The Standing Senate Committee on
National Finance
Issue No. 42 - Evidence - October 24, 2017 (Afternoon Meeting)
OTTAWA, Tuesday, October 24, 2017
The Standing Senate Committee on National Finance met this day at 2:15 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.
As a reminder to those watching, the committee hearings are open to the public and available online on the Senate website at sencanada.ca.
At this point I would like to ask the senators to introduce themselves, starting on my left.
[Translation]
Senator Forest: Éric Forest, senator from the Gulf region in Quebec.
Senator Pratte: André Pratte from Quebec.
[English]
Senator Marshall: Elizabeth Marshall, Newfoundland and Labrador.
Senator Eaton: Nicky Eaton, Ontario.
[Translation]
The Chair: I would also like to mention the presence of the clerk of our committee, Ms. Gaëtane Lemay, as well as our two analysts, Mr. Sylvain Fleury and Mr. Alex Smith, who help the committee in its work.
[English]
To the witnesses, thank you for accepting our invitation. 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 of 2017.
This afternoon, we have before us some business-oriented organizations. We have two panels of witnesses for the senators, each of which will have 45 minutes, so time will certainly be of the essence.
Until 3 p.m., we will hear from and have a question period with the first group of panellists. I would ask the senators and the witnesses to keep their questions and answers short.
For the first panel, honourable senators, we are pleased to welcome, from the Conference for Advanced Life Underwriting, Warren Blatt, Chair, Government Relations Committee, Board Member; Paul Taylor, President and Chief Executive Officer of Mortgage Professionals Canada; from the Insurance Brokers Association of Canada, Peter Braid, Chief Executive Officer; and from the Investment Industry Association of Canada, Ian Russell, President and Chief Executive Officer.
I would now invite the witnesses to make their presentations, and I would ask, please, that you each limit your opening remarks to five minutes maximum. After your presentations the senators will be posing questions.
Mr. Blatt, the floor is yours.
Warren Blatt, Chair, Government Relations Committee, Board Member, Conference for Advanced Life Underwriting: In addition to being an independent financial adviser, I’m a board member for the Conference for Advanced Life Underwriting, otherwise know as CALU for short. CALU and our sister organization, Advocis, represent approximately 12,000 insurance and financial advisers who in turn provide financial advice to millions of Canadians across the country. We appreciate the opportunity to comment on the government’s tax proposals involving private corporations on behalf of our members and their clients.
Our written brief to the committee contains 14 recommendations. While announcements last week by the finance minister addressed our concerns relating to the conversion of income into capital gains, and we applaud the minister for this change, our recommendations concerning income sprinkling and passive investments still stand.
Moreover, we believe there is urgency to provide an exception to section 84.1 of the Income Tax Act in order to make it less punitive from a tax perspective to pass on an incorporated business to a family member. We encourage the government to follow through on its stated commitment to further examine this issue in the context of tax fairness.
Due to time limitations, I will speak to two of our recommendations relating to income sprinkling and then will briefly discuss the issue of intergenerational business transfers.
We continue to be of the view that spouses and common law partners should be excluded from the income sprinkling rules. We are concerned that the revised rules will not adequately deal with the issues raised in our brief, and that the scrutiny of dividends paid to spouses by the CRA will create a significant burden on business owners and the tax administration system as a whole.
With respect to income sprinkling for family members aged 18 to 24, CALU submits that instead of using the tax on split income rules the government extend the existing attribution rules set out in sections 74.1 to 74.5 of the Income Tax Act, in combination with an appropriate contribution test.
This is because under the tax on split income rules situations exist where split income would be taxed at a higher rate than if it had been earned directly by one person. That is, adult children would have their dividend income subjected to a tax at a higher rate, whereas it would be taxed at a lower rate if the parents had received the income directly.
Thus the proposed changes would not only remove the incentive to income split with family members but would also create an even more significant disincentive for those owners in the lower tax bracket to not include young adult children, in the ownership of the business operations.
This is particularly problematic for family-owned businesses and individuals wanting to formally include their children in the corporation in order to help facilitate the smooth transition of the business from one generation to the next.
On this latter point concerning intergenerational transfers of family businesses, we offer further comments contained in a separate brief on how an exception to section 84.1 could be provided to better accommodate such transfers. Any changes would still need to achieve tax fairness by protecting against abuses of any such accommodation.
It is important to remember in such discussions that it is no small issue for Canada. Due to our aging demographics, close to 75 per cent of current business owners plan to sell or exit their business in the next 10 years, and many will want to pass on their businesses to family members.
Unfortunately, existing tax rules can penalize owners who want to sell their business to family members since it is more expensive, from a tax perspective, to sell to a non-arm’s-length person than to a stranger. Accordingly, business owners are often faced with the difficult decision of selling business outside of the family in order to preserve more after-tax proceeds to fund their retirement, or to receive less money in order to pass their business to their children. We don’t think this is fair.
To address this, CALU proposes that section 84.1 be amended to permit the transfer of incorporated small businesses to the next generation of family owners on a more tax neutral basis. We believe this action will facilitate the successful transfer of family businesses and, in turn, protect local jobs generated by these companies.
We have provided detailed comments to the Minister of Finance, along with our recommendations on how the tax system can be protected from potential abuse.
We hope this committee can provide further impetus to the government in developing tax rules that will accommodate genuine intergenerational business transfers on a tax neutral basis.
I am pleased to respond to any questions you may have. CALU’s tax adviser, Kevin Wark behind me, is also here to answer any technical questions the committee may have.
I thank you for your time and attention, merci beaucoup.
Paul Taylor, President and Chief Executive Officer, Mortgage Professionals Canada: Thank you for the opportunity to be here today. I am joined by the chair of our board, Mr. Mark Kerzner, President of TMG the Mortgage Group.
Mortgage Professionals Canada is the national mortgage industry association representing 11,500 individuals and approximately 1,000 companies, including mortgage brokers, mortgage lenders, mortgage insurers and industry service providers. Our members make up the largest and most respected network of mortgage professionals in the country.
Since the tax change announcements and the beginning of the consultation period our members told us they were frustrated by the seemingly confrontational tone and general lack of clarity within the proposed changes. Our members support tax fairness but were disappointed with how the government characterized small businesses that use legal tax planning strategies as not paying their fair share.
We surveyed our members to determine what the proposed changes would mean to them. The results are a reliable representation of how our members expected to be impacted. Approximately 65 per cent of the respondents indicated that they were an incorporated business. Of those incorporated, then, 66 per cent said they would be negatively impacted if income sprinkling were disallowed.
The majority of those indicated that they would see their household tax bills increase between $10,000 and $25,000 per year. Almost 75 per cent of those incorporated respondents indicated they would be negatively impacted by the changes to passive investments, with the plurality estimating that this would reduce their net wealth at retirement by up to 30 per cent.
Finally, on the capital gains conversion provision, 53 per cent of our members who responded to this survey indicated they would have or were planning to use this mechanism in the future. We shared these results with the minister’s office in September.
We are encouraged by the recent announcements of the small business tax reduction, the announced amendments to the original proposed corporate tax changes, and specifically the adjustments that directly address some of the concerns we have raised.
We recommend that the government change the language used when communicating these changes. Our members appreciate that the government no longer suggests individual business owners are tax avoiders and is instead discussing how potentially unintended tax advantages may be unfair to some Canadians.
While we still have concerns with the income sprinkling provision, we are appreciative of the additional clarification that has been provided regarding what will be allowed and what will not. We recommend that the government clearly outline what family structures would be permissible under the new rules.
We are thankful for further clarity on the point. However, we are concerned that a reasonableness test may be interpreted differently by individual CRA agents during their reviews and anticipate some variation in the practical execution. These discrepancies in application create confusion and differing standards. As such, we caution the drafters of the final legislation to be specific and precise in their descriptions of what is acceptable.
We also applaud the decision to abandon the proposed changes to capital gains provisions. Additionally, the government listened and directly responded to concerns we raised regarding changes to passive investment.
Since most corporations already have contingency plans in place, we recommend that certain types of passive investments be permitted for business owners to plan for emergencies, retirement, parental or sick leave, or to weather an economic downturn. We are pleased to see the government agree with that recommendation.
The minister has made it clear that passive investments already in place and any investment made prior to the new rule’s implementation date will be grandfathered and not subject to the new tax, and that an allowance for passive investment with a threshold of $50,000 a year be permitted on a go-forward basis.
We had recommended that an indexed amount of no less than $1 million of passive investment be permitted to ensure that middle class business owners are not impacted. In discussion with our members and tax professionals, we arrived at this figure by estimating 12 months of operating and salary costs for small to mid-size businesses.
The government announcement of $50,000 a year equates to roughly $1 million in savings based on a nominal 5 per cent rate of return over 15 years. We feel that this is in line with our recommendation and can grow beyond the $1 million mark as the business ages and expands.
We do suggest, however, that the $50,000 limit be indexed or an equivalent RRSP adjustment be made to that limit on annual basis to ensure that the size and intent of this allowance is maintained over time. Similarly, we recommend that any unused portion of this allowable allotment be accrued for future years in the years it is not completely exhausted.
It’s clear the government has listened to the concerns of our members. We have been encouraged with our direct engagement with the minister’s office. I would like to credit the minister directly for listening to our concerns and recommendations.
That said, we remain concerned that the overall impact of these changes will still result in a net tax increase for a number of our members. We will continue to work constructively with the government as they move forward with these proposals to ensure our members are not unduly impacted.
We want to ensure that Canada is a place where entrepreneurship is encouraged and small businesses can continue to thrive.
I’m happy to take any questions.
The Chair: Thank you, Mr. Taylor. Now we will hear from Peter Braid.
Peter Braid, Chief Executive Officer, Insurance Brokers Association of Canada: I am very pleased to be here today to discuss the important elements of tax planning for small businesses.
As a former parliamentarian I know first hand the Senate’s excellent reputation for reviewing matters of importance to Canadians and making a difference with thoughtful study. I know that you will add valuable perspective and insight to this issue.
As the CEO of the Insurance Brokers Association of Canada, I am particularly pleased to represent the views of over 36,000 brokers, many of whom are small business owners and community builders in virtually every town and city across the country. I’m also pleased to be joined by my colleague, the President of IBAC and our board of directors, Mr. Scott Treasure, from Edmonton.
Since the government first proposed changes to the small business tax regime, our association has been active in voicing the concerns of small business brokers. We welcome the revised strategies announced last week. It is clear that public debate on this issue has made an impression as members of Parliament from all parties heard from their constituents that changes and further consultation were needed.
I am optimistic, as the details of the revised proposals become clearer, that we can make real progress. The planned reduction in the small business tax rate is a step in the right direction.
The government’s previously proposed tax changes immediately raised two concerns with our members. First, the elimination of the distinction between business and personal funds. The current small business and corporate structure in Canada support growth and employment and encourages entrepreneurship. Significant changes in this area should be undertaken cautiously to avoid the potential negative impacts on business activities and economic growth. As tax expert Jack Mintz recently stated in an op-ed in the Financial Post on October 19:
. . . Taxes can hurt the economy. They can discourage entrepreneurial effort, family succession, or investment in innovation. Complex provisions can also impose unwelcome compliance costs on taxpayers and burden the government with auditing demands.
Maintaining adequate liquidity in corporate holdings is essential to small business growth and economic stability. Business savings are an important factor for investment and expansion opportunities. They also provide a buffer to sustain business and employment during economic downturns and support the owner’s retirement planning when the business winds down or is sold.
No small business owner considers money held within a private corporation as their personal money until it is pulled out. For these reasons, federal tax policy should incentivize saving within private corporations as a driver of long-term growth and sustainability.
IBAC welcomes the government revised plan to allow passive investment income of $50,000 annually. This will go a long way to relieving the concerns of our members. It will, however, be important to see further details on this measure. The devil is in the details.
Let me turn to the importance of tax treatment that allows family businesses to be passed from generation to generation as we’ve heard from previous speakers as well.
Insurance brokerages are often family-run enterprises, and it’s not unusual to see a business go back several generations. That’s why brokers were very concerned about the proposed changes that could impact the ability to pass the family business to their children. Policies that potentially put the acquired family business at a competitive disadvantage are not in the public interest. It seems, from public announcements by the Minister of Finance more recently, that this issue will be resolved. We welcome this as a positive move.
In closing, the government has moved off their initial policy direction and signalled that they better understand how these issues affect small businesses in Canada. IBAC looks forward to seeing further details on the revised policy changes and to working together to ensure support for small businesses in our communities across the country. Merci.
The Chair: Next, from the Investment Industry Association of Canada, Mr. Ian Russell.
[Translation]
Ian Russell, President and Chief Executive Officer, Investment Industry Association of Canada: Mr. Chair, my name is Ian Russell and I am the Chief Executive Officer of the Investment Industry Association of Canada. With me today is Mr. Jason O’Halloran from S+C Partners, a tax advisor of the IIAC who will be fielding any specific questions on taxation.
We commend the committee for undertaking this study, and appreciate the invitation to appear before you today.
[English]
The IIAC represents 130 member firms in Canada’s securities industry. Our members are key intermediaries in carrying out wealth management services, securities trading and underwriting in public and private markets in Canada.
I will focus my remarks on the proposed tax treatment of passive investment income in private corporations and its negative impact on capital formation in the country.
At present, Canadian controlled private corporations based in Ontario, for example, pay an effective tax rate of 50.17 per cent. That is federal-provincial rate combined on passive investment income. The taxation rates in other provinces are similar. This tax rate includes a refundable portion of 30.67 per cent which gets refunded to the corporation when dividends are paid to individual shareholders. The goal of the current taxation rules is to ensure that individuals pay approximately the same rate of tax when the income is earned personally or through a CCCP.
Under existing tax law, CCCPs are more inherently likely to reinvest in other businesses. A withdrawal of these funds would be subject to taxation as dividends received by the shareholders at a rate of 39.34 per cent for eligible dividends and 45.4 per cent for non-eligible dividends.
Conversely, if the Canadian corporation is owned by a U.S. parent corporation, then similar intercompany dividend would only be subject to a 5 per cent withholding tax under the tax treaty. As such, a shareholder of a CCCP is motivated to reinvest these funds inside the corporation to avoid the relatively high cost, while a foreign-owned corporation does not have this cost and can easily access the capital for other purposes outside of Canada.
Under one option of new proposals the refundable portion of the tax, the 30.67 per cent, would not be refundable when income is paid out to the shareholder. This could result in the combined corporate and personal effective rate of over 70 per cent on passive income. Moreover, this tax regime applies only to Canadian private corporations, not to public corporations nor to foreign-owned private corporations, creating an unlevel playing field.
The proposals, if implemented, will have serious unintended consequences. While the latest changes improve some aspects of the original proposals, they do not address the fundamental problem of changing business behaviour.
Approximately $27 billion in passive income is earned through small business corporations annually. This income and the related assets, estimated at $200 billion to $300 billion, are put to use in a variety of ways in the Canadian economy. Corporate savings give businesses the resources to draw down during economic downturns; enable business to keep liquid assets on hand to purchase equipment, to invest in property, land or operations, or to expand operations requiring additional working capital.
It’s important to emphasize that passive income held by a private corporation is one of the most significant sources of capital for private equity and public venture companies in the country. The proposed tax changes will discourage Canadian entrepreneurs from taking on the risk of newer business adventures, constricting the already scare flow of capital to new and emerging enterprise.
The proposed corporate tax changes could not come at a more inopportune time for small businesses in the Canadian economy.
First, the flow of equity capital to small businesses collapsed in recent years, reflecting a weak and uncertain business climate and structural changes that have reduced investor participation in small business markets.
Second, despite buoyant growth in the first half of this year, economic momentum is likely to falter later this year, placing more importance on support of the small business sector.
Third, a strengthening U.S. economy boosted by the likelihood of tax reform will draw Canadian capital south of the border as well as reduce capital flows of U.S. venture funds to Canadian small business markets.
The Canadian economy needs steadily expanding capital to drive capital formation, innovation, job creation and economic growth. The tax proposals pertaining to the taxation of passive investment could mean Canadian business will have fewer resources to meet legitimate strategic business objectives in Canada.
The IIAC recommends the government take these proposals off the table. The taxation of passive investment income in privately held Canadian companies has been well understood for 40 years. It’s fair and it has worked effectively for a long period of time. The government’s proposals introduce unneeded complexity, serious unintended consequences, and a disincentive to business investment and entrepreneurship in Canada.
Since I believe it’s important that this committee understand the reaction and behaviour of small business to these proposed tax changes on passive income, I will let my colleague, Jason O’Halloran, take any questions in this area that the committee may have. Thank you.
The Chair: Before we move on, five senators have joined us, so I will ask them to introduce themselves, starting on my left.
Senator Black: Douglas Black, Alberta.
[Translation]
Senator Moncion: Lucie Moncion from Ontario.
[English]
Senator Andreychuk: Raynell Andreychuk, Saskatchewan.
Senator Neufeld: Richard Neufeld, British Columbia.
Senator Oh: Victor Oh, Ontario.
Senator Marshall: I have several general questions but I have some specifics for Mr. Russell because he was talking about passive income.
Could you tell us about your membership? You were saying you have 130 member firms. Are those firms providing services to other firms and individuals? Am I correct?
Mr. Russell: That’s right. Those firms would provide financial advice to retail or individual clients. They provide corporate advice, helping companies raise capital in the public or private markets. Those clients would be corporate clients. In regard to corporate clients, they would arrange underwriting of financing transactions and trade their securities.
Senator Marshall: How many corporations are there in total? You are talking about the 130 members, but that doesn’t really convey the breadth of the corporations that you touch.
Mr. Russell: It would include every large corporation in Canada, each of which would be a client of one of the 130 investment dealers. They act as an intermediary between investors and corporate clients.
The corporate clients would include all the large and all the mid-size companies in Canada that would be listed and traded on stock exchanges in Canada. Some are multi-listed in the U.S. and on the venture exchange. As well, a number of my firms would engage in financing private companies.
Senator Marshall: Those were the ones I would be interested in, the CCPC ones, because I’m trying to get a handle on it. You made your comments on the passive investment income, so I was wondering how big a group you are representing in the CCPCs.
Is it half a dozen or hundreds or thousands?
Mr. Russell: It would probably be in the magnitude of a relatively smaller number of private companies that would use an investment dealer. I can’t give you a precise number of them, but the reason this is important to my industry is not simply because it may represent a relatively smaller proportion of corporate clients. The fact is that small businesses have the potential to grow into publicly listed companies and into larger companies. That certainly is the bulk of the business my members would do.
Senator Marshall: The number you gave us was that there were $27 billion earned annually in passive income. Is that the right number?
Mr. Russell: That’s the figure that comes from the Department of Finance.
Senator Marshall: I am trying to get a handle on who has all the passive income. From items I’ve seen coming out from the Department of Finance, it seems like they are focusing on 29,000 Canadian-controlled private corporations. They think this is the group that has the majority of the passive income, so this is the group they’re targeting, but witnesses that we’re hearing from seem to like the $50,000 threshold the government recently announced.
My question to you is: What is your opinion of the $50,000 threshold? Does that look sufficient? Do you agree with the other witnesses we have been hearing from?
Mr. Russell: I guess it’s sufficient. It depends on what the context is. If it’s in terms of the number of companies that are affected by it, a lot of very small mom and pop businesses would benefit from that threshold. By the same token, a lot of thriving private Canadian corporations that generate income well above that level. That threshold would not be an alleviating factor for those successful businesses.
What we’re looking for is a tax regime that, in effect, will not penalize successful growing enterprise in Canada.
Senator Marshall: Are you saying that the $50,000 would probably exert pressure for it to stay small and not really look to becoming a bigger corporation?
Mr. Russell: It wouldn’t provide a benefit to the larger successful companies. It wouldn’t make any difference to those companies as an ameliorating measure. That’s really the point.
Senator Marshall: Mr. Blatt, of the 12,000 members of CALU, how many would be incorporated and would be CCPCs?
Mr. Blatt: I would say the majority. Probably over 70 per cent.
Senator Marshall: Do most of them take advantage of income sprinkling?
Mr. Blatt: To my knowledge and in my own business, my spouse has been a big part of my business. Every day I have a board meeting with her and she is involved. Yes, I do believe that they would.
Senator Marshall: Do you think that is across the board?
Mr. Blatt: Many are family businesses. They are legitimately families working in a business who happen to be husbands, wives or common-law partners.
Senator Marshall: Could you comment on the threshold for the passive income? I’ve just asked Mr. Russell about it. I have indicated that other witnesses seem to like that $50,000 threshold.
Could I get some reaction from you with regard to that dollar amount?
Mr. Blatt: I would have to get back to you, and I would look forward to it. This is our first collaborative meeting with the Senate Finance Committee. If you will allow me, I will definitely get back to you.
Senator Marshall: I would be interested in knowing that.
This is a comment rather than a question. I made a note as you were speaking. I think you referenced the capital gains plan. It says here that Minister Morneau was changing the third pillar or the third part of his tax proposal with regard to capital gains.
I want to make the point that it has not been scrapped. What he is saying is that he is just going to go back and take another look at it.
Mr. Braid, I have similar questions for you with regard to insurance brokers. You said you represented 36,000 brokers. How many of those are incorporated?
Mr. Braid: You are correct, 36,000 brokers across the country. Of those, over 2,000 are owned brokerages and the majority of those would be incorporated.
Senator Marshall: Would you have any idea as to how many would avail of income sprinkling? Is that an issue for your members?
Mr. Braid: I suspect that some would. Income sprinkling is not a significant issue for our association. As a result, we don’t have a particularly strong position on it.
I would suggest that on any changes made the “reasonable test” seems, on face value, reasonable to have. We would caution against additional red tape. Any insurance brokerage or small business owner wants to see less red tape as opposed to more red tape.
Senator Marshall: Have any of your members raised the issue of the subjectivity of the reasonableness tests?
Some of our witnesses are indicating that the Canada Revenue Agency is the one that will make the ultimate decision. Where it’s not in the rules in black and white, there is a lot of subjectivity to the reasonableness test.
Have you had any feedback from your members with regard to that issue?
Mr. Braid: Not any specific feedback, no. I would say as well that in many cases where family members are working for an insurance brokerage, these would be situations where the family members are actual employees. It would perhaps be more of a moot point for our association from that perspective.
Senator Marshall: The issue with regard to passive income where the minister has responded by putting this annual threshold of $50,000 in, is that something that is received favourably?
I know that the transitional rules haven’t been nailed down yet, but with regard to the threshold what has been the reaction or response of your members?
Mr. Braid: We were extremely concerned with the original proposals. The outlining of a threshold makes this much more acceptable and palatable from the perspective of an insurance broker association. If there needs to be a threshold, it seems sufficiently high. That said, it is important, as we look at any individual changes to the small business tax regimes, that they can’t be looked at in isolation.
With respect to passive income, any changes there or reductions to the small business tax rate, for example, need to be seen in the context of changes to taxes paid on dividends or to reductions in the dividend tax credit.
It’s important that we see the details and that we look at the broader context of these changes.
Senator Pratte: Mr. Blatt, discussed the intergenerational transfer in detail, but I would like you, sir, to elaborate more on it.
My understanding is that even before July 18 there were some problems with section 84.1 that made it more costly to transfer a company to your children than it was to transfer to a third party.
Would you elaborate on why this is so and why solving that problem is so complicated? We see in the consultation document that the government is aware of the problem and is asking for recommendations on how to solve it.
Apparently, it’s not easy to solve the problem.
Kevin Wark, Tax Advisor, Conference for Advanced Life Underwriting: The problem existed prior to the consultation period. In fact, a private member’s bill was introduced last year trying to address this issue. I believe it was narrowly defeated by the House. The issue was that when the lifetime capital gains exemption was introduced, it created an exemption today which is over $800,000 on the sale of qualifying shares in a small business corporation. The concern was that someone may use that exemption to transfer the business to a family member to qualify for the exemption while still retaining control and an operating management of that business.
As part of our pre-budget submission for the last three years, CALU has been asking for a review of section 84.1 to put in a very detailed submission relating to how we felt the rule could be revised to eliminate, to the greatest extent possible, the abuses that might arise.
The issue is: If you sell to an arm’s-length person, you can claim your capital gains exemption.
Senator Pratte: But you can’t if it’s a family-owned business.
Mr. Wark: If you sell it to a corporation controlled by a family member you can’t. There’s a significant difference in tax liability.
We’re proposing that the exception apply for transfers to children. Perhaps an age limitation could be put in place. Most of these transfers are done because the business owner is retiring. Maybe you put in an age limitation before the exemption can be accessed. Sometimes it’s illness. That could be a trigger to allow this.
You put in an anti-avoidance provision that says that if the person who transfers the business is still in control of the operation, either because of control of the shares or through other influences, the CRA can review that transaction and reverse the exemption being applied for.
We believe the tools are there to moderate it. Quebec has implemented legislation to do it, which is another model that can be looked at. We have some very bright people in finance. An exemption can be figured out that will work and can be put in place.
Senator Eaton: Mr. Russell, in your “Letter from the President”, you have written:
. . . Despite the well-intentioned objective to achieve tax fairness, these tax changes will constrict the flow of capital to new and emerging enterprises, . . .
In fact, you also argued that the fairness argument makes no sense in terms of passive investments since the shareholders have always been taxed on distributions of corporate income as if it was earned personally.
Canada always lags behind in productivity. I know the present government is trying to push innovation. What do you think these tax measures will do to innovation start-ups? Do you think it will get worse? Do you think it will level out?
Mr. Russell: I think it will get worse for two reasons. One is the argument that I made in the letter. First of all, whether or not these proposals go through, it has engendered a lot of uncertainty among Canadian business generally, but particularly among small and mid-size companies, especially the CCPCs that would be impacted by these tax changes.
If the proposal I elaborated on in my letter goes forward, which is the proposal that went into effect, the effective tax rate on passive investment that moved outside the corporation at 73 per cent, as others have mentioned, would clearly be a disincentive to the accumulation of passive investment. That passive investment, that $200 billion to $300 billion, is an important source of capital to private enterprise.
To the extent that you are placing a punitive tax on the dividends withdrawn from that passive investment, it would be a disincentive to building up the passive investment itself. The even bigger concern is that at some point in the life of a small privately controlled Canadian corporation, the owners will want to draw dividends out of those companies.
To the extent that the tax on the withdrawal of the dividend is so punitive relative to the risks taken in the business, it will provide a disincentive for the actual establishment of these small private corporations.
We had a regime for 40 years that achieved some important objectives. It encouraged the buildup of passive investment income. It taxed it a higher rate than the corporate tax. It was effectively a 50 per cent tax. Also there was a mechanism that meant a dividend earned from the earnings of that private corporation, as they were paid out, was essentially equivalent to an individual outside the corporation.
To achieve a tax fairness between someone earning a dividend outside a corporation and someone with a corporation paying himself a dividend through it, the tax system dealt with that. By imposing these tax changes on passive income, we have damaged an important mechanism for funding small business in Canada.
I know I am answering your question, senator, but my colleague Jason O’Halloran can elaborate if you wish.
Senator Eaton: No, thank you. You’ve given me some good things to think about. Just clear this up for me: My understanding is that the proposal on passive investments will result in much different tax treatment for private corporations than it does for public corporations.
Mr. Russell: That’s right. Public corporations are unaffected by these proposals for the tax on the dividend paid out.
Senator Eaton: Can you possibly imagine what the public policy rationale is for that? I think Mr. O’Halloran might want to speak.
Jason O’Halloran, Tax Advisor, Investment Industry Association of Canada: I will make it brief. I would be happy to discuss it in more detail afterward.
There is a fundamental question even on the $50,000 about where it is best to have an entrepreneur. From my perspective, and I think less from a tax perspective and how they roll out, the important part is that someone who lives here is more likely to invest in Canada. The capital is close to home. That’s where they live and that’s normally where they would bring their money back.
There are two concerns about passive income. One is that the tax rate will be so high it will be a discouraging investment in Canada if you are to take on risk with the business and you only have a down side. You would have an environment where an employee and a business owner both make the same income, but it doesn’t take into account the earlier part of their careers where they might have had to take on risk or put up their home as collateral for a mortgage to get money to invest in a business. It doesn’t take into account all the time they would have to put into the effort. It doesn’t take into account the family sacrifices they would have to make. It doesn’t take into account sick time, overtime and all the other stuff that is little intangible from this perspective.
If you make an environment where the tax rate is so high that there is no upside for taking on all this risk, why would you bother? We have a fundamental concern about the growth of entrepreneurship in Canada and redeployment of wealth.
I have another concern which is the primary reason Mr. Russell brought me to this presentation. If you have a different playing field for different companies, you have an environment where you can have a Canadian entrepreneur who has built up a successful business. It could even be in an environment where there are a limited number of companies affected by this tax change. The question becomes: If they are successful, the system is designed to leave money back in the company.
First, entrepreneurs based in Canada have a choice. Let’s say the number is $1 million, to use a number that is meaningful. You have a choice to reinvest in Canada or to pull it out and use it for other purposes. The existing treatment is: If you reinvest in an active business in Canada, you don’t have to pay any other tax. It would probably be the first choice of most business owners. They would be in a position where they would normally do it because they understand the investment. They’re investing in stuff they have control over. They’re likely to do that.
Second, there are not always opportunities to invest at the moment. Sometimes things take a bit of time. Sometimes you might wait. It might go into passive for a short time. It might go into redeployment in some other business venture. A lot of things go into the decision tree.
If they invested in the short term in passive income, even the ones that would qualify would be above the $50,000. The issue would be that they would get 50 per cent taxation on it regardless, the way it works. It’s a little more complicated than what it shows from a short presentation, but they pay taxes as an individual. There is no deferral on that, which I don’t think anybody has a problem with, other than that there are dollars involved.
The issue that American company would have is that they don’t have to keep the capital in Canada. They could take it out. They only have to pay $50,000, depending on the tax treatment.
The Chair: I will have to interrupt because of the time factor. I will ask the other four senators to be to the point, and I will ask the witnesses, if you want to respond, you can respond in writing. If you want to add additional information to any of the other questions that were posed earlier, please do it in writing to the clerk.
Senator Black: Gentlemen and colleagues, thank you for the tremendous panel. I have two short snappers that relate to policy questions.
My questions are very straightforward. One, what is the public interest being served or the business advantages to any of these proposals? I need to be convinced if there is any public policy reason or economic advantage for any of these suggestions.
Two, I’m interested in your comments on what this does to the competitive landscape between Canada and the United States.
The Chair: Please get back to us in writing.
Senator Black: I wouldn’t mind just a comment, if you will.
Mr. O’Halloran: I can answer and make it short.
Initially, for both foreign companies and Canadian companies the corporate tax rates are similar. In Ontario, it’s 26.5 per cent as the general rate or lower for a small business.
The issue will be that if you make the tax too punitive on the passive income and some of the other measures, it will turn into a branch economy, in my view, because there is not the incentive to leave the money back in Canada and reinvest with the proposed changes. With the way it is, there is incentive to reinvest, which is why there are $200 billion or $300 billion in passive assets.
Senator Andreychuk: This is a follow-up. I honestly didn’t talk to Senator Black before this. It’s public policy. The government introduced it saying it’s unfair the way it is now and that someone who is employed should have the same tax advantages or disadvantages as a small business.
That’s how it was originally sold, but as we’ve gone into this debate it’s very complex. You’re making a case that the fairness isn’t between the employee and someone who is self-employed. It’s between corporations.
Why did the government choose that? Did they explain to you that was their public policy? I understand when you start talking about corporations and U.S. branch offices. That makes sense if you want fairness, but they chose employees. Did they ever explain that to any of you? That’s one of the conundrums I have in trying to get to public policy.
Mr. Blatt: No is the straight answer. The thought process was never explained. Had it been, perhaps we would be in a different position to discuss different issues, but that was not our experience, have sat with the minister four times in his office.
Mr. Braid: I will add that it’s extremely important from a public policy perspective that governments create conditions for businesses, including small businesses in particular, to succeed. Small businesses create 75 per cent of the jobs in the country and philosophically there should be no concern about rewarding the risk that a small business owner takes on.
In terms of the broader macroeconomic context that Senator Black alluded to, it is really important to think of these changes in that context. We have potential tax reform in the U.S. that may or may not be achieved. That will mitigate, reduce or eliminate a competitive advantage that we have in Canada. We also quite clearly see that free trade or NAFTA negotiations are challenging, to say the least. I might suggest that we consider these changes in that broader economic context as well.
[Translation]
Senator Forest: Thank you for having travelled here to come to speak to us about your experience. I have a brief question about passive income. You say that it contributes to the investment of many small and medium businesses. In reality, when you look at the capitalization of passive income, 85 per cent of this income — which represents several billion dollars — is concentrated in 1.6 per cent of Canadian businesses. That concentration leads us to wonder if the $50,000 allowance threshold would have a positive impact on the majority of Canadian SMEs. Is that the case?
[English]
The Chair: On that question, could the four members of the panel follow up in writing to the clerk, please?
Senator Oh: My question is this: What will be the impact if the government proceeds without making any additional changes? And because of the impact of proposed changes on the capital market, will there be a flight of capital going out of the country?
The small business sector is probably one of the most important backbones of Canada’s business. Many successful businesses actually started from corner stores, basements, garages, and worked their way up to become big corporations today.
Would you comment on how the tax changes will affect Canadian families?
The Chair: To the witnesses again, I’ll have to interrupt because of the time frame of our committee.
Thank you very much for appearing. There is a possibility that we could call you back. Again, if you feel as we go forward that you want to add to the discussions and the study, please do not hesitate. We are looking forward to tabling the report before Christmas.
For the second panel we have the following witnesses: From BDO Canada, we have Rachel Gervais, Partner, GTA Group Tax Service Line Leader; from the Canadian Franchise Association, Ryan J. Eickmeier, Vice-President, Government Relations and Public Policy; and from the Canadian Home Builders’ Association, Eric DenOuden, President.
Thank you very much for accepting the invitation to come to the Senate of Canada. I ask each of you to make your presentation for five minutes each and then senators will commence questions.
Rachel Gervais, Partner, GTA Group Tax Service Line Leader, BDO Canada: Thank you for the opportunity provided to BDO Canada LLP today. I am a tax partner with BDO, the Tax Service Line Leader for the Greater Toronto Area, and I sit on our firm’s tax leadership board.
My practice, and BDO’s practice as a whole, focuses specifically on owners/managers in Canadian-controlled private corporations, many of which are small and medium size businesses. As the majority of our business focuses on this market, we believe we have unique insight into this important segment of the Canadian economy, the challenges they face, and the type of tax policies that we as a country need to properly support Canadian entrepreneurs.
Our firm formally responded to the July 18 proposed tax changes with a detailed submission on September 29, and a summarized version of that submission was sent to the clerk of this committee yesterday.
In light of the announcements made by the federal government last week, my time with you today is intended to summarize our firm’s remaining concerns about the proposals and announcements. Our primary concern, which has been echoed by many of the submissions in your meetings to date, is the need for a thorough and comprehensive tax review with all relevant stakeholders before the introduction of any new legislation.
There are three primary reasons for such a review. Canada’s tax system has not had a thorough review since the royal commission in 1966. Our tax code is overly complex and there seems to be widespread support for tax reform.
First, Canada needs tax reform to create a tax system that both helps Canadian businesses grow and thrive, while at the same time being fair to all Canadians. We have been and continue to be willing to work with the Canadian government, Canadian businesses and all relevant stakeholders in a thorough and comprehensive tax review.
With respect to the income sprinkling proposals in particular, we believe that proper analysis and recognition are needed to acknowledge how family members of a family business, both directly and indirectly, contribute to the growth and success of that business.
Family businesses involve all members of the family, not just the primary entrepreneur, where all contribute in different ways. Family businesses and entrepreneurs take risks and contribute to the growth of the Canadian economy in ways that salaried employees do not, including job creation. We believe the tax system should be designed to support these businesses in a manner that is fair to all Canadians.
Family business owners do not have safety nets to support them should their businesses fail and they often put family assets at risk, such as using the family home as collateral to guarantee business loans. We believe the tax system should recognize this. The proposals released and the announcements made last week do not appear to take into account the indirect contributions by family members.
Any necessary changes to tax policy should also provide for a reasonable transition period to the new rules to give Canadian business owners time to make consequential changes to their structures. Appropriate transition periods are a key part of ensuring that any necessary tax policy changes are made in a fair manner. In particular, the income sprinkling proposals are said to be effective January 1. However, due to the timing of the consultation process that follows until the enactment of changes, there is great uncertainty as to the actions that taxpayers should take before 2018.
Our second major concern is the need for simple and clear legislation. Simplification of the tax rules should be a key component of any changes to tax policy. Our firm believes the current proposals fail on this count. The wording of the draft legislation in respect of income splitting, in particular the TOSI rules, are very complex, very broad, and in many cases very difficult to interpret. It won’t be possible for small and medium size Canadian businesses to navigate these rules without tax specialists.
We also believe the reasonability tests that are being proposed will read to a great deal of uncertainty and disputes with the Canada Revenue Agency. That in turn will increase compliance costs for Canadian businesses.
Third, our last concern to raise with you today is with respect to the passive investment proposals. Last week the federal government announced it would move forward with measures but would exempt all past investments and income earned from those investments and provide an annual threshold of $50,000. That’s very welcome news but those approaches are still incredibly complex. Such measures will substantially increase tax compliance costs for private Canadian companies.
In closing, we’d like to highlight that we’re concerned about Canada’s competitiveness in light of these proposals. Competitive tax systems are fair, have efficiency in administration and low compliance costs. The U.K. has moved in this direction by simplifying its tax system and by reducing compliance costs. The U.S. intends to move in this direction as well.
We are not aware of any tax system in any other jurisdiction that applies reasonableness tests to dividends like have been proposed by our government. Canada’s recent proposals in recent enacted legislation is incredibly complex. The proposed solutions do not give consideration to the impact of the tax system as a whole and we feel will significantly increase administration and compliance costs.
It’s time for Canada to stand up for entrepreneurs and small and medium business owners and perform a comprehensive tax review that involves all stakeholders. Our firm strongly believe our tax system needs to be fair, simple and clear. We serve thousands of hardworking Canadian business owners, families and individuals who are true entrepreneurs and drivers of the Canadian economy. We welcome the opportunity to be part of such a study.
Thank you for hearing our views, and I look forward to answering your questions later.
Ryan J. Eickmeier, Vice-President, Government Relations and Public Policy, Canadian Franchise Association: I’m joined here today by our Chief Executive Officer and President Lorraine McLachlan.
I would like to thank the clerk and members of Standing Senate Committee on National Finance for the opportunity to appear today to speak about the franchise industry and our response to the proposed tax changes being studied.
The Canadian Franchise Association was founded in 1967 and for 50 years has promoted excellence in education to Canadians. To provide insights into the franchise sector in Canada, we’re a thriving community that spans over 50 sectors, from automotives, educational services and restaurants, to health, home improvement and renovation, to hotels, retail, senior services and virtually everything in between. In reality, any business model that be exactly replicated can be a franchise.
In total, there are over 1,300 franchise brands in Canada, with an estimated 78,000 individual locations. It is important to note that franchising is not all big business. In fact, the majority of businesses that make up our sector, both the franchisors and the franchisees, are small businesses that directly and indirectly employ over 1 million Canadians. In many ways, franchising has become the new mom and pop.
Over the previous four years we have seen growth in franchising in every region in Canada in the number of franchise brands that operate there. That includes a 9.2 per cent increase in Atlantic Canada, a 2.3 per cent increase in Central Canada, a 20.5 per cent increase in the Prairies, a 5.6 per cent increase in the West and a 6.1 per cent increase in the North.
While joining a franchise certainly provides many advantages of being part of an established, proven recognized branding system, it is not a golden ticket. The tens of thousands of Canadians who are successful in this model invest significant amounts of sweat equity and reinvest capital into their business to modernize, expand and open new locations, all to the benefit of new employment and economic activity.
Franchisees are also active in the communities they operate in across Canada, sponsoring sports teams and donating to local initiatives and charities, further extending their positive contributions.
With a clear understanding of the franchise sector in Canada now established, my comments today focus on the need to ensure we are fostering a small business environmental that encourages entrepreneurship. I can attest that our members have been deeply concerned over the past three months as the consultation around these proposed tax changes have unfolded.
For franchisees across the country, it is critical they are able to access and retain a certain level of liquidity to reinvest in their business, save for a rainy day, and ride out slower times. For prospective franchisees or franchise systems looking to open their first unit in Canada, we’ve heard directly that uncertainty in government policy and continued cost increases like hydro rates and minimum wage increases act as a deterrent for investment.
In challenging economic times for many regions in the country, we encourage the federal government to do all they can to create an economic environment that allows small business owners to thrive and is attractive to those outside our borders looking to do business in our country.
I’m pleased to share that our members did indeed breathe somewhat of a sigh of relief last week when new tax fairness measures were announced. It has become clear that the target of the government is not hardworking small business owners like franchisees across the country. We commend the government for listening to Canadians on the topic. We hope they continue to do so.
We would also like to express our support for the planned reduction of the small business tax rate. That being said, we strongly recommend that the government be mindful of placing additional red tape and regulatory burden on small business owners as they introduce new requirements, particularly a meaningful contribution test for income sprinkling.
We are hopeful that this committee will ensure these tax proposals will not negatively impact small businesses in the country instead of allowing them to thrive.
In closing and on behalf of the Canadian franchise industry, I thank the committee for their in-depth study. This is precisely the type of proposal that the Senate, with your collective private sector background, stands to contribute greatly to. I look forward to answering the questions you may have.
Eric DenOuden, President, Canadian Home Builders’ Association: The Canadian Home Builders’ Association is an association of some 8,600 company members. I am joined here today with Jason Burggraaf from our national office staff. We only have a few short moments for the opening statements, so I will make those. Afterward, we are both available to answer any questions that you may have.
Although the government has announced some adjustments to its proposed tax changes, my fellow builders and I still have a number of concerns as we move forward. The residential construction and renovation industry is made up mainly of small, family-run businesses. Some 83 per cent of construction, renovation and associated speciality trade firms have nine or fewer employees, accounting for approximately two-thirds of all on-site employment.
The residential industry is cyclical in nature and vulnerable to regional economic conditions. The fragmented nature of its trade and subtrade work, and importantly the liability issues that come with the job, have meant that the industry has always largely consisted of small companies and incorporated individuals. These two factors mean that the industry is particularly sensitive to changes in the business environment.
When the government’s plans were initially announced, we were concerned that well accepted standard practices in our industry were under considerable threat: practices like your family’s important involvement in the business, carrying considerable equity that could be liquefied quickly like GICs to take advantage of business opportunities such as purchasing land, and having the kids buy you out to help fund your retirement. We are pleased to see the government acknowledge these concerns in its announcements last week and make attempts to address them.
There are still numerous details to be clarified by the government before we can fully analyze the impact of specific rules around income sprinkling and passive investments. We hope the new rules on income sprinkling recognize the dynamic contribution of family members to a business. We are encouraged by the government’s references to capital and equity contributions as well as taking on financial risk in determining meaningful contributions to creating and running a business. We will also work to ensure that the red tape burden for businesses in our industry resulting from these tax changes does not increase.
In terms of passive income, we are pleased that the government recognized passive investments within a corporation are a critical tool for residential construction business. Such investments are essential to manage risk, operate efficiently and effectively, and plan for the future.
We hope the government will agree to periodically revising the passive income threshold to ensure that it is targeting only the very top earners and at the same time limiting impact on the real business requirements for passive investments.
As well, there will be new rounds of discussion and consultation, a process CHBA looks forward to participating in, on how to address what the government sees as a problem, issues related to intergenerational transfers of business ownership.
Finally, while the plans to reduce the small business tax rate are welcome, the benefit is lessened when you consider the discontinuation of the small business job credit at the beginning of this year. While overall EI premiums were lowered, because of the loss of the credit, EI premiums for small business actually went up.
As has been observed by others when considering the government’s plans last week, downside protection is more important to small businesses than a lower tax rate. Lower taxation of profits certainly helps when business is good, but it doesn’t help when business is bad.
In a similar way, uncertainty is always bad for business, and the government’s proposals have created a great deal of uncertainty within the industry. The uncertainty is still with us today.
It is imperative that the government release final and detailed rules and implementation time frames for the provisions that are moving ahead, so that businesses can make any necessary adjustments.
It is also critical for the Department of Finance, Canada Revenue Agency and private industry to work together to ensure that interpretation guidance for the legislation is clear, so that implementing the new rules does not create confusion and a whole set of new problems.
CHBA and CRA have done great work together to address the underground economy in residential construction and renovation, but higher tax rates and perceived unfairness are known to drive more cash deals. It would be a shame if the result of tax changes was more people operating illegally and therefore government realizing less tax revenue.
We are pleased that the government is adjusting course in light of the concerns raised by CHBA and other business organizations but more needs to be done.
We are ready to fulfill our commitment to engage in meaningful consultations to address areas the government sees problematic in relation to tax policy. Our goal, one I would expect is shared by the government, is to ensure the integrity of our tax system without harming the viability and vitality of small businesses across the country.
Thank you for giving me the opportunity to speak to you and your ongoing interest in this issue.
The Chair: Thank you.
Senator Pratte: My question is for Ms. Gervais. First of all, your firm is asking for a thorough and comprehensive review of the complexity of the tax regime, if I understand correctly.
Are there other aspects of the Income Tax Act that you would like to be looked at besides its complexity? On the complexity, are there specific aspects that you would like such a review to look at?
Could you provide us with some examples of the complexity of the act? If you can’t give us examples right away, maybe you could provide that to the clerk. That would be very helpful for us.
Ms. Gervais: Certainly. I can speak to a couple of measures that have been enacted over the last number of years. The small business deduction rules were expanded and with that became layer upon layer of legislation that you have to walk through. That would be one area where it seems that each round of legislation we have introduced is incredibly broad and sometimes has unintended consequences.
It would be wonderful if the tax community as a whole could work together in advance of legislation being passed, so that you’re working through some of those unintended consequences before they become unintended consequences. That would include government officials, the business community, tax professionals, and the Canada Revenue Agency. We need to come together and work through the perceived problems to come up with appropriate, clear solutions that don’t have broad or far-reaching unintended consequences.
An area that was introduced and revamped was the safe income proposals in subsection 55(2). That seems to again have become very broad reaching, potentially attacking transactions that weren’t intended to be picked up by those changes in the legislation.
That would be a couple of areas that we would welcome. Again, it comes back to our firm as a whole and the taxpayer community as a whole stand behind needing to close down any abuses, but as a community we need to work together to come to solutions, rather than receiving a round of proposed legislation that has complex unintended consequences that we are then trying to fix after the fact.
Senator Pratte: You are referring to the focus of that review, royal commission, task force or whatever. The focus of the Carter Commission was equity.
Ms. Gervais: Right.
Senator Pratte: I understand the focus of the review you are asking for is to simplify the system.
Ms. Gervais: Simplifying the system, yes. I would actually suggest as well that taking a look at the taxing unit again would be something that BDO would stand behind. A lot of complications in the Income Tax Act would be solved if the taxing unit was investigated again. Potentially, is it a spousal unit or a family unit, rather than just the unit of an individual?
Senator Pratte: That would be a major change.
Ms. Gervais: That would be a major change.
Senator Pratte: Thank you very much.
Senator Eaton: As the government has often said, this is about fairness, but perhaps you can explain to me what I have trouble with. Passive income is currently taxed upfront at a combined federal and provincial rate of 50 per cent. It is then further taxed when the income becomes personal income. No Canadian small business person opposes paying tax, but eliminating the line between small business and corporate income and personal income will create a disincentive.
I thought we were trying to become more productive and more competitive. Do you agree with that statement or not?
Ms. Gervais: Can you repeat the statement for me?
Senator Eaton: The statement that income becomes personal income tax. If you have a small business you’re taxed upfront, combined federally and provincially, at 50 per cent. As soon as the income becomes personal tax, you’re taxed again.
Ms. Gervais: Right.
Senator Eaton: How does that help our competitiveness?
Ms. Gervais: For small business income it’s approximately 15 per cent that would be taxed upfront. The issue there is that you’re talking about the passive income and the tax rate that applies to passive income.
Senator Eaton: It says tax on passive income is taxed.
Ms. Gervais: That is intended to decentivize businesses from using corporations to gain passive income. I agree with you that the system we have in place today does have measures in place already. If you choose to use your corporations to hold passive investments, you should be treated like an individual that would pay a high personal tax rate.
Senator Eaton: If I’m a small franchise owner and I want to buy another franchise opportunity down the road, I will obviously go into my passive income or my savings to buy the next franchise, right? However, if that’s being taxed, or I’m not allowed to accumulate very much of it, that will decentivize.
Mr. Eickmeier: I’ll comment on how franchisees use passive investment now. We’ve been told by our members that in many cases it’s a future growth opportunity. It takes them many years to get to the point where they have the ability to use passive income. At that point it becomes a vehicle for them to expand or to grow. They are at a point in their business where they’re running now. They spend 20 years building it —
Senator Eaton: And paying off debt.
Mr. Eickmeier: — paying off debt and putting kids through school. They’re at a point now where they can become a major employer by expanding, growing and reinvesting.
That’s where it comes into play for franchises. It is a vehicle that some of the larger franchisees in the country use.
Ms. Gervais: Even if we agreed that a $50,000 annual limit for investment income was something that mattered greatly to small and medium size enterprises, we have a concern with how those small and medium size enterprises will actually comply with such measures.
We will now be faced with potentially four different corporate tax rates for a small and medium size enterprise business. They will have the small business rate that they’re faced with. If they are over the small business limit, they will be faced with the general corporate tax rates as well.
We have a refundable tax system in existence already with respect to passive investments for Canadian-controlled private corporations. Then potentially we could go to this fourth measure where anything over the $50,000 annual limit has to be complied with as well. It’s a complex web of a four-tiered system that they will be faced with.
Senator Eaton: The $50,000 number seems pretty subjective. You can have a bad year or a medium year when you save $25,000, or you can have a great year when you have $75,000 but you can’t because it’s $50,000.
Ms. Gervais: Nothing has been said so far as to what happens if a business falls into that one year and does not the next. There is no cumulativeness to the measure.
Senator Eaton: This is not always, as we know. Thank you.
Ms. Gervais: Exactly.
[Translation]
Senator Forest: I think that the issue of passive income is complex, because 85 per cent of the capitalization is in the hands of 1.6 per cent of companies. As for your members, the franchisees, I presume they are not necessarily part of that 1.6 per cent. The $50,000 amount would come out of the capitalization and not out of projected investment. Did I understand correctly?
[English]
Mr. Eickmeier: Likely not for the majority of franchisees. As we mentioned, the majority of them are small business owners themselves. The greater majority are single unit or single location owners. They likely would not be in that 1 per cent or even the top 3 per cent, which is where we breathed a sigh of relief last week when we saw clarification on that.
With that said, there are some, such as those who have been highly successful in the model and have grown to multiple, double-digit locations. They have the ability to get there. That’s where they would potentially see additional restrictions on their use of passive income.
[Translation]
Senator Forest: In fact, since we became aware of these changes last week, the majority of comments we have heard indicate that they seem to be well received. The application rules are worrisome, however. Is the important issue today to ensure that the CRA will be able to clearly define the application rules, in light of how it functions, given that it may make a judgment concerning an enterprise that will then have to defend itself later? Is one of the main issues to obtain specific rules from the CRA concerning the application of amendments to tax legislation?
[English]
Ms. Gervais: I can definitely speak to that. That is one of our primary concerns. With respect to the TOSI rules that have been suggested, the reasonableness test, or what causes some great concern, we fear that it will be a big burden on Canadian small businesses to work with the Canada Revenue Agency unless there is clear guidance provided either in the legislation itself or in administrative commentary that would be necessary.
The Canada Revenue Agency is responsible for enforcing the legislation. They need to have a clear understanding of exactly which transactions and situations are expected to be caught by these new rules and which ones are not.
We absolutely share that there needs to be either clear administrative guidance or something right in the legislation on how these things will work.
Mr. Eickmeier: CFA would agree, as well.
Mr. DenOuden: From Home Builder’s, it’s a cyclical industry and we definitely would want to see that amount indexed. We too alluded to the fact that we need to make sure that the guidance for the legislation is very clear and not ambiguous when we implement new rules to make it fair, open and honest for everybody.
Senator Marshall: I have a question on passive income. When the initial proposal came out, there was quite a lot of pushback and then, of course, the government came back and they established the $50,000 threshold.
We still don’t know what the transitional rules are, but based on discussions with other witnesses we know that it will probably inhibit some companies from growing. We’re getting mixed messages. Some witnesses are saying it’s a good thing, and then others are a bit more hesitant about whether or not it is.
Is it a good thing or is it not a good thing?
Ms. Gervais: I think it’s a move in the right direction. I do believe that many small businesses will be able to take advantage of that threshold. The issue comes with the complexity of administering it. They’ve mentioned that all past investments and the income off those past investments will not be captured. Then you will also have an annual $50,000 income exemption.
Small businesses are now faced with having to deal with those three concepts. We haven’t seen anything in legislation yet as to how that would work, but I think that is the reaction. It’s welcome news to many small businesses that there’s a threshold. The issue is how will we deal on an annual basis with that threshold and with the costs of annual tax compliance that are to greatly increase.
Senator Marshall: You feel that what has been said with regard to the transitional aspect is satisfactory and doesn’t raise any concerns from your point of view.
Ms. Gervais: The words they used when they said that all past investments would not be captured in the income off of those are welcome words, but we have to see what comes out in suggested measures as to how that will actually work.
Senator Marshall: Are there any other comments from the other two witnesses?
Mr. Eickmeier: Just to add to that, one of the comments we’ve received from our members is that this is essentially changing the rules of the mid-game or mid-business venture.
You have folks who have set up a business, invested and done things the right way throughout their whole career, and now the new rules are coming in and they will have to make significant changes to the way the business is structured.
That creates a challenge for them. We’re not sure how significant that challenge is at this point in time. When the details come out we’ll be able to provide a more detailed explanation, but it does change things.
With that said, the announcements last week did provide a better set of proposals than we had seen in the past. It was positive in that.
Senator Marshall: It was more palatable.
Mr. Eickmeier: It was more palatable.
Mr. DenOuden: Once a threshold is set and a dollar value determined, we would really be looking for indexing to make sure that doesn’t become a stagnant figure and that it grows with the growth of the economy and businesses. That’s something we would be looking for.
Senator Marshall: My other question relates to uncertainty. At least one of you in your presentation mentioned that because of the way that the rules were released and the controversy surrounding them, there tends to be uncertainty now in the community.
How does that uncertainty roll out into reality? There is an uncertainty there, but people aren’t closing up their businesses. How do you see it? How does it roll out?
Ms. Gervais: At this stage in the game we’re working with our clients to educate them on what proposals were released and then, in light of the announcements last week, where we think things will go.
My suggestion would be that there is uncertainty. If the TOSI rules are to go forward, maybe there should be a longer transition period rather than a January 1, 2018, implementation date. Rather than saying, “This is your new regime and this is the world you now live in,” seeing the draft legislation and enacting it one year later would provide a period of time when people could go through the legislation, understand the new playing field and restructure their affairs potentially to comply with that new legislation.
I have one very simple example of a very typical Canadian-controlled private corporation that maybe has one class of share and a husband and wife who own that class of shares. Maybe they are both involved in the business but to varying degrees. Maybe you can come to terms on reasonableness. However, now you don’t have the ability with one class of shares to pay a different dividend to each shareholder. Even people who are able to comply with the rules that may have a very simple business structure now need to reorganize their share structure to come into the new regime. There isn’t time for them to do that before January 1, 2018.
Senator Marshall: What do you say to your clients? If the third pillar was withdrawn and Minister Morneau had said they were going back to think about the one on capital gains, what would you tell your clients? Is it just a wait and see?
Ms. Gervais: There is a bit of a wait and see. I would say openly that many tax practitioners are saying that if income splitting capability is to be removed as of 2018 there are suggestions that you would maximize some of that income splitting in 2017 while the rules still exist the way they do.
Senator Marshall: Thank you very much.
Senator Black: Thank you very much for your strong support of somebody somewhere doing an overview of the tax system in Canada. That is very much appreciated, and your intervention was extraordinarily articulate on that point.
I want to step back quickly, because I know the chairman will make sure it is quick. Do any of you see any advantages in the remaining proposals?
Ms. Gervais: I see no advantages. I see a lot of complexity.
Mr. Eickmeier: None from our perspective.
Mr. DenOuden: We don’t see any advantages to our members here, no.
Senator Moncion: Following Senator Black’s question, you don’t see any advantages for whom?
Mr. DenOuden: For our member businesses. When it comes to the thought of income sprinkling and things like that, to rescind that would be devastating to our small businesses run by families.
Senator Moncion: How about tax fairness?
Mr. DenOuden: Keep in mind that a family-run business is not entitled to employment insurance. Usually there are no pensions, disability and things like that. To be fair to those who have taken the risk and worked hard for 12-hour or 15-hour days, I’m not sure why we would penalize them by paying even more taxes for taking that risk.
Senator Moncion: Taking this a bit further, do your members pay benefits to their employees? Do they pay pension funds to their employees, or do they just pay the amounts required by tax law?
Mr. DenOuden: With 8,600 member companies it would depend on each individual company. Sometimes it depends on the size. From what I understand and know, a smaller company does not normally provide benefits per se to their employees. They have to do their own due diligence to save for the future.
Also, within the family-run businesses they have to look after that themselves. They grow a business, and the ideal situation would be to sell it to the next generation and use those funds for retirement later on.
Senator Moncion: If I go back to the question I was asking, there is a ripple effect here. Yes, we have compassion for the business owners, but we should also have compassion for their employees if they don’t have access to benefits or other things.
The employment base is another interesting study. It would be interesting to have those numbers. How many are touched by the fact that they’re working for companies that don’t have benefits but have passive incomes? How many employees are touched by not having benefits, pension plans and whatnot?
Mr. DenOuden: Again, all employees have the federal and provincial pension plans, but you’re right.
Senator Moncion: But nothing else if they don’t put any money by themselves into it.
My other question is about the complexity of the tax measures that are being brought forward. You were speaking of a potential of four levels of income tax. Because of the complexity that is there right now, most of these small and medium size companies deal with accounting firms. Accounting firms are there to find ways for these companies to diversify, to save income tax, to create growth and all of that.
It’s not necessarily a bad thing that it becomes more complex because it will give you more work and give you more. There are two sides to the changes that are being brought forward.
I understand that it is not pleasant for someone who is working and has a company to be paying more for taxes. It’s not even pleasant for us who work for salaries and have to pay quite a bit of it in income tax.
At the end of the day we understand all of that. At some point it is just a question of fairness. You will have higher income earners. They are the ones who are being targeted by these changes.
When I look at your small and medium size members, how many are really in the higher earners bracket?
Mr. Eickmeier: A small percentage for our members.
Senator Moncion: Is it a very small percentage?
Mr. Eickmeier: I don’t have an exact number, but it would be a smaller percentage.
Senator Moncion: How many of your members will be touched by these changes?
Mr. Eickmeier: The proposals last week brought more clarity to that. As I said in my remarks, it was the realization that the government was not targeting small businesses in many ways like it seemed that they were two weeks ago. The readjustment of their messaging and the clarification as to whom they were targeting, the top 3 per cent or 1 per cent that they mentioned, reduced a lot of stress for the greater majority of our members who in most cases will not be impacted by this in any type of significant way.
With that said, many of them participate in things like passive investment and income sprinkling or splitting with family members. There will be a tangible impact on them, but perhaps they won’t be in that targeted group the government has identified.
Ms. Gervais: I will just add a comment. It is something that our firm has looked at, absolutely, with every round of legislation that has come out that is more complex and unusual.
It is true that firms like ours would earn more tax revenues from our clients to help them through the new legislation, but we stand back and say that’s not the right result for the taxpayer, the end Canadian entrepreneur. It definitely benefits us as a firm, but it is not the right result for Canadian entrepreneurs to be faced with more complexity and more compliance costs.
Mr. DenOuden: If I may just add that 83 per cent of construction and renovation associated work is done by small businesses that employ nine or fewer people. I can’t imagine that these people are in high income earners.
Senator Moncion: No. They are probably not even touched by passive income. I have dealt with quite a few of them. They need to have the liquidity ratios just to be able to keep their businesses going on a daily basis.
Mr. DenOuden: And through the annual cycles of economics.
Senator Moncion: It is whom we are trying to target and how badly some of them will be impacted by it.
Mr. DenOuden: That’s why we would concur that the $50,000 is a palatable number.
Senator Moncion: For most.
Mr. DenOuden: For the vast majority.
Senator Moncion: For 80 per cent of the businesses it’s probably a good threshold. For the other 20 per cent, some will be impacted more and others a little bit less.
Senator Andreychuk: I will be mindful of the time, Mr. Chair.
We’ve talked about tax fairness and reasonableness. Fairness is difficult: It is in the eye of the beholder. Reasonableness is: Is it a subjective test or an objective test? It is difficult enough in criminal law, let alone in taxation law where I don’t think we have embedded a universal value system as we have in the Criminal Code.
You mentioned, Ms. Gervais, that this was brought forward originally to plug abuses. If you did not say it, just correct me.
Ms. Gervais: In the original announcements in July the words used were to close down loopholes.
Senator Andreychuk: Did you say that was because it was an abuse of the system?
Ms. Gervais: No, not an abuse of the system. The income splitting regime that has been in existence for many years has been sound policy. It seemed, with the language the government used, that they were attacking a very small group of Canadian taxpayers to close down perceived loopholes. However, it is obvious, with the retractions that have taken place in the last few weeks and all of the over 21,000 submissions that came forward, it is quite obvious it was not just going to impact the top 1 per cent or those who are abusing the system. This was to impact all ranges of Canadian controlled private corporations.
Senator Andreychuk: We’ve heard indirectly, and I have certainly heard privately, from women entrepreneurs. There are two points. One is it’s very hard to get in. You start in your basement, with babysitting and trying to do everything else at the same time. You want to get ahead and you have a good idea. Some of them make it and some do not.
It’s difficult enough now. They say the system is too complex anyway. It was an idea. It was a way of getting over the poverty line, et cetera. This will add a burden to them.
Do you have any comments about those women entrepreneurs we’ve been trying to get at?
Another problem was the next step once you get a good idea and it gains resonance. The Standing Senate Committee on Foreign Affairs and International Trade looked at that. The feedback was that we’re so small we’re running at capacity and can’t stop to rethink and to replan to have the expertise to move to the next step.
Where do we get the financing because there is still not enough of a base? Is any of this percolating?
Mr. Eickmeier: I can build on an example I gave earlier. It does, in many cases, take many years to build a business to a point where you can take advantage of things like passive income, where we finally have men or women entrepreneurs at the point where their business is sustainable and large enough and strong enough that they can go out and look to expand. We don’t want to put roadblocks in place. We want to give them the opportunity to continue to create jobs and build in new provinces. I go back to the growth numbers I provided earlier.
We will leave it at saying be mindful of those who are at the point where they can take advantage of these types of things. They can become major employers in the country. If we put up a roadblock in place to preventing them from doing that, that is not good public policy.
Senator Oh: Thank you, panellists, for being here.
Do you agree that this round of tax grab is mostly hitting on individuals and families in the small business and family business sectors, but not on the middle class or the big corporations?
Ms. Gervais: I suggest that it’s hitting all Canadian controlled private corporations. Many very large organizations, the very wealthy, can afford to deal with some of the complexity in this rule and have tax advisers that will be helping them through it. They can afford the additional compliance costs. I don’t think it’s not impacting them.
The significant impact, or the burden that is being felt, is how small and medium size businesses will deal with all the new rules.
Senator Oh: Do you have a comment?
Mr. Eickmeier: I would agree. Going back to what some of our other panellists have said, the devil is in the details. With what the reasonableness test looks like and how much burden that puts on them, that is where we will be able to determine the impact on small businesses.
Senator Oh: Next year accounting fees are going up and there will be more of an impact on small business.
Ms. Gervais: Yes.
The Chair: Witnesses, thank you very much for basically giving us a lot of information. It has been informative and even educational, to some extent. As we go forward and before we table our report in the Senate, please do not hesitate to send to the clerk any additional information in writing. We would appreciate that.
With that, honourable senators, our next meeting is at 2:15 p.m. tomorrow in the same room.
(The committee adjourned.)