits and how many people have been denied benefits, we can also include any information available to us on the savings plan.
The Chair: Absolutely. Thank you.
[Translation]
Senator Pratte: I would like to pick up on the relationship between taxpayers and the agency. We were talking earlier about people who were unable to get a response from the agency or who were given the wrong information. I was curious as to whether you had looked into the accuracy of the information provided, the level of client satisfaction with the information available through the agency’s website or automated telephone system. I know the information provided by the automated system is accurate, but it is not always the information people are looking for. Have you done any analysis of those two response mechanisms?
Ms. Caron: The public opinion survey we conducted in 2016 revealed that 62 per cent of Canadians felt that our agents were competent and that 80 per cent had received the information they were looking for in their contact with the agency.
Senator Pratte: What does the 62 per cent represent?
Ms. Caron: I have the English documents.
[English]
Seventy-two per cent of Canadians rated CRA’s employees’ level of knowledge as high.
[Translation]
Respondents were of the view that our employees were knowledgeable about the topics discussed.
Senator Pratte: Do you plan to examine what happens to callers who aren’t able to reach a person when they call the agency? We are talking about a lot of people, after all. Actually, I don’t know —. Frankly, I have to tell you that, when I read the Auditor General’s report, I was not satisfied as to how many people were unable to reach someone. I was trying to get a handle on that. A good many taxpayers were unable either to reach an agent or to obtain information using the automated telephone system. These are taxpayers who never received the information they needed. What happened to those people? What did they do? You made no effort to determine whether they were lost in space. Perhaps they provided the wrong information, I don’t know.
Mr. Gallivan: We take it very seriously when taxpayers have to call the agency five or six times before they are able to speak with an agent. That means a lot of calls have gone unanswered. These are cases where multiple calls were made. Some people end up finding the information by looking on the website or calling an accountant. We did not conduct a survey on taxpayers who were unable to reach the agency. We do not have any data on that. That type of analysis will, however, be possible with the new technology we are implementing. As Ms. Caron indicated, a general population survey revealed that 62 per cent of respondents had confidence in the agency.
Senator Pratte: When you say general population survey, I assume you are referring to people who contacted the agency. Is that correct?
Ms. Caron: I do not have the details on how the survey was conducted, so I do not know whether the respondents had dealings with the agency. I would assume that would be one of the first questions in order to solicit their opinion on the services they received.
Senator Pratte: Can you forward us the information on the survey in question?
Ms. Caron: Yes.
Senator Pratte: Thank you.
Senator Forest: I have two questions along the same lines. When an agency like yours provides services to Canadians, its game plan should include criteria such as ease of contact and ease of navigation. That means contact with an agent or the agency’s website. Some 62 per cent of Canadians reported receiving accurate information, whereas 38 per cent indicated that that was not the case, so there is certainly room for improvement. Does your strategy or game plan to raise client satisfaction levels take into account the Web platform and telephone contact with an agent? Do you have specific targets for wait times, response accuracy and ease of website navigation?
Ms. Caron: It is clear that our efforts to improve call centre service are focused on wait times and response quality. Are we going to measure client satisfaction with our website? We may use a different process for that. Our website has a wealth of very important information. The options offered to callers sometimes direct them to the website for more detailed information.
Senator Forest: The government’s tax base relies on two main sources of revenue: personal and business income tax and GST revenue. What percentage of the overall tax base does each of those two revenue sources account for? Clearly, if the split is eighty-twenty, I imagine you concentrate 80 per cent of your time and energy on reducing loopholes related to the bigger portion. I am trying to get a sense of the scale of the revenues from personal and business income tax versus GST.
Mr. Gallivan: To answer your second question regarding how we focus our time and energy, I will tell you that it depends on the organization. In my division, individuals with high net worth and multinationals represent 40 per cent of our focus. To put it in everyday terms, the infamous 1 per cent, which is actually less than 1 per cent of the Canadian population, receives 40 per cent of our auditing attention. My colleague deals with the other 60 per cent, made up of 3.5 million businesses. I have 1,200 business clients.
Senator Forest: You have a personal relationship with them.
Mr. Gallivan: Yes, we have fairly high-level coverage. The determining factor for us tends to be the type of entity involved; how we divide our efforts is based on that. The long-standing nature of the Income Tax Act may afford more opportunities to be creative when it comes to compliance.
Ms. Caron: Revenue recognized by the agency on March 31, 2017 does not necessarily represent all government revenue. We collected a total of $242 billion, and, of that, $22 billion is from the GST. We also administer a provincial portion on behalf of the provinces, and that accounts for around $26 billion.
Senator Forest: Therefore, $220 billion is from income tax and $22 billion is from the GST.
Ms. Caron: That is correct. We also collect employment insurance premiums, which amount to another $22 billion.
Senator Forest: The $242 billion does not include that amount, then.
Ms. Caron: Yes, it does. It’s one of the revenue types we administer on behalf of the federal government.
Senator Forest: The $20 billion from the provinces is also part of that $242 billion, then.
Ms. Caron: The $20 billion from the provinces is part of a larger total of $402 billion, which represents all the revenues we administer on behalf of the federal government and the provinces and territories, as well as the employment insurance and Canada Pension Plan accounts.
Senator Forest: It would be useful if you could send us a breakdown of that $402 billion.
Ms. Caron: Absolutely, we can do that. It is in our financial statements, so we can easily make that information available.
Senator Forest: Thank you.
[English]
The Chair: With the indulgence of the other senators, I would like to pose one question. This is in consideration of your sophisticated equipment that you have to monitor income tax. My question is this: With hundreds of thousands of employees of the government not being paid, with the problem that we have with Phoenix, what amount of money would the impact be for the revenue of Canada vis-à-vis the employees who cannot pay their income tax?
Ms. Caron: We acknowledge that the public servants are affected by the Phoenix payroll errors, and it’s putting them in very stressful and difficult circumstances.
The Chair: That’s right.
Ms. Caron: The tax-filing season can be an additional stress for those employees, for sure. So the CRA is well equipped to handle the scenarios involved with overpayments or underpayments and the need for amended T4s to be processed. We have a role to play there after the initial filing.
Our processes to manage these situations have been in place for many years. We’ve processed 51,000 amended T4s as of November 2017 for the 2016 tax year, and we are ready to process all of them that will also be shared with us. We proactively complete the revised T1s as well for those individuals.
So the issue is less about the reduced revenues that the government would have but more about making sure that the public servants are well supported in that process.
The Chair: I agree absolutely because I have these questions everywhere I go in my province. What amount of money would that impact on?
Ms. Caron: I’m afraid I don’t have that information at hand.
The Chair: There is no doubt in my mind that your system could determine what would be the amount that it would impact on. If so, can you please send the information through the clerk?
Ms. Caron: We will look at whether that information is available.
The Chair: Ms. Caron, Mr. Gallivan, thank you very much for being here.
We now turn to another topic, the order of reference of the Senate of Canada on a study of the changes proposed by the Minister of Finance to the Income Tax Act.
We finished our public hearings on the road last week in Saint John, New Brunswick. However, since then we have had the PBO’s report that he published on the potential changes to the taxation of corporate passive investment income. We felt that an appearance from the Office of the Parliamentary Budget Officer was in order today.
Before I officially introduce the witnesses, I wish to thank Mr. Jean-Denis Fréchette, Parliamentary Budget Officer, and his colleagues for accepting our invitation and for the time of your response. When it was sent to you, approximately two minutes later you said yes.
With that said, as witnesses from the PBO we have Jean-Denis Fréchette, Parliamentary Budget Officer; Mostafa Askari, Deputy Parliamentary Budget Officer; and Govindadeva Bernier, Financial Analyst, Office of the Parliamentary Budget Officer.
I’ve been informed that Mr. Fréchette will give a few comments, and then we will move immediately to questions by the senators.
[Translation]
Mr. Fréchette, thank you again. The floor is yours.
Jean-Denis Fréchette, Parliamentary Budget Officer, Office of the Parliamentary Budget Officer: Thank you, Mr. Chair. The fact that the request came from this committee, as opposed to another, no doubt explains why I answered two minutes later. That said, I do not have written speaking notes, but we did send you a brief earlier today.
I would like to speak to you briefly about the table on page 7. In our analysis of private corporations, we estimated that 47,000, or 2.5 per cent, held 88 per cent of all passive investment income. These are large firms set up primarily for passive investments, with the highest share in finance, real estate and management industries. That is what you see in the table on page 7.
[English]
The outcomes, the results that we came with, are that, in terms of the annual federal revenue impact, it will be about $1 billion in the short term, that is, one to two years, and up $3 billion to $4 billion over the medium term. That is five to ten years. Those numbers are, right now, the only numbers you can use in your report because I am not aware of any other numbers evaluating the federal revenue impact so far.
[Translation]
On that note, Mr. Chair, I would be pleased to answer the senators’ questions.
[English]
Senator Marshall: I have a number of questions. I’m working from the report and not from this document. There are a lot of numbers there, and then the numbers are sort of moved around and presented in a different format. I just want to make sure that I understand what’s presented in the report.
I’m starting on page 10, and I’m going to work backwards. I have several questions, and the questions are confined primarily to the paragraph that says, “In the latter subsample, firms with investment income above $1 million earn almost half of all investment income.” What are the industries that predominate there? Are they the ones that are on page 14? I find I have to cross-reference. What are the industries that are mostly represented in that group? Is it the finance, the real estate and the management?
Mostafa Askari, Deputy Parliamentary Budget Officer, Office of the Parliamentary Budget Officer: Yes, that’s correct.
Senator Marshall: I understand that. So it represents 18 per cent of the CCPCs with investment income. So are we saying that the other 82 per cent have less than $50,000 in passive income?
Mr. Askari: Or no passive income.
Senator Marshall: Okay. Then, when you say that only 75 per cent of all taxable passive income earned would be above the threshold, is it the 75 per cent of all the taxable passive income, or is it 75 per cent of the 88 per cent?
Govindadeva Bernier, Financial Analyst, Office of the Parliamentary Budget Officer: It’s 75 per cent of all of the taxable passive investment income. Basically, there’s about $18 billion that was earned in 2014. Seventy-five per cent of that $18 billion, which is about $13 billion, is the income that’s above the $50,000 threshold.
Senator Marshall: On page 14, those three groups that dominate the passive income — the finance, the real estate and the management — what would be considered active income for them?
Mr. Askari: Some of them actually probably have no active income, especially the ones with management, sort of the title. Finance and insurance, obviously, have finance and insurance activities, which are their active income. Then we have rental and real estate. Again, those obviously may have active income in terms of renting properties or owning properties and selling properties, and that would be their activity.
Senator Marshall: But not much active income? That’s what I got from the report.
Mr. Askari: Those may have active income, but we don’t really know how much of that is active. In general, what we are looking at is that something like 60 per cent of all of the enterprises or firms don’t have any active income. Sorry, about 50 per cent don’t have any active income. They are set up for tax planning purposes, it seems.
Senator Marshall: That’s the impression I got for those three firms, that that’s what it was for.
I was kind of surprised. When you put a dollar value on the revenue that was anticipated to be collected by the federal government, I wasn’t surprised with the $1 billion, but I was really surprised at the $6 billion, how it increases. That $6 billion is an annual figure, isn’t it?
Mr. Askari: That’s the current dollar value when the system matures completely or we reach sort of a normal level of investment, because part of the investment portfolios of the firms are now grandfathered. So they’re not subject to the new tax changes. So by the time the firms accumulate new investment and new firms accumulate investment to reach a normal level, or what we call a steady-state level, then current dollars would be about $6 billion in revenue. That’s what we estimate.
Senator Marshall: What’s in that $6 billion? It would be the refundable dividend tax on hand that’s no longer refundable, correct?
Mr. Askari: That’s right.
Senator Marshall: It would be the tax now on the capital gain dividends, right?
Mr. Askari: That’s correct.
Senator Marshall: It would be on the passive income that’s over the $50,000 amount. Would it be the additional income taxes on the 33 percenters?
Mr. Bernier: What do you mean?
Senator Marshall: High-income people. I don’t think it’s in the report anywhere what’s in the $6 billion, and I’m just trying to get a handle on that.
Mr. Bernier: How we obtained this $6 billion figure was that we took the 2014 tax year data, which was the latest data available to us, and, as Mr. Askari mentioned, over time, eventually all of the grandfathered assets will have been depleted. What will remain is only new investments. So we made the assumption that if, in 2014, we were already in a steady state, where all the investment income that we witnessed was from new investment, if all that investment income was taxed under the new rules so that, as you mentioned, they wouldn’t be refundable, then that’s the additional tax revenues that would be generated. It does include both corporate income tax revenues and personal income tax revenues. We took 2017 tax parameters, so we took into account the 33 per cent tax bracket.
Senator Marshall: I just want to make sure. What’s in that $6 billion is not just one type of tax, right? It was the four that I mentioned, but have I got them all? What else is there, and are you able to break down the $6 billion by category?
Mr. Bernier: We could break it down. We haven’t done it so far, but it’s something that could be done. Basically, it’s all of the refundable part of the taxes that would no longer be refundable. It’s the additional personal income tax that would be paid on those dividends that would be paid out.
Senator Marshall: The capital gains?
Mr. Bernier: And the capital gains — right now half of it flows through tax free — which would now be taxed.
Senator Marshall: That’s three. Then there would be tax on the passive income over the $50,000?
Mr. Bernier: Yes. In each case, we set a $50,000 threshold per firm. So the first $50,000 of income was still under the old rules, and this tax revenue is not counted in the $6 billion.
Senator Marshall: It’s not?
Mr. Bernier: No. The $6 billion is really incremental revenues based on the new rules.
Senator Marshall: But you must have assumed that in future years some of those corporations are going to generate passive income in excess of $50,000 and estimated an amount of tax.
Mr. Bernier: Yes. We estimated with the actual investment income that was witnessed in 2014. We only applied the new rules to the amounts that were above $50,000. Obviously, there’s a downside risk here in the sense that, in 2014, these rules were not in place. So it’s possible that when these new rules come into place, maybe some of this income was actually capital gains. Maybe some of these corporation owners are going to realize these capital gains spread out on multiple years in order to stay under this $50,000 threshold. As we mentioned somewhere in the text, there are some possible behavioural effects, but we assume that, with the investment income that we witnessed in 2014, if new rules were in place on that income that was earned in 2014, then that’s how we ended up with the $6 billion figure.
Senator Marshall: For our study, I’m assuming it’s those four types of taxes. I just wanted to let you know that.
I noticed on page 4 that there are 580,000 CCPCs that aren’t categorized as to what category they fall into. Where would doctors be? We had a lot of representation from doctors. I’m trying to find where they are in the group. Are they all over the place? Are they professionals, or where are they?
Mr. Askari: We have a professional section that includes doctors, dentists and lawyers. In the middle of that table, you see the professionals, of which only 4.3 per cent will be affected by the tax changes. However, some of those professionals may actually incorporate under a different kind of code than a sector, so we may not know those. There might be some other doctors or dentists who have incorporated but who are not included in that group.
Also, among those 12,295 for whom we could not identify which sectors they belonged to, some of them could be doctors. In general, from the information that we have from the tax files, we see that only 3,674 professionals, which includes doctors, dentists, lawyers and other professionals, will be affected by the tax changes. These are the people who have investment income above the $50,000 threshold.
Senator Marshall: But one third of the CCPCs aren’t coded; we don’t know what category they fall into.
Senator Black: Thank you for being here. I find it quite difficult to extract any take-aways from the information you have provided. You’ve analyzed the data as presented to you, but, for me, it was perfectly exemplified by the last question of my colleague Senator Marshall when we talked about doctors. You and we all know intuitively that there are more than 3,371 doctors, dentists, lawyers and accountants who are utilizing these tax-planning vehicles. We don’t “know,” but we intuitively know. It seems that during this hearing, we’ve heard from more than 3,371 doctors.
So I would suggest that a lot of the doctors, lawyers, accountants, farm families and fisher families would fall into the management category you have described. That makes intuitive sense to me. Would you agree with that?
Mr. Askari: Perhaps, but again, we don’t know. Unfortunately, the tax files that they make — if they don’t identify themselves as to which sector and if the code is not there, we cannot say.
Senator Black: I completely understand. None of my comments should be taken as being critical. You’re dealing with the data as presented to you, but I don’t think the data tells much of a story here, other than potentially that $6 billion will be transferred to the Government of Canada from small business in Canada.
Mr. Askari: I wouldn’t necessarily call them small business. As we mentioned in our report, many of these corporations that will be affected are corporations that actually have more than $15 million of capital. So it’s not necessarily a small corporation.
Again, it’s very hard to say that; it’s not clear. These corporations are going from very small corner stores to very large ones, with significant amounts of capital. We have said that the number of corporations that will be affected because of the exemptions and the grandfathering the government has proposed will be only 47,000. Those are the ones that essentially have most of the passive investment income. It’s not clear that they’re necessarily small businesses. Small in what sense — in the sense of revenue or capital? We’re not sure about that.
Senator Black: But the essential take-away is that, given the state of the data at this moment in time and the moving goalposts, it’s very difficult to really take anything substantive from this report. Do you agree with that?
Mr. Askari: There are two things. First of all, the data is the tax data. That’s official tax data. There’s no other data you can rely on.
Senator Black: But the interpretation of that is not necessarily clear, as we’ve just agreed.
Mr. Askari: That’s correct.
Another issue is that we have done this based on some assumptions we have made that derive from the announcement of the government, not official legislation.
By the time the government announces the legislation and actually tables that, they may introduce other measures that would change these estimates completely. For example, regarding the $50,000 threshold, in our calculation we have assumed that every corporation will get that $50,000 threshold for the minimum income that would not be subject to tax. Presumably and realistically, when the government designs the legislation, they will make sure corporations cannot use that as a loophole to create many corporations. One person could incorporate 10 different times. Then, for each corporation, he or she would use the $50,000. Obviously, the government will do something to prevent that.
We haven’t done this. We assume every corporation will get that $50,000 exemption announced by the government. We don’t know exactly what the government will do in those cases.
Senator Black: Then we add another layer of assumptions and uncertainty to your report. I would suggest, with respect, that it’s an interesting read, it’s highly theoretical and we shouldn’t rely on it, particularly.
Mr. Askari: Rely on it in an official sense, probably not. The only reason we’re doing this kind of thing is to provide a framework for discussion and debate.
Senator Black: Thank you. I was looking for clarity, and I think you’ve provided that clarity.
Senator Neufeld: I believe I understand what you’re saying. When you say the revenue the government could get out of the legislation as it’s put forward now, we’re really not sure what’s going to come, but what people anticipate — the $1 billion, the $3 billion to $4 billion, or the $6 billion — is really assuming that everybody who is there now will actually carry on their business exactly the way they do today. I would suggest that if all of a sudden you’re going to get hit with a big tax bill, there might be a different approach to how you do your tax planning. Would you not agree?
Mr. Askari: We have actually mentioned that in our report, namely, that there is obviously a possibility of a behavioural change by corporations. Based on the literature and historical experience we could have gathered, we have assumed that probably about 10 to 15 per cent of that $6 billion is at risk of the behavioural change and the way that firms may decide to restructure and change their tax planning.
It could be bigger than that, but that’s sort of the assumption we have made.
Senator Neufeld: I’m going by your report, too, and when I look on page 2, where you have those numbers at the top — it does explain it a little bit further down. But when the media actually project this on the screen, that the government is going to get $1 billion to $6 billion if we just make these moves, that sounds pretty good, but it should be qualified with “that’s if everything stays exactly the same as it was in 2014,” which is where you derived your numbers from.
That’s a bit of a problem, to me. I’m not faulting you; I’m just saying that numbers are numbers, and when Fred and Martha sit at their kitchen table and hear “up to $6 billion coming from those wealthy individuals,” they say, “Good on them,” but they don’t realize what the ramifications will be. Would you agree with me?
Mr. Askari: I don’t want to repeat myself, but yes, you’re right: There will be behavioural changes, and some of these numbers may change over time — also, as we get actual legislation for these measures.
Senator Neufeld: These are averages across Canada. There is no breakdown for provinces, or rural to urban. There’s no breakdown for that at all, is there?
Mr. Askari: No. This is national.
Senator Neufeld: Actually, what came out — and Senator Marshall talked about it a bit — was the issue about doctors. It seems that professionals and doctors were mentioned by those in government, not by me, as not paying their fair share. I come from a rural part of Canada where we need doctors. We don’t need to chase them away. There might be lots of doctors in the city, I don’t know, that can be chased away, but there are not many in rural B.C., where I come from. So I was also surprised to see that “professionals” were such a small number. I guess they must be in the “missing” category. Would they be in the 581,000 “missing”? Could you explain “missing” to me again?
Mr. Askari: These are the ones who, when they file their taxes, there is a box they can identify which group they belong to, but it is not compulsory to provide that information. Some of them will leave that blank. If they leave that blank, then there is no information exactly as to which sector they belong to.
Those 12,500 or something are the ones who did not provide that information in their tax filing, so we have no way of knowing exactly what they are and whether they are holding companies, professionals or belong to any other sector.
Senator Neufeld: Have you found the definition of “passive” anywhere in the Income Tax Act?
Mr. Askari: “Passive income” is defined as income derived from the activities that are not the direct activities of the firm — the purpose of the company. For example, a doctor’s income is provided from seeing the patients or performing operations. Those kinds of things are active income, but if they invest the money they get in stocks, bonds or in any other real estate, that’s not active income; that’s passive income. The same thing for any other corporation.
Senator Neufeld: Thank you for that. Where is it in the Income Tax Act? Where is it described as you just described it in the Income Tax Act? Where is “passive” actually defined —absolute — and where?
Mr. Askari: That I don’t know, sir. I’m not a lawyer. I don’t know the Income Tax Act.
Senator Neufeld: Would you agree with me that it may not be?
Mr. Bernier: This income is taxed at a different rate. We use certain schedules from the T2 returns. The rate on the active business income is different from the rate on passive income. The active business income, if it’s the first $500,000 of a small business, is at 10.5 per cent. The remainder is at 15 per cent. Dividend portfolios, interest income, rental income or capital gains are all taxed at different rates, and they’re filed under different boxes on the tax return.
So I can’t give you exactly the articles in the law where it defines these types of income. We could always find them and send them to you eventually. But on the tax form, this income is specifically entered in boxes where those tax rates are different, so we can differentiate what is active business income from what is passive investment income.
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Senator Pratte: I would like to pick up on the “missing” category and the group of industries in question. If I understand correctly, then, of the 1.8 million CCPCs, we have no idea which sectors 580,000 of them belong to.
Mr. Askari: That’s right. We do not know.
Senator Pratte: In the case of about a third of these corporations, then, we have no idea who they are. I would like to know how you arrived at the conclusion that many of the firms are likely “corporations that are established solely for the purpose of earning passive income,” to use the words in your report. These are firms under NAICS code 55, in other words, the management of companies and enterprises category. Am I to understand that these firms have only passive income? Is that what you mean?
Mr. Bernier: Actually, our determination that these were corporations set up solely to earn passive income was not really based on the NAICS codes. Rather, it stems from the distribution of investment income by active income range.
As I mentioned in response to the previous senator’s question, we are able to determine a corporation’s active business income versus its passive investment income. What that means is that firms reporting no active business income earned 60 per cent of all passive income. That is equivalent to 107,000 corporations with investment income, but no active business income.
Senator Pratte: They have only investment income.
Mr. Bernier: Precisely, passive investments.
Senator Pratte: That means they are taxed only on passive income.
Mr. Bernier: Exactly. The source of that income is from another connected corporation, because connected corporations are able to transfer dividends between one another without paying tax on the dividends. The income was likely earned within an active business and then moved to a corporation that was set up solely to make these investments and earn investment income.
Senator Pratte: I am going to think for a moment about what kind of tax benefit that represents for corporations.
I would like to pick up on Senator Neufeld’s question about how you endeavoured to measure the potential impact —. You tried to estimate the elasticity in relation to the impact of these tax changes on government revenues. How did you arrive at that figure?
Mr. Bernier: As a basis, we used existing estimates in the available literature. Kevin Milligan and Michael Smart wrote an article on the subject in 2015. The Department of Finance also released a study in 2011, entitled Tax Expenditures and Evaluations 2010, in which it arrived at a specific figure for the elasticity of taxable income. We based it on the figures in the literature. We used an elasticity of 0.38, but we, ourselves, did not endeavour to measure what that elasticity would be. We relied on results in existing academic literature.
Senator Pratte: Without getting too detailed, I would like to know whether their estimates took into account previous tax increases.
Mr. Bernier: Yes. In fact, the Smart and Milligan study focused on changes in provincial tax rates. Since every province, except Quebec, has the same tax base as the federal government, they were able to do a provincial comparison of a tax rate change in one province versus no change in the others. They were able to measure how individuals responded to that tax change, focusing on the highest-income individuals — as did our analysis — because they are the ones in the highest taxable income ranges with the most passive investments.
Senator Pratte: You determined that it could reduce the government revenue estimates you provided initially by 10 per cent to 15 per cent.
Mr. Bernier: That is correct.
Senator Forest: I have two quick questions. I would like to get something straight. In your key findings, you indicate that 2.5 per cent, in other words, 47,072 firms, are affected, and that they hold 88 per cent of all passive investment income. Then, in parentheses, you state that 75 per cent of passive income is above the threshold. That does not mean, then, that all 47,000 corporations are above the threshold.
Mr. Bernier: No, in fact, it means that only 47,000 corporations earned more than $50,000 in passive income, and so, in all, they held 88 per cent of all passive investment income. Given that the proposed measures are not yet certain, it is assumed that each firm would be entitled to an exemption on their first $50,000 of passive investment income. Subtracting $50,000 some 47,000 times, we are left with 75 per cent of all passive income.
Essentially, we identified $18 billion in passive income in 2014, $16 billion of which is held by the 47,000 firms that earned more than $50,000 that year. If we subtract $50,000 for each of those firms, under the old rules, we are left with approximately $13 billion; in other words, 75 per cent of all passive income would be above the $50,000 threshold.
Senator Forest: Basically, it’s because of the $50,000 exemption; that’s the logic. We can assume that the exemption does not apply to those who make less.
Mr. Bernier: That’s correct. They would not be affected by the new rules since they earned less than $50,000.
Senator Forest: Okay. Actually, one aspect is that the passive income is generated through capital that is not related to the usual operations of the business. One of the comments we have heard regularly from young entrepreneurs and SMEs is that they need capital in order to renew their equipment, to provide operating funds, and because they do not have a pension plan, for example. So there are two concepts to passive income, which is the actual revenue generated by the capital, but, at the moment, they are not able to open up the capital in their businesses.
Clearly, when a company has no active income, only passive income, a yellow light comes on. For a business that has a mix of both passive and active income, I think it’s important to see how the needs can be measured by the type of business, whether in agriculture or new technologies. This information is very relevant in determining the fairness of the tax measure because, yes, I was blown away to see the potential revenue — and I mean “potential” — because when we look at all our businesses, 88 per cent, or the vast majority, of them are unable to open up their capital.
Mr. Bernier: Not with the data available, no.
Senator Forest: That is one of the major concerns raised in the comments we have received.
Mr. Askari: Perhaps the Department of Finance will consider the issue in the final version of the legislation, because you’re right that it’s a challenge.
Senator Forest: It is a major issue.
Mr. Askari: Yes, certainly.
Senator Forest: Thank you.
Senator Dagenais: At the outset, let me tell you that I don’t sit on this committee. This is my first time, but I find it very interesting.
We always say that the devil is in the details, but I will tell you a true story. In my neighborhood, there are two female doctors whose spouses stay at home because they are splitting their incomes. They are both in high demand in the United States because they would surely earn double their salary and could pay less tax. They told me that, with the tax reform, they will be tempted to leave Quebec.
That said, medical training is expensive, and it falls under provincial jurisdiction. The government tries to retain them, but when we talk about doctors, we are talking about a small group, and if a few doctors leave the regions, I do not think that will go over well. Are you not afraid that this will cause an exodus? People who have money are mobile, and when you have mobility, if you don’t like a tax measure, you move and go elsewhere. Does that not scare you a little?
Mr. Fréchette: That’s a good question. This committee has heard a lot of stories like that from across Canada in the testimony. As Parliamentary Budget Officer, our office does not necessarily deal with this issue. We look at a government policy proposal and try to estimate the costs for the parliamentary debate. I do not have a question for you because I cannot ask any, but it was interesting that, when we came up with our figures of $1 billion, $3 billion and $5 billion, the only comment from the Department of Finance was that our numbers were a little too high. We asked what too high meant. We did not get an answer.
As Mostafa said before, perhaps the department should provide that data if it thinks that our numbers are too high and that physician mobility may be affected. The department is responsible for providing this information to the committee. As I said at the beginning of my speech, you have the only document, whether it is good or not — and I think it is very good — informing you of the value of this policy.
That said, in the case of physicians — yes, I’m in an area where I know a lot of doctors — moving to the United States is certainly a possibility, and it’s very expensive to practise in the United States because of the insurance. People do not always calculate all the costs that come with an opportunity when they decide whether to stay here or to go elsewhere. But we do not provide that estimate. You are raising some good points, but unfortunately, you have not had a response from the department, I am sure.
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Senator Marshall: Just a couple of follow-up questions: This report just estimates the additional revenues that are going to be collected, and that’s it.
Mr. Fréchette: You’re correct.
Senator Marshall: When you look at the $6 billion — I said I was really surprised when I saw the $6 billion for an annual figure — if you divide that by the number of corporations that are going to be affected, the 47,000, you come up with an average figure of about $130,000 a year when the system matures. I just want to make sure that I’m reading the report correctly.
On average, each of those corporations that will be impacted will be impacted to the tune of $130,000 a year. Go back to my first question when I asked you whether you are able to break that down between the different components. This is the government’s tax proposal, but this proposal on passive income has many individual features, like the refundable dividend tax on hand. The government is not going to refund it anymore. That’s one.
Are you able to break it down so that we could see which one is the most financially beneficial to the government?
Mr. Bernier: We don’t have those numbers right now, but it’s something that we could definitely look into. We would be able to break it down, although there is maybe a problem with this breakdown. As we mentioned, a lot of people might reorganize their affairs or try to put money offshore, whatever, and the $6 billion revenue impact — because the aim of the proposal of Finance is so that an individual would be indifferent in the end, with the new rules, between investing through a CCPC or paying himself his profits in dividends, paying personal income tax on those dividends and then investing the remainder of this income through a personal account.
So, if the end result of these new rules is that corporation owners end up paying themselves all of their profits in dividends and then investing personally, for example, because, technically, the end result would be somewhat similar if Finance tailors this proposal properly, then most of that $6 billion is still going to be raised. But now it’s going through personal income tax revenues rather than through the refundable tax not being refundable anymore.
So we could do a profile based on the 2014 data and give you the number by each type, but, in the end, once it’s fully matured, we don’t know what the breakdown is going to be for real.
Senator Marshall: I know, but I’d still like to see the 2014 data broken down. Regardless of whether you generate that information and provide it to us, once the new rules come into place, taxpayers are going to start looking at other alternatives with regard to where they’re going to put their income and their investments.
I would really like to see it, because I think that would give me a better understanding of the revenues.
Mr. Bernier: I can tell you that I remember that almost half of all the taxable investment income witnessed in 2014 actually stemmed from capital gains. Since it’s only half of the capital gains that are taxable, it means that in 2014, about two thirds of all passive investment income, taxable or not, was from capital gains. So you can imagine that if we do that breakdown, I’m expecting that about almost half of that $6 billion would come from those capital dividends that were paid without tax paid on them.
Senator Marshall: Right, but I think if we had the breakdown, the Finance Committee could probably get an idea of where the government is going next for revenues. If you can generate it, I would really appreciate it. Thank you very much.
Mr. Fréchette: Your question is interesting. It makes me realize that there’s a lot of focus on the $6 billion, which is in 20 years. I did not mention it in my opening remarks. I understand the focus, though. Maybe we should not have included it in 20 years. The $1 billion should be the short and the medium term, and I think it should be the main focus, although I understand that the $6 billion now is important for this committee.
Senator Marshall: Could I comment on that?
The Chair: You absolutely can.
Senator Marshall: Yes, I’m looking at it because when the government announced the proposed tax measures, they put a dollar value on the income splitting. There was $250 million on the income splitting, but they didn’t put a figure on the passive income. Except Minister Morneau, when he did an interview with The Globe and Mail last fall when he released his proposals, the term he used was that it was going to be multiples of the $250 million.
That just made me and others suspicious. This kept coming up as a question. That’s why we focused on the dollar amount.
The Chair: To complete the second round, Senator Neufeld, please.
Senator Neufeld: I just have one question. When we talk about “missing” $580,950, I understand that, but just above that — and I meant to ask this before but it slipped my mind — there’s “other” for $518,400. What’s “other”?
Mr. Bernier: It’s basically all of the remaining sectors we didn’t break down. It’s not professionals, agricultural management, et cetera. There are a bunch of other sectors that we just bunched together.
Senator Neufeld: It could all be in “missing”; is that what you’re saving?
Mr. Bernier: No, it’s not missing. These actually filed a NAICS code in their returns, but it’s not one of the main ones that we show here.
Senator Neufeld: Okay, thank you.
The Chair: To the witnesses, Mr. Fréchette, Mr. Bernier and Mr. Askari, thank you very much for your information. No doubt it was a lot of information, especially when we look at the order of reference from the Senate of Canada.
If you feel that you want to add further comments as we proceed before we table our report, please feel free to do so.
With that, honourable senators, our next meeting is tomorrow night at 6:45 in room 9, Victoria Building. We will continue our examination of the Supplementary Estimates (B).
(The committee adjourned.)