Proceedings of the Standing Senate Committee on
National Finance
Issue No. 41 - Evidence - October 17, 2017 (Afternoon Meeting)
OTTAWA, Tuesday, October 17, 2017
The Standing Senate Committee on National Finance met this day at 2:16 p.m. to continue its study on the Minister of Finance’s proposed changes to the Income Tax Act respecting the taxation of private corporations and the tax planning strategies involved.
Senator Percy Mockler (Chair) in the chair.
[Translation]
The Chair: Honourable senators, welcome to this meeting of the Standing Senate Committee on National Finance.
[English]
My name is Percy Mockler, senator from New Brunswick and chair of the committee.
I wish to welcome all of those who are with us in the room and viewers across the country who may be watching on television or online.
[Translation]
As a reminder to those watching, the committee hearings are open to the public and available online at the Senate website at sencanada.ca.
[English]
Now I would like to ask the senators to introduce themselves, starting on my left.
Senator Oh: Victor Oh, Ontario.
[Translation]
Senator Pratte: André Pratte from Quebec.
Senator Forest: Éric Forest from the Gulf region in Quebec.
[English]
Senator Neufeld: Richard Neufeld, British Columbia.
Senator Marshall: Elizabeth Marshall, Newfoundland and Labrador.
[Translation]
Senator Eaton: Nicole Eaton from Ontario.
The Chair: Now I would like to recognize the clerk of the committee, Gaëtane Lemay, and our analyst, Sylvain Fleury, who team up to support the work of this committee.
[English]
Today, our committee continues its special study on the proposed changes to the Income Tax Act respecting the taxation of private corporations and the tax planning strategies involved, changes that the Minister of Finance proposed during the summer.
[Translation]
Today, we have with us two organizations from the province of Quebec. We are pleased to welcome Stéphane Forget, President and Chief Executive Officer of the Fédération des chambres de commerce du Québec, and Marc St-Roch, Accounting and Taxation Coordinator of the Union des producteurs agricoles, the UPA. Gentlemen, thank you for accepting our invitation to appear before our committee.
I would like to inform you that we will limit the presentations to 10 minutes each to allow senators to ask you questions and make their comments.
The clerk informs me that Mr. Forget will be the first to speak.
Stéphane Forget, President and Chief Executive Officer, Fédération des chambres de commerce du Québec: Thank you, Mr. Chair and senators.
[English]
Thank you for giving us this opportunity to present our remarks about this fiscal reform today.
[Translation]
Thank you as well for the opportunity to speak following what we believe was quite a short consultation, one that should definitely be extended and even expanded.
I would like to provide you with a brief overview of our extensive network of some 140 chambers of commerce and 1,150 corporate members. The Fédération des chambres de commerce du Québec represents 50,000 businesses operating in all business sectors across Quebec.
To begin with, I would like to hail the announcement the federal government made yesterday. The cut in the small business tax rate to 9 per cent for 2019 is good news and will give those businesses some leeway in carrying on their activities. The government is thus keeping an important election promise.
However, this cut cannot conceal the fact that the tax reform announced this past summer has created considerable uncertainty and discontent. In their original form, these tax changes have caused great concern among Quebec businesses and entrepreneurs. Rarely have we seen our entrepreneurs challenge anything so unanimously. I have been with the federation for three and a half years and have never had so many comments and calls from, or discussions with, entrepreneurs from small, medium, and large enterprises on a subject such as this.
The cuts have raised many questions among entrepreneurs and farmers, who are pillars of the economies in many of our regions. Although we agree with the principles of reducing tax avoidance and correcting the flaws in the tax system, the contemplated measures will have major consequences for private corporations. We feel that the reform, which essentially pits business owners against the middle class, is wrong. It creates a cleavage that does not exist, since the families of most entrepreneurs are an integral part of that middle class. Entrepreneurs are not workers in disguise, and the realities they experience are quite different. These tax changes risk undermining the growth of both SMEs and the largest corporations. We are afraid the reform will discourage initiative and investment, ultimately have an impact on job creation, and make it difficult to transfer businesses to the next generation and even to keep the headquarters of businesses of various sizes here in Canada.
We therefore submitted our brief to Minister Morneau two weeks ago — and I will also forward it to you — asking him to delay the tax changes announced in July. We highlighted the many concerns heard across Quebec and made four recommendations that I will present to you in a few moments.
First, we asked that the government continue to allow business owners to split income with family members and to avoid arbitrary analysis. Remember that many entrepreneurs draw on the contributions of all family members, including their spouses and working-age children. Extending to adults the tax on split income to which minors are subject attaches absolutely no value to the genuine contributions family members make to the creation, growth, and success of a family business. In many instances, entrepreneurs create their businesses using family assets as start-up capital. In addition to risking their assets, an entrepreneur’s family members make major sacrifices to ensure the business succeeds and, in many cases, actually work for it. The reforms appear not to acknowledge this fact or at least seem to question it in certain cases.
Second, we asked that the government continue to allow business owners to accumulate and invest earnings retained within the company. An entrepreneur uses that money to invest in growing the business and to provide cash in the event of a business downturn. We hope this continued measure will apply to all private corporations, not merely SMEs. Passive investments — the term used — also enable entrepreneurs to save money for retirement and to offset their lack of access to the social benefits provided to their own employees. Many of them feel they should not have to feel ashamed to do so. In our view, our tax system must acknowledge the importance of private family businesses, promote competitiveness, and support investment and job creation.
In a context in which long-term economic growth forecasts are more modest and the household saving rate is particularly troubling, we feel that a potential increase in the tax rate on passive investments from 50 per cent to 73 per cent, as many experts estimate, is counterproductive and unfair to business owners.
Third, in its proposed intergenerational business transfer measures, the government appears to have taken a step sideways yesterday to restrict access to the cumulative capital gains tax exemption. We believe the federal government must go beyond the status quo and draw on Quebec’s new model in this area. These tax measures must be consistent with those announced by the Quebec government earlier this year, measures that will help facilitate business succession and keep decision-making centres here, in many instances within a single family. We ask that the government refrain from implementing the planned reforms to access to the capital gains deduction to ensure consistency with the measures announced by the Quebec government, which will help facilitate intergenerational business transfer and keep decision-making centres here.
Lastly, when the government imposes such significant tax changes, a study must be conducted on the impact of this kind of reform because we genuinely feel these measures could alter entrepreneurs’ behaviour. We believe the government must therefore make good on another election promise it made in 2015, to provide a cost analysis for every regulatory proposal. For a reform this significant, it is right to conduct such study and to make it public. We fear the government at the very least underestimated the impact of its proposals this past summer.
In conclusion, there is a risk this reform may alter the behaviour of entrepreneurs, leading them to invest less in their businesses. As you know, a dollar that leaves is often a very quiet dollar. We must watch for that. Similarly, these measures cannot be analyzed without considering the recently announced U.S. tax reform currently under discussion in the United States.
At a time when businesses face the major challenges of technological change, labour shortages, and international competition, it is essential that we provide them with a business environment conducive to risk-taking and investment. The flaws should be fixed, but we should not undermine the competitiveness of our businesses or our economy. Furthermore, administrative and tax constraints must not sap confidence in our tax system. Business owners invest their own money, put their assets at risk, and accept full responsibility for the fate of their businesses seven days a week. In addition — and this is wise — they give thought to their succession.
The measures initially presented send an entirely different message, despite their initial objectives, which, I repeat, are laudable. The federal government must re-examine its proposals, which will hurt the growth, confidence, and prosperity of our businesses. Thank you very much.
The Chair: Thank you, Mr. Forget.
Marc St-Roch, Coordinator, Accounting and Taxation, Union des producteurs agricoles (UPA): Thank you, Mr. Chair. Senators, I represent the Union des producteurs agricoles. I am not a farmer but rather a permanent employee of the organization. Since I am its tax advisor, this file was assigned to me.
The Union des producteurs agricoles is a Quebec organization that represents nearly 41,000 farmers who work on approximately 29,000 farms.
The announcements the Minister of Finance made this summer have obviously raised serious concern among those businesses and farmers. We at the UPA examined all the proposed measures to determine which ones raised the greatest concerns for business operation so we could see whether farms were affected by the measures and where the problems lay.
Some 35 per cent of Quebec farms are incorporated, and 25 per cent of those businesses are operated as partnerships, groups of individuals who join forces to run their businesses. The remainder consists of individual businesses belonging directly to individuals. These measures do not directly affect them for the moment, but many were considering adding personnel to take over the business and moving to another structure, either incorporating or becoming partnerships. Consequently, the measures may have altered their plans for the continuation of their business.
The announced measures target three sectors, and one of the measures of concern to us involves the rules respecting income-splitting and addresses the question whether the sharing of business income among family members is indeed reasonable. This measure concerns incorporated businesses and partnerships. As I said a moment ago, more than 60 per cent of businesses are directly concerned by this measure.
As you know, farm operators live on the land on which their business is established. The major challenge these measures raise is to show that the operators’ involvement is reasonable based on the criteria the minister has announced. Since families still live on site, they are involved in a different way than they would be in a business that closes at 5 p.m. on a Friday and re-opens at 9 a.m. the following Monday, or in the case of businesses where people do not live on site. For example, a parent may ask a child to put away the tractor, drive it to the barn, and help with the chores. In many instances, all these hours of work and this family participation are not directly compensated. The number of hours worked is not calculated. However, that participation does not seem to be acknowledged in the measures the minister announced.
According to what was announced, those persons had to be involved, it had to be shown that they were reasonably involved in order to be entitled to share in the profits or dividends of the business. In our view, that measure is hard to reconcile with the reality of farms, both in Quebec and elsewhere in Canada. It is very hard to apply.
Another criterion is designed to distinguish between young adults 18 to 24 years of age and those 25 and over. The involvement criteria are increased for young adults who must be regularly, continuously, and significantly involved, whereas we know perfectly well that those young people may generally pursue their studies and thus do not spend all their time on the farm. They go home in the evenings and lend a hand. We therefore wonder why the importance of the work young people do is not recognized, even though they do not work full time. We feel these criteria are excessive and place an extra burden on farms. They are compliance measures that farmers oppose.
Employees mean paperwork, direct and indirect taxes, and so on. Now farmers would be required to monitor closely the work family members do in the business. This is too much. It is a problem. To measure children’s involvement, the government would want to know the amount of time spent and the amount of capital invested in the business.
To recognize children’s participation, the Income Tax Act contains tax measures for transfers of property and shares in farm businesses that enable parents to transfer those shares to their children on a tax-free basis so they can continue working in the business without having to disburse funds to acquire those shares. Now we are being told that, if there is no significant capital contribution, these rules may apply and the share of profit or dividends that could be allocated to the children will not be reasonable, even if the parents transfer 35 per cent, 40 per cent, or even 50 per cent of the business to them. How can capital contributions be re-evaluated when the children may not have disbursed any money but are entitled to 50 per cent of profits? This is all in the hands of the tax auditor who will determine the significance of that contribution.
People are concerned and do not understand how these rules will be implemented. In his announcement yesterday, Minister Morneau did not say the rules had been cancelled; on the contrary, he was talking about new rules. Family income-splitting will remain, and he has reviewed the criteria. The concern of farms and farmers has not disappeared. It continues and is real. In view of this entire situation and the reality of the farming world, people think that income from a farm business should not be subject to income-splitting rules. I am not talking about other income. In our view, farm income should not be subject to those rules.
The other problem is the capital gains exemption. Yesterday we learned that measures had been withdrawn. However, it is still unclear today whether all the measures respecting the multiplication of the capital gains exemption will be withdrawn. One of those measures, which is of particular concern to us, is designed not to recognize the accumulated increase in value until the age of 18 for the person receiving his or her property. In other words, the gain accumulated until the age of 18 would not grant entitlement to the capital gains exemption. We do not know whether this rule is part of the rule on the multiplication of the exemption, but it is a concern.
Some transfers are made between parents and children under the Income Tax Act. A capital gains deferral is allowed. Does this rule counteract what was allowed for the maintenance of farm businesses? We may receive more news this week, and we hope this capital gains measure is not retained as it stands.
We would obviously like the rules contained in the Income Tax Act to take precedence over those that have been announced and that the farm assets eligible for those transfers not be concerned by the measures announced as part of the reform legislation proposed in the summer.
We thought that aspects of the proposals concerning portfolios of passive investments held in private corporations were a concern for the farming world. The Canadian government has put in place farm income security measures, such as the AgriInvest program, which involve amounts invested by farmers and various orders of government. Those amounts are retained in the event of financial problems on the farm. Will they be considered as passive income by tax authorities? Could the rules that must be put in place apply to this type of investment, knowing that it is considered property income for the purposes of the act? We feel it is somewhat excessive that this aspect could apply, and we hope that all these income security programs, which enable farmers to establish a reserve fund in anticipation of hard times, are not subject to the new rules.
Some types of property are also temporarily leased. As you know, business on a farm may fluctuate. Someone may rent land for a period of time in anticipation of subsequently expanding a farm. That temporarily leased land should not be targeted by these measures.
There is also the case of property leased to a business with which a person is not dealing at arm’s length. Consider the example of an owner of an incorporated business who leases land to the company or to a child who is operating the farm. That rental income should not be subject to this type of taxation either. Cash is always necessary for a business and for reinvestment.
Consequently, as regards the passive income component, we feel that some aspects should not be included if the government decides to pursue this measure further.
Furthermore, the Quebec government has established rules to encourage the transfer of incorporated businesses, to enable vendors, people who are retiring, to claim the capital gains exemption. This is possible where the sale is made to non-family members, but not where the sale is made to family members. The Quebec government has made an effort by establishing criteria to enable vendors at least to claim their capital gains exemption as though they had sold to non-family members.
We recommend these rules be applied at the federal level as well. I know that Minister Morneau’s documents suggest this possibility. We believe it would be a good start for the government to base its approach on the rules proposed in Quebec. Those rules are well framed within Quebec legislation, and we think this may promote the transfer of businesses and their retention within families.
That completes our presentation on the points we wanted to make with regard to Minister Morneau’s proposal.
The Chair: Thank you very much, Mr. St-Roch.
Senator Eaton will ask the first question, followed by Senator Pratte and Senator Marshall.
[English]
Senator Eaton: Thank you very much for your testimony. Mr. Forget, in an article last month in the Montreal Gazette you wrote that the proposed tax plan has no equivalent in the industrial world.
I have read similar statements from tax experts, particularly in relation to passive investments. We heard Mr. Michel Coderre this morning talk about passive investments at great length.
Could you expand a bit? Are we the only country in the G7 or G8 that’s doing this?
[Translation]
Mr. Forget: First of all, I would say that, for some time now, Minister Morneau has frequently referred to the fact that we have the lowest tax rates in Canada and that the measure he announced yesterday will further contribute to that for small businesses. We do have a very low tax rate. However, as I mentioned earlier, the U.S. reform currently under way could have an impact. That is the first point.
The second point, regarding passive investments, is that there are jurisdictions in the United States, for example, where they are more tightly controlled. Their approach is slightly similar to that of the reform Mr. Morneau has proposed, but it is more targeted, according to the tax experts. Consequently, there are places where passive investments — this is the example I can give you — are somewhat more controlled. Generally speaking, however, they want businesses to accumulate those funds in order to invest more, to create new businesses, to diversify their investments, to provide for harder times, and to be able to retain their employees as well during those times. Consequently, our view is that, particularly in the case of passive investments, we would be one of the jurisdictions hardest hit from a tax standpoint if the government went ahead with these measures.
[English]
Senator Eaton: There has been a tone to the presentations on the closing of these tax loopholes which I don’t quite understand. The federal government itself has said it’s not going to bring in a lot of money. It’s going to bring in $250 million or $300 million, which is nothing in terms of our budget.
This morning I asked Mr. Michel Coderre to give us a range of income which would be considered middle class. He said $60,000 for an individual and perhaps $150,000 for a family or joint income.
Maybe I’m slow, but I have not yet understood how closing these particular loopholes will benefit that income bracket of people. Perhaps you see how they will benefit “the middle class.”
[Translation]
Mr. Forget: I share your opinion because I think it is a bad idea to talk about fairness by comparing an entrepreneur to a middle-class salaried employee. We can have fairness among classes, between entrepreneurs and salaried employees, but it is extremely difficult to establish comparable measures for them because, as I mentioned earlier, their situations are completely different.
[English]
Senator Eaton: Even if you’re talking about salaried people and entrepreneurs, we know that a lot of small businesses don’t make incomes much more than $60,000 or $100,000 a year. I don’t see the benefit of closing these loopholes. How is this going to help?
[Translation]
How will it help the entrepreneurs among us who earn only $60,000 or $100,000 a year? What will it change for them? What benefit will it give them?
Mr. Forget: It will not give them any benefits. As I said earlier, this is a reality, and I have never seen so many people talk about this. Many entrepreneurs say somewhat ironically, “I am a middle-class entrepreneur,” meaning an entrepreneur who is part of the middle class, precisely for the reasons you just stated.
The new low tax rate of 9 per cent announced yesterday essentially applies to businesses run by entrepreneurs who earn quite modest incomes. I agree with you. I believe there is a desire to correct the flaws of a system that some people might be abusing, not necessarily in a dishonest way, because no one stands outside the present tax system, even though some people perhaps should not benefit from it. However, in seeking to solve certain problems, the government is affecting all entrepreneurs, and many experts tell us that two or three of these measures will ultimately affect most Canadian private corporations.
Senator Eaton: That have quite moderate incomes.
Mr. Forget: Yes, and I do not think the government can provide more encouragement to entrepreneurs with assets to invest by massively taxing passive investments the way it wants to do it. Instead it risks triggering completely opposite behaviour, which we think would not be desirable for the economy.
Senator Eaton: Can the same be said for the agriculture sector?
Mr. St-Roch: Yes. The example cited from the minister’s documents referred to people who had incomes of $300,000 or more and who put legal structures in place to share income among family members who did not work. It showed that those people would save $40,000 to $50,000 a year in tax as a result of those structures.
You do not see these types of structures in farming, but now we are wondering whether it is reasonable to pay a salary of $15,000 to $20,000 to a child who has worked during the summer and a little in the winter but who, at 19, will unfortunately have to pay a 53.3 per cent tax in Quebec. We are not talking about huge incomes here; we are talking about farming incomes. In spite of everything, these rules would apply to the sector because no ceiling has been set. The rules would apply to any type of business. Consequently, you can see the impact that would have. We think it is excessive to target incomes in such a broad manner.
Senator Pratte: I have two questions. The first concerns passive income. The data the Department of Finance published yesterday on passive income indicate that 84 per cent of private corporations have no income from passive investments and that 1.6 per cent have more than $100,000. The government’s message has always been that it wants to make the corporations with the largest passive incomes pay. In its shoes, I would announce that we will limit ourselves to the corporations and individuals with the largest passive incomes. I would establish a threshold that would leave approximately 95 per cent to 97 per cent of businesses alone and apply the measure to the 1.6 per cent that make $100,000.
Mr. Forget, you said you wanted the passive investment reform abandoned for everyone, not just for SMEs. You are not in favour of a measure like the one I am referring to. Why not?
Mr. Forget: We have indeed heard the idea of a ceiling. Earlier I talked about entrepreneurs’ behaviour. Many of them told us that, from now on, given what is on the table, they will consider what trust they can place in our tax system and in their medium- and long-term business plan, and that they will have to speak with a tax expert to determine how to proceed in future with the investments they want to make, the transfer of a family business, and so on. The people who raise these arguments are the ones who have passive investments and who are among the small percentage you just referred to.
We are saying that, until a genuine economic impact study has been conducted on the proposed reform, it will be difficult to set a ceiling and to determine its impact and entrepreneurs’ behaviour once such a ceiling is established. That is why we do not advise setting a ceiling or focusing solely on SMEs but rather thinking about the largest businesses as well. There is an issue, and many people told us that. We want fairness. The competitiveness of a large private corporation must not be compromised relative to that of a public corporation operating under different tax rules. Given a set of these kinds of factors, tax experts tell us to watch out for the actual impact on entrepreneurs.
In the past few days, we have started to sense a concern about farmers. There may be a concern about women involved in income splitting. There may be another concern about the smallest businesses. However, it should not be forgotten that entrepreneurs in the biggest businesses work as hard and must be viewed the same way. If we are talking about fairness, it has to apply to everyone.
I do not know whether that clearly answers your question.
Senator Pratte: The reform’s objective is to focus on a class of people who use these investments not to invest, but as a pension fund or as a way of saving. There is nevertheless an objective to this reform that has clearly been poorly targeted, but I think one of the reform objectives is still valid. The problem is that it has been poorly targeted and is far too broad. A way of targeting has to be found. If you do not target the amount, you must find another way or else abandon it all. However, if you abandon it all, you will also abandon the valid objective.
Mr. Forget: We agree. However, can we determine the percentage of these people’s passive income that will theoretically be used to make investments, to expand, to buy equipment, and to make other acquisitions? What should be considered as a reasonable threshold? Is it $100,000 or $1 million? The only reasonable threshold may be lower for one entrepreneur than for another. So there is a concern.
You talk about targeting. Who did they want to target in this reform when they decided to correct the flaws? Was it entrepreneurs in general or a class of entrepreneurs? That is a valid question.
The minister is concerned that an increasing number of businesses are incorporating. A number of tax measures toward which governments are directing businesses, particularly in research and development, require that they be private corporations. It is hard to strike a balance. Going at it one case at a time, as we seem to be doing, may be having an unmeasured impact as we speak.
[English]
Senator Eaton: Talking about putting a “plancher” or a “plafond” on passive investments, I thought countries wanted to attract money for investment.
Would there not be a danger of money leaving the country? If you’re a big enough, fat enough corporation, you have good tax lawyers. If they see the penalties coming down, wouldn’t they find an excuse to take the money out of the country? Do you see capital flight because of this?
[Translation]
Mr. Forget: I do not have any tangible evidence, but that factor must be considered.
I am going to read two comments by one of the tax experts we work with, referring to passive income:
The government should generally promote saving and investment, not discourage them. Passive income is one of those measures. Second, the decision as to whether profits should be reinvested or distributed is a business matter.
The question is not that we should do it based on some tax measure or another. This is a business measure that a business adopts based on income that it has decided to save and invest over time. I believe this is what should guide the federal government’s thinking on this issue.
[English]
Senator Marshall: Thank you very much. My first question is a general one. Have your respective organizations responded to the tax proposals? I think the deadline was October 2. Would both of you have submitted a brief?
Mr. St-Roch: Yes, both the same as we present today to the committee.
Mr. Forget: I will send you a copy of our document.
Senator Marshall: We would like that. Thank you very much.
I want to ask a question with regard to income sprinkling. I know, Mr. St-Roch, that you commented on it in your opening remarks, but I was wondering, Mr. Forget, what kind of comments you heard from your members with regard to the income sprinkling and the reasonableness tests.
Some of the words being used are regular, continuous and substantial. There have been a number of commentaries with regard to whether people who are taking advantage of income sprinkling now will be able to under the new rules and how the Canada Revenue Agency will apply the rules.
Could you tell us what you’re hearing from your members and then, if Mr. St-Roch would like to add, I’d like to hear anything additional you would like to say.
[Translation]
Mr. Forget: I have two things to say. The first concerns recognition of the family’s role. We often talk about family businesses. This is not an overused term, but a reality. A family business means that the family makes a genuine contribution to the business. You mentioned this in the case of farming, but I think it is also true for many other types of family businesses.
Our members told us about recognition of the role of the family, which plays a very active role at certain times and another role at others, and about the recognition it should be given throughout the process and even at the end. When the decision is made to sell or close the business, particularly where a capital gain is realized, that will have a genuine impact on the owner’s spouse, depending on who owned the business. Thus, the first factor is recognition.
Second, the reasonableness test for entrepreneurs is utterly incomprehensible. How will we go about having a discussion with the Canada Revenue Agency to determine what is reasonable, the type of justification that will have to be provided, and what will be challenged? Because the reasonableness test will be very hard to apply in its initial form. However, they have been very silent to date. I would be curious to hear what the Canada Revenue Agency thinks about having to apply this kind of reasonableness test. We consider it vague, difficult to apply, and extremely easy to challenge. In regulatory matters, entrepreneurs find it complicated to have to invest time and money hiring tax experts to help them determine what is reasonable. It makes no sense.
[English]
Senator Marshall: The rules are obviously going to tighten. That’s the whole objective of the reform. The government is estimating that it will collect $250 million out of this.
When you are talking about the contribution of the family, it is the family unit. We did have Finance officials testify. My read of what the Finance officials testified here is that they weren’t very sympathetic to this concept of the family business. It was almost dismissed.
I know they won’t be the ones applying the rules and that it will be the Canada Revenue Agency making the decision, but that did raise concern by some of the members.
Mr. St-Roch, do you have any further comments with regard to the income sprinkling?
[Translation]
Mr. St-Roch: We met with Department of Finance representatives during the consultations and explained the same thing to them as we explained to you today. Their view was that this would not apply. They seemed quite candid about their understanding of the rules they were proposing. What is a concern is that the people who draft the legislation are not the ones who enforce it, and tax auditors currently have no directives. To give you some understanding of how they operate, they are required to enforce the act as it is drafted, and, in the absence of any judgment or decision indicating how these rules should be interpreted, things could be a mess.
What does all this add to the operation of a business when a family tries to show that one person actually worked 10.25 hours and took 30 minutes to drive the tractor to the bottom of the field, helped with the chores, and so on? In addition, these rules provide that the situation of one person must be compared with that of another with whom I am dealing at arm’s length. Is the salary I pay my child comparable to that of an employed labourer? Does that person understand the business in the same way as my child? How do I justify paying him or her $25 an hour and the other person $13 an hour? How far do the comparisons go? That is where it all falls apart. How do you value the capital shares of young people who have no money but to whom you have transferred shares to involve them in the business? Will the shares in the income of the business distributed to them be reasonable in view of the fact they have not invested any money? The situation is still very unclear with regard to these rules.
[English]
Senator Marshall: Thank you.
I also wanted to ask a question with regard to passive income because the material provided by the Department of Finance indicates that if you have a private corporation and you have passive income you will have a monetary advantage by keeping the money in that corporation and the individual doesn’t have that same benefit.
Some of the responses being received from some accounting tax experts and lawyers indicate that in some cases, actually, the reverse is true. What is being said is that the Department of Finance has only selected particular examples to support what they are putting forward. They are not providing all possible examples in that in some cases having a private corporation is actually not advantageous. It would be more advantageous if that money were taxed as an individual.
I’m trying to determine the validity of who is right: the Department of Finance or the tax experts. Has anything of that nature come to your attention with regard to any of your members?
[Translation]
Mr. St-Roch: No. Generally speaking, there is not a lot of surplus cash in the agriculture sector. Farmers use money to replace equipment, buy additional land, or repay debt because they are quite highly indebted. When they want to transfer their business to the next generation, they clean up the business’s finances to leave as little debt as possible to facilitate the transfer. Parents and children live from the income from the business. That was not a significant factor with respect to accumulated surpluses. The question was not raised.
If I invest money in the AgriInvest income security program to insure against hard times, will that investment be recognized as valid? If I have leased land to my child, will it still be recognized as valid and will it be subject to the rules the government wants to put in place? These are examples of the concerns raised because surpluses are uncommon in farming.
[English]
Senator Marshall: In your opening remarks I believe you indicated that in some instances some income would be taxed at 73 per cent. Am I not correct?
[Translation]
Mr. Forget: Yes, according to many tax experts, the July proposal withdraws the partial refund of the corporate tax. When an investment is made, a portion of the tax is withheld. Ultimately, when that money was paid out, the tax retained at source was refunded. We understand that this partial withdrawal would be abolished and that is what results in tax rates that could reach 73 per cent. That is what the tax experts in this area explained to us.
[English]
Senator Marshall: Thank you very much.
[Translation]
Senator Forest: Thank you for your testimony, which is very useful. A tax system must serve two important purposes: to fairly share the tax burden of natural and legal persons for collective services and to create a competitive tax environment in an increasingly global economic context. In the circumstances, we have work to do on the tax environment to create greater fairness.
The fact that 1.6 per cent of all Canadian businesses have more than 85 per cent of passive capital tells me something. Is this not a situation that we are entitled to question? For example — and this is the challenge — this morning, another witness suggested that we should set a threshold and, considering the nature of the business, define its needs for working capital, to renew its technological stock, or for retirement purposes. Mr. Forget, is that not an exercise that your organization has thought about and the purpose of which would be to establish guidelines? Because the fact of the matter is that 1.6 per cent of Canadian businesses hold more than 85 per cent of all passive assets in Canada. That is quite a significant fact.
Mr. Forget: The answer is yes, but first you have to examine the fabric of Canadian businesses. A large majority of our businesses are small and even very small. That is a challenge. We do not have many large and medium-size businesses. Do we want more? Do we want to interest more businesses in getting established and growing? Do we want more of them? We should hope more small businesses join forces to become larger ones and export more and create more value-added products. We are an exporting society because we do not have a choice. We must promote the idea of having larger businesses. Consequently, that being said, yes, a small number of larger private corporations hold this passive income, but, if the ultimate objective is to invest more for the long term, we will win as a society. That is why I am in a poor position to say what the ideal threshold is.
However, I can tell you that, if we do not conduct a genuine impact study on the measures that are being put forward — I can see, and I always say, that we are often a good barometer organization because we hear from entrepreneurs and a lot of thinking is currently being done that will change entrepreneurs’ behaviour. And yet the objective is to ensure that this large mass of money is re-invested in the economy. However, will this mass of money actually be invested in the economy? I do not know. We have to ask the question, and, before taking any action, we must conduct serious studies that guarantee that the money will not disappear or be invested otherwise or sold to foreign corporations.
This is a complex problem. The basic objectives are laudable, but I am afraid the results will be the opposite of what we want, and that will be tragic. Yes, a lot of small businesses have set aside small amounts of capital, but some medium-size and large ones have a lot, and they would probably like to make medium- and long-term investments and would prefer to do it themselves than through financial institutions. This is the business reality of entrepreneurs. Consequently, the premise should not be that entrepreneurs have set aside this money to save on taxes. We are starting the debate on the wrong foot by thinking they are doing it solely to save on taxes. In many instances, the entrepreneurs’ primary objective is to grow their business. That is the premise that should be put forward.
Senator Forest: We are talking about entrepreneurs, but we are talking about 98.4 per cent of entrepreneurs who have less than $100,000 in passive capital, and we don’t have any data on the remaining 1.6 per cent. We do not know how they use their capital.
Mr. Forget: However, we know that private investment has been constantly declining for years, particularly in Quebec. That should not be overlooked. We need more private investment. Businesses must be encouraged to invest more, not discouraged.
Senator Forest: Mr. St-Roch, I am greatly concerned about the next generation of farmers. We are in a tax environment that too often encourages agricultural entrepreneurs to sell their quotas and their machinery at auction and their land. Will this reform further accentuate this environment, which, instead of protecting agriculture, protects land that is often sold to large consortiums, which is unfortunate? Does that further exacerbate the succession problem of our farm businesses seeking to sustain agricultural activity on the land?
Mr. St-Roch: I would say yes because the announced measures merely cast uncertainty on the operation or sprinkling of family income from the business. Changes will obviously be made to the capital gains exemption, but, once again, this adds a burden, an additional tax, even in the case of a family transfer. In that instance, people felt that, at that cost, they would be paying more taxes on those transfers. In many cases, it is fine if they transfer their business to their children and there is no tax. However, when a tax burden is added to the fact that they have no money, because the children are not buying the property that is being transferred to them, the uncertainty thus created prevents them from proceeding with the transfer because of the risk that their children will be taxed at 53 per cent of the income since the capital they have been given is not a recognition of their involvement. They will not do it, and what will ultimately happen if they do not do it? They will lose their assets? We are taking the reasoning further, but this adds to the climate of uncertainty about the future. Positive changes may be made. We hope so, or at least clarifications to these rules, but we are not there for the moment. To answer your question, yes, this cannot help in the spirit of the business transfers at this time.
[English]
Senator Oh: Thank you, witnesses. You mentioned earlier that there were 41,000 farmers in Quebec.
Mr. St-Roch: Yes.
Senator Oh: We are looking at probably over 300,000 people that are directly involved with the farm business. With 41,000 farmers it would come out to over 300,000 people that are directly involved in the farming business.
Mr. St-Roch: Yes. You are talking about the employees, yes.
Senator Oh: You mentioned earlier their fear, that farmers are very worried about the tax reforms that are coming out.
Mr. St-Roch: Yes.
Senator Oh: If it is making it hard for farmers to save money on operating the farm, what about the next generation of younger farmers? We need younger farmers. If there is no incentive, who will farm? That will affect the country’s next generation of farming.
[Translation]
Mr. St-Roch: The problem is bigger than the tax issue. The income problems are significant, of course. We can see that today in the NAFTA negotiations, in which the Americans are taking a threatening approach to supply management and farm products. Consequently, the issue of having market incomes is becoming a problem in the context of the transfer of businesses to keep those businesses in operation. Obviously, however, if, in addition to that, you insert rules that may increase the family’s tax burden as a result of asset transfers, once again, you have just discouraged the continued operation of those farm businesses. People might think that it is less worthwhile to continue, that someone might be prepared to buy their land or quotas because they see no future in it, and that, by transferring their assets, they will be more in the negative than the positive.
Yes, these measures are not an incentive, and work must be done to open market access and protect agricultural markets.
Going back to the government’s efforts to provide income security programs, earlier I talked about the AgriInvest program, and there is also the AgriStability program. These are useful programs, and we wonder whether these statutory amendments will not also undermine these programs by imposing an additional tax. This raises various issues. All this is global, but it affects several aspects, and we need clarification.
There are technical rules, such as certain anti-avoidance sections that were mentioned in the proposal this summer, which also suggests a problem with the interpretation of the Income Tax Act, under section 246.1, for example, which seems to limit the possibility of making transfers to incorporated businesses. The minister advanced this without providing any examples. People therefore wonder whether they can transfer assets to their companies to maintain their operations. If that realizes a capital gain, they wonder whether they will be taxed twice. These are problems that have not been explained, but the government has enforced rules saying that people were violating them, but we do not know who or what.
Agricultural assets are commonly transferred to agricultural companies. Is this targeted or not. We do not know. The Minister of Finance should explain more clearly what he is targeting. You will consult the documents. We can find no examples of applications, but the government nevertheless clearly said it would target asset transfer transactions, and that is all it said. What does that mean? We do not know, and it will be retroactive to July 18, 2017. That is another factor that makes business development somewhat uncertain.
[English]
Senator Oh: Do you agree that this tax reform is not helping economic growth? Plus, now that we are having problems with NAFTA, is this going to make it worse for the agricultural sector?
[Translation]
Mr. St-Roch: That is a good question.
I would say that, apart from the bill, which creates uncertainty for farm businesses, those businesses are experiencing other uncertainties regarding potential markets and the dangers arising from Americans’ access to the Canadian market. This is already a concern, and now the government has set the cat among the pigeons by saying they are also going to look into the families to see whether their children are working enough to be entitled to their salaries of $15,000 or $20,000 a year. That is an additional issue, and we do not think it should apply to businesses.
Mr. Forget: I would like to add two comments to what was just said. A major demographic challenge is shaping up in Canada, and it is even bigger in Quebec.
According to the Business Development Bank of Canada, 30 per cent to 40 per cent of entrepreneurs will transfer, sell, or hand over their businesses to someone else in the next 10 years. Those are very large numbers. We will have to consider what kind of tax system we want to put in place so those businesses can continue to grow and stay in Canada. That is my first point.
I have already mentioned my second point, but I will repeat it for you because I think the way this reform was proposed will leave traces. I agree it is hard to put toothpaste back into the tube. However, we have to hope that the federal government can rectify the situation quickly because trust in the tax system is very important for Canadian entrepreneurs’ business decisions and for entrepreneurs who have an interest in investing in Canada. That fact should not be overlooked in the sequence of events that will start today.
[English]
Senator Marshall: I was listening to the response to Senator Oh and wondering where you think all this is going, then. I’m thinking specifically now about the comments you made about Quebec farmers.
You have NAFTA. You have these tax proposals, and you think about demographics. Earlier we were talking about the flight of capital. We know that the 33 per cent tax rate last year didn’t materialize in the revenues as they thought, so I don’t know if the 33 percenters are moving south.
Where do you think this is going? Do you think that this is just a bump that farmers will get over and adjust to? Or, do you think there will be some deeper impact with regard to these proposals because you have other factors mixed in with it like NAFTA, access to market, and things of that nature?
[Translation]
Mr. St-Roch: It is a bit difficult to predict the future. However, even if things change, businesses will remain profoundly familial. They operate in the same way they always have. At the family level, the informal relationship that exists in these businesses is threatened by these measures, since the government expects accountability for the way people work, the capital contribution to be invested, and so on.
If these proposals are maintained, I believe that will create another dynamic that might undermine people’s drive or motivation. They will wonder whether they can get paid properly, whether they have to talk to an accountant, whether they have to record all hours of work, and how much they would pay another person to do the same job. It is unproductive to do all that when you are working more in a group or family operating environment. This will harm all that if these measures are put in place.
It is hard to combine all this with international trade disputes, but I believe this adds to the pressure being put on farm businesses. There is already enough pressure associated with the need to be profitable. Consequently, if you also have to catch them out on compliance issues, the effect will simply be negative on the whole.
[English]
Senator Marshall: Mr. Forget, what about your members? I would suspect some of your members are farmers, are they?
[Translation]
Mr. Forget: Few of them. Essentially, our members are mainly large organizations such as Agropur and Coop fédérée, large groups of farmers.
Mr. St-Roch will correct me if I am wrong, but I understand that the value of farms, the assets, which is rising sharply, also requires a different type of tax organization. There are increasing numbers of incorporations, and increasing pressure in view of the value of farm assets. This is a comment that I heard at various meetings on this issue.
[English]
Senator Marshall: I guess the first step before you actually do anything is to start asking yourself some questions. Where am I going in the long term? Is this something that my children can make a living at? What do we see coming down the tubes?
People might think it’s probably better if their children follow some other course of action in life rather than to stay and look after the farm. It’s very interesting because there are pressures. It’s not just the tax proposals. The tax proposals might be the straw that broke the camel’s back, but there are other factors in the mix also.
[Translation]
Senator Pratte: Many questions have been asked since the reform project was presented, questions, for example, about the meaning of tax fairness. Many people discussed what “tax fairness” meant, and, as Senator Forest said, the main purpose of the tax system is to ensure fairness among taxpayers, but tax fairness is hard to define. Many people also emphasized the complex nature of the tax system. The reform project is very complex. With regard to these two questions, many people recommended a full review of the tax system. That has not been done at the federal level since the Carter commission some 50 years ago. The witnesses who appeared this morning were in favour of that exercise. What do you think about it? Once the case of this reform is settled this week, would it be a good idea to conduct an in-depth review? If so, what do you think should be reviewed?
Mr. St-Roch: I am going to cite an example from Quebec. A few years ago, a committee was struck to review all the measures in the Quebec system, which is similar to the federal system. It is not an exact copy, but many of its measures are identical. There were pages and pages of statements of existing measures. They conducted an evaluation to determine whether those measures still served their purpose as incentives, because, in many instances, tax measures serve as incentives for economic actions such as investment credits or accelerated spending for certain assets, and so on. At any event, a lot of work was done.
The Quebec government obviously “made its bed” on certain measures, and a bigger overall reform should have been conducted. I think certain elements produced results in Quebec. Since the federal system is similar, there are no doubt certain elements that could be reviewed in the federal system. The act is constructed in such a way that all the rules overlap. Mr. Morneau’s legislative proposals from the summer — I am going to cite the agricultural example — overlap other measures promoting transfers and undermine those measures by producing other effects. Consequently, we have wound up with tax measures that are not conducive to the same ends. I do not know; perhaps we did not think to look at the act as a whole to ascertain all the implications. The application of that measure undermined another measure that was already in place.
I think it would be a good exercise to review the act as a whole and to ensure all the measures align in the same direction because some provisions do undermine each other. We lose sight of certain objectives. This is obviously a lengthy exercise, but it might result in potentially beneficial recommendations and adjustments. It is good to examine our system from time to time, particularly if we want to use it to promote and improve the economy. This may not be what happens at times as a result of limits placed on businesses.
Mr. Forget: I agree with all that. As an organization, we have requested it in our pre-budget briefs to the federal government for some time now, particularly since Quebec’s Godbout commission on tax reform, which did a fairly exhaustive job. I think we have really come to that point. First of all, our tax system is complex, and, second, apart from the fairness issue, which is very important, does it serve the Canadian economy well? Four elements must be examined in all that. The first is tax competition among jurisdictions. We are in an increasingly open market, we have free trade agreements, and there is increasing labour mobility under these treaties. Consider the example of higher paid employees: the tax rate has just been increased to 53 per cent. Is tax competition among jurisdictions profitable for Canada? That is one of the aspects to be examined.
The second is tax expenditures. They conducted part of this exercise in Quebec and realized they were too often implementing tax measures without monitoring them or ultimately measuring to see whether they had achieved the desired results. I do not know whether we are better equipped to do this at the federal level. In the case of the Godbout commission, it was even suggested that sunset clauses should be established for tax measures based on the occasionally asked question whether they produced the desired results. We might be very surprised to see the number of extremely effective tax measures whose potential is limited by all kinds of constraints, or, conversely, we might focus more on other measures in place that serve few people and are not that useful. A great deal of work remains to be done on tax expenditures.
The third element is greater harmonization between the federal system and, in this instance, the Quebec system. How many tax experts and accountants tell us that it makes no sense not to have better harmonization between our two systems?
The final element, as many experts say, is what harms the economy most, and that is the corporate income tax, after the capital tax that was abolished in Canada years ago. Consequently, we should reflect on what is most beneficial for the Canadian economy. Should we look more closely at consumption taxes and reduce the corporate income tax and personal income tax? We need to think about the allocation between income and consumption taxes. There are at least four elements that should be analyzed as part of what we consider a more generally logical reform.
[English]
Senator Eaton: I would like to talk about passive investments in the agriculture sector.
I sat on Senator Percy Mockler’sAgricultural Committee for five years, and one thing we found out was that nowadays, the bigger the farm, the more fiscally productive it was in some ways. If Canadian farms in Quebec and across the country want to remain solvent, they tend to have to get bigger and more efficient. To do that, they have to buy equipment. There’s always the possibility of debt and of bad crops.
I don’t understand why the federal government is even looking at farmers in terms of trying to tax whatever passive investment they could have from one year to the next. I find that stunning when they live on the edge a lot of the time, all of the time.
[Translation]
Mr. St-Roch: In fact, I think that is somewhat related to our concern. Certainly, as I said earlier, there is not necessarily a lot of available capital in the agriculture sector. It is mainly reinvested, as you said, in the purchase of productive assets. That is why, when we looked at the measure from an agricultural standpoint, we were more concerned with certain types of assets acquired in the businesses and that, according to the documents, might be considered as passive income and be subject to extreme tax rates, as it were. Based on our understanding, yes, this is passive or potentially passive income, but, when you want to retire, for example, why would funds placed in the AgriInvest accounts to offset deficits or problems in the business be subject to such a high tax rate?
That is why we targeted certain investments we thought were essential to the operation of the businesses and that should not be subject to all this regulation of passive income. Apart from that, I think this may be the position of the businesses, other than in agriculture, that are still facing more the problem of capital that is not immediately reinvested in productive assets.
[English]
Senator Marshall: I think as I hear more testimony I have more questions.
We heard earlier that 20,000 private corporations have passive income greater than $100,000. Would you know how many of your members have passive income in that category?
It seems like the federal government is focusing in on those that have passive income over $100,000. Do you know how many of your members would fit that?
[Translation]
Mr. St-Roch: No, I do not have that information. We do not have the details. We know the types of production our members are engaged in and what type of business they have, whether they are incorporated or not. However, we do not ask what assets they have and we do not know their financial position. Based on my experience with many farm businesses, we may see this situation in a case where the farmer ceases operations, sells his assets, and has disposable capital. That person is generally no longer a farmer and is not part of our concern. Our concern focuses especially on farmers who are active in the field.
[English]
Senator Marshall: Mr. Forget, would you have any knowledge with regard to your members? Would you have that information?
[Translation]
Mr. Forget: I unfortunately do not have information on that subject. However, you have to think of all the entrepreneurs who aspire to obtain it in order to grow and expand. I am also thinking of those entrepreneurs. The objective should be to increase the percentage of businesses that have passive capital so they can subsequently invest it here. Do not forget that some entrepreneurs accumulate capital for their retirement because they have no other means to do so, or for other issues of that kind. You should also take that point into account in thinking about the available amount of passive capital.
[English]
Senator Marshall: We know there are 20,000 and we know it’s the $100,000, but it would be interesting to know other characteristics of that group.
[Translation]
Senator Forest: Yes, if we have 1.6 per cent, that is $26,800, and therefore more than $20,000. They have accumulated more than $100,000. The directives exist, but it is not determined how the rules should be enforced, which may be troubling. An executive from the Department of Finance appeared before our committee and said that a spouse’s decision to stay at home so the other spouse can devote himself or herself entirely to the business is still a personal one. Consequently, that person cannot be considered a partner in the development of that business. That raises problems in the absence of guidelines as to how the rules will apply. Between the spirit and the letter, there is often a fairly significant gap between the policy objectives and the technocratic application.
They say a picture is worth a thousand words. You referred to the contradictory tax provisions. I would like you to send us some examples of tax policies that contradict the net policy results. That would help clearly explain the inconsistencies of the tax system as a whole. That is more a request than a question.
The Chair: Gentlemen, can you send the information to the clerk?
Mr. Forget: Yes.
Mr. St-Roch: With pleasure.
The Chair: Mr. Forget, I listened closely to your comments about tax competition among various jurisdictions. My question is this: in your view, should the professionals who are creating economic uncertainty be subject to the same tax rules respecting income allocation as the other shareholders of Canadian-controlled private corporations? What is your opinion on that subject?
Mr. Forget: First of all, as an organization, we represent only businesses. I do not represent professionals as such. A few large offices of accounting firms are members of the federation. What I have often heard in recent weeks is that a distinction must be made between a professional and a person who takes risks, who invests in assets, who has a growing business, and who is subject to bankruptcy, as the case may be. You should think this way when talking about professionals in the various classes I just mentioned. We have examples of professionals who have incorporated and gone bankrupt. That is quite different from someone who is self-employed and incorporates.
The Chair: If I understood correctly, we should instead conduct a comprehensive study on the personal income tax and the corporate tax in order to make recommendations to the government even in competing jurisdictions?
Mr. Forget: I was answering Senator Pratte on the subject of a comprehensive tax reform. This should take into account the personal income tax and the corporate income tax and evaluate the tax competition on both the personal and corporate sides.
The Chair: Should we also examine what is being done internationally and temper it, particularly as regards the banks?
Mr. Forget: I do not have the specialized knowledge to answer your question. I apologize.
The Chair: Thank you for being here today, for giving us your opinions, and for answering our questions. We should be able to table our report before the Christmas break. In the meantime, if you have any comments to pass on to the committee, please feel free to do so through the clerk or the senators.
[English]
Thank you very much, witnesses.
Our next meeting will be tomorrow night at 6:45 in the same room.
(The committee adjourned.)