THE STANDING SENATE COMMITTEE ON NATIONAL FINANCE
EVIDENCE
CALGARY, Tuesday, November 7, 2017
The Standing Senate Committee on National Finance met this day at 1 p.m. to study the Minister of Finance’s proposed changes to the Income Tax Act respecting the taxation of private corporations and the tax planning strategies involved.
[English]
Senator Mockler: Honourable senators, I see that we have the quorum and I declare the meeting in session. Before we proceed to introduce our witness, we have been joined by Senator Scott Tannas from Alberta. I would ask Senator Tannas to say some words of welcome to the Standing Senate Committee of National Finance.
Senator Tannas: Thank you, Senator Mockler.
On behalf of all Albertans, we're glad you're here to explore this subject that so many Albertans have an opinion on. We're sorry that we couldn't order up our world-famous chinook for you today. It is what it is in terms of weather, but we're glad to have you here. Thank you for allowing me to participate along with colleagues in these hearings this afternoon.
Senator Mockler: Thank you.
My name is Percy Mockler, a senator from New Brunswick, and at this time I would like to ask the senators to introduce themselves.
Senator Jaffer: My name is Mobina Jaffer, and I'm from British Columbia.
Senator Pratte: André Pratte, Quebec.
Senator Tannas: I'm Scott Tannas from Alberta.
Senator Oh: Victor Oh, Ontario.
Senator Marshall: Elizabeth Marshall, Newfoundland and Labrador.
Senator Andreychuk: Raynell Andreychuk, Saskatchewan.
Senator Cools: Anne Cools, Toronto, Ontario.
Senator Mockler: The Standing Senate Committee on National Finance was authorized to examine and report 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 in particular: income sprinkling, holding passive investments inside a private incorporation and converting income into capital gains. The order of reference also says that the committee take particular note of the impact of the government's proposed changes on incorporated small businesses and professionals, economic growth and government finances, the fairness of the taxation of different types of income and other related matters. The committee will submit its final report to the Senate of Canada no later than December 15 and retain all powers necessary to publicize its findings for 180 days after presenting the final report.
This afternoon we have with us Mr. Kim G. C. Moody, Director, Canadian Tax Advisory of Moodys Gartner Tax Law LLP.
Mr. Moody, thank you for accepting our invitation. I want to also bring to the attention of senators and the public that Mr. Moody was asked to reappear before the committee to share with us his opinions, his views, and his recommendations on the changes that were presented by the Government of Canada through the Minister of Finance.
Mr. Moody, please make your presentation, to be followed by questions from senators.
Kim G. C. Moody, Director, Canadian Tax Advisory, Moodys Gartner Tax Law LLP, as an individual: Thank you very much. It's certainly my pleasure to be asked to come back, especially in my home town of Calgary.
I want to thank you for inviting me to appear again to discuss these proposals. It is my pleasure to be here. I commend all of you for your initiatives to truly understand the concerns of Canadians.
By now you've heard most of the concerns that the tax community has. In addition, you've also heard from some advocates of the proposals. So to make effective use of my time, I thought I would discuss four basic points: a quick reminder that the process we've been through since July 18, 2017, has been less than impressive; a comment on where we are after the Santa Claus week of press releases from October 16 to 20, 2017; some quick comments about the remaining issues; and the obvious lesson from our recent experiences. That lesson, in my view, is that Canada needs a better path for future tax policy changes.
For my first point, no one here likely needs a reminder and a reiteration of my earlier comments of the offensive parts of what we have and are currently experiencing. However, I think the reminder that the July 18 proposals, released under some of the most offensive and arrogant rhetoric that the tax and business community has ever experienced, is important context to the balance of my comments. Misleading statements and defensive behaviour by the minister was not helpful. The truncated 76-day period for consultation, released in the middle of the summer under the guise of closing loopholes, was again offensive. Some may say, “Yes, Kim, we've heard all this and that's old news.” Well, this news is not going away any time soon. The massive reaction by the tax and business community should make it obvious that people were offended, and rightly so. The anger has not cooled very much and has since turned to a mistrust of our Finance Department. Canada deserves a much more transparent, honest, and open approach to massive tax policy changes. More on that later.
So where are we after the Santa Claus week of October 16 to 20, 2017?
Well, the retractions of the capital gains deduction and surplus stripping proposals was welcome and the tax and business community look forward to assisting the Department of Finance in developing proposals to improve intergenerational transfers. While some are thankful about the reduction in the small business tax rate that was announced as a carrot, don't count me as part of that group. I think the reduction was an unnecessary distraction from the real issues and an out and out marketing gimmick.
Tax rate reduction was never an issue with the July 18, 2017, proposals and it will compound some of the issues that the government apparently had an issue with. Given our integrated tax system, it also increased the overall tax cost of non-eligible dividends, thus greatly reducing the overall cost to the government of offering such a distractive carrot. The government committed to simplifying the income-splitting proposals, but no details have been released. Of course, we anxiously await the details.
Finally, the government committed to implementing a form of the passive income proposals with a one size fits all $50,000 income exemption, so-called grandfathering for existing assets, and some form of an exemption for angel investors, again with no details.
Providing guidance on tax policy and legislative proposals, via kitschy photo ops and limited detailed press releases after reading 21,000 submissions in a record time of two weeks, has led to a tremendous amount of uncertainty. In business, uncertainty is never good. Such uncertainty, distrust, and anger has led to many investor projects being put on hold and an incredible amount of private capital seeking greener pastures.
I've been swamped with such projects, and I mentioned that to you in early October. Where is the money going? South. And I fear that U.S. tax reform, which was announced last week, will further increase the amount of capital leaving Canada.
Last week at the Senate Finance Committee meeting, which I watched with interest, Minister Morneau made some comments that implied he wasn't worried about capital leaving. Apparently people told him the same thing when he raised personal income tax rates for the highest income earners. It's too bad that Minister Morneau couldn't work with me side by side in my office since those tax rate increases, because the amount of private capital that has left Canada since those rates became effective has been tremendous in my practice. None of those files will become public. Lately the number of high net worth persons who want to investigate their options has skyrocketed. As I mentioned earlier in October, I just can't keep up. Again, I wish Minister Morneau could follow me around for a day and see the activity.
For the simplification of the income-splitting proposals, it would be ideal if some form of bright line test was introduced by the government. Many submissions on October 2 or earlier were for the government to scrap the July 18, 2017, proposals and introduce similar rules that the U.S. has, which is a bright line application for adult children up to the age of 24. In my opinion, there are very valid reasons for exempting spouses from the proposals. The uncertainty involving whether or not proposed subsections 120.4(4) and (5) will be eliminated is not good. Currently such provisions, if enacted, could cause otherwise capital gains realized on a non-arm's-length disposition to be considered taxable dividends. And given the large difference in tax rates between dividends and capital gains, such proposals can result in a very punitive and unfair result for genuine, non-arm's-length dispositions of private corporation shares. This should, in my opinion, be eliminated.
Apparently the income-splitting proposals will still have an application date of January 1, 2018, less than two months away. I believe such proposals should be changed to have an application date of January 1, 2019, to be fair and enable taxpayers to absorb such proposed changes.
Where do I start with the passive income proposals? I know you've heard lots about that in your travels. The one size fits all $50,000 investment income exemption is loaded with issues. Is such an amount too low? In my opinion, yes, for a whole bunch of reasons that I would be happy to expound further on. How will capital gains be treated in the calculation of the $50,000? Don't know. Will the effect of the grandfathering be to punish new accumulated wealth given the commitment to grandfather old wealth? If the answer to that is yes, how is that fair?
How many pools will need to be created in the legislation to keep track of some of this stuff? So far our firm has counted five. Will the legislation be difficult? Without a doubt. I have a hard time imagining how such proposals can be easily legislated, but, more important, applied in practice. Small business owners are already struggling to deal with the complex requirements foisted upon them as a result of the recent small business deduction changes in subsection 55(2) amendments. It's one thing to ask large corporations with dedicated tax departments to comply with difficult legislation. It's a completely different thing to ask small business owners to comply with this. Many simply don't have the resources.
The reason for these proposals being implemented was all in the name of so-called fairness and neutrality. While some economists can create great spreadsheets to prove tax neutrality will be achieved, such spreadsheets only go so far, proving whether or not such proposals fit within a tax system that should be equitable, fair, provide certainty, not be overly complex, and encourage economic growth and efficiency, which are all good policy tenets of a good tax system.
Let's chat quickly about economic growth, and specifically Canadian competitiveness. My good friend Jay Goodis of Tax Templates Inc., who some of you know, has spent hundreds of hours creating a tax model that tests the new passive asset proposals against the current regime -- Canadian public corporations, the U.S., the U.K., and other countries. Jay randomized data for 2,000 scenarios where the Canadian private corporation paid tax at the general rate, had passive income above the $50,000 threshold, and in 100 per cent of the randomized scenarios Canadian private corporations were the least competitive; in many cases by quite a long shot. Combine this with the fact that the U.S. might be successful in implementing very aggressive tax reform to assist its entrepreneurs, and this is a recipe to significantly harm the competitiveness of our Canadian job creators. In a simple scenario that I have in front of me on my iPad here that Jay created, over a 25-year period a Canadian private corporation earning $500,000 annually, which is indexed for growth, with such profits subject to the small business deduction taxation rate and assumed amounts going back into the business, and into a passive asset pool with conservative investment yields, the private corporation shareholders could be left with approximately 12.1 million, as compared to 16.9 million in the U.S. under the current regime. Should the U.S. tax reforms pass, that would increase to 19.3 million; so a whopping 9 million delta.
Canadian businesses and their shareholders cannot ignore that large differential and any intelligent and informed Canadian entrepreneur will look to better alternatives outside of Canada, where possible.
It's my opinion that on an overall basis there is no compelling need for the passive investment proposals and, if implemented, they will lead to a very complex system that will surely stifle economic growth and impair Canadian competitiveness. Accordingly, I do not believe, using Minister Morneau's language of last week, the right balance has been achieved with all of the Santa Claus announcements.
To close, the experience that we've had since July 18, 2017, is a lesson for all of us now and into the future on how not to implement tax policy changes. As mentioned earlier, Canada needs a comprehensive review of our entire tax system, not just for private corporations. The patchwork approach to implementing tax policy changes leads to many unintended consequences and ultimately unworkable complexity. The comprehensive review should have the time to do a thorough and thoughtful review that engages all stakeholders, again not just government and academics.
Minister Morneau said last week at your committee meeting that there was no plans for a major overhaul of the tax system at this time. I believe the government needs to start listening to the outcry for comprehensive reform. Canadians expect better. Thank you.
Senator Mockler: Thank you.
I will call on Senator Marshall for the first question, to be followed by Senator Jaffer.
Senator Marshall: I'm going to focus right on the passive income, because in your remarks you started to say that they're too low, that the $50,000 is too low. You talked about there now being five pools. Then you went into quite a lot of discussion about the passive income. When you referred to it being too low, you said you would indicate why and you would elaborate on it further.
So do you have further remarks on passive income that you didn't give in your opening remarks?
Mr. Moody: There's lots that I didn't, just because I don't have time, but would you like me to comment on that low amount?
Senator Marshall: Yes, I would because you say that it's too low. Perhaps you can talk about that first.
Mr. Moody: I think it's too low for a variety of reasons. For a, let's say, one- or two-person small business, $50,000 might be just fine and it wouldn't affect them if they're not accumulating passive assets at a fair rate, if you want to call it that.
Let’s use my scenario, for example. I'm a chartered accountant. Using their numbers, is 1$ million dollars at 5 per cent enough for me to retire on to maintain my family's lifestyle? Not even close.
So is that fair? I don't think it's fair. Let’s park that for a second and look at the $50,000 for a construction company that I'm working on right now. They employ 300 people here in Calgary. It is a very seasonal business. They collect money throughout the year and earn passive income.
So the first question: Is that investment income passive? Don't know. Let's assume it is. If it is, the investment income that they receive is well over $50,000 per year. So are they going to be punished by accumulating moneys throughout the low parts of their season? Clearly they will be. Is that fair? I don't think it is.
Senator Marshall: The government is looking at that now and saying $50,000 and one size fits all. At the end of the day, we will be writing a report. We're thinking ahead and asking ourselves what should we recommend? Should we say that the passive income threshold is too low or that it should be scrapped altogether? You addressed both scenarios. Which one do you prefer?
Mr. Moody: Do you want to guess?
Senator Marshall: Yes. Scrap it.
Mr. Moody: Exactly. I just see no compelling need for the passive asset proposals. I mean, I understand the theory. I'm no dummy. Do I think that it's a well-rounded argument? Absolutely not. I think it's very short shrift.
Senator Marshall: You also talked about keeping track now of the five pools of income. What are the five pools, because before there were only four.
Mr. Moody: Oh, great; you're going to test my knowledge here.
Senator Marshall: Yes.
Mr. Moody: So if they're grandfathering presumably the investment income, there's going to be a grandfathering pool. Then there's going to be this so-called non-grandfathering pool. You’re going to have to likely break that up into accumulated small business rates versus corporate rates, but let's just not even count that.
Then you're going to have the so-called angel investor pool, of which we have no idea because they said they're going to work with the angel investor community to make sure that they're not adversely affected. I have no idea how that's going to work. Presumably they're going to have to pool that out somehow or exclude it out. Then you're going to have what? Somebody help me out here, tax geeks.
An Hon. Senator: The accumulated earnings.
Mr. Moody: Yes, the accumulated earnings is number 4.
Then I'm missing a fifth one, and I wish my right-hand man was here.
Senator Marshall: You talk about having all these pools. So you've got to start off with your opening balance. So is it already broken out? Or is this something that's got to be done by the company? Somebody has to do that.
Mr. Moody: Somebody has to do it. They're simply going to look to their tax advisors.
Senator Marshall: And Canada Revenue Agency is going to have to audit it?
Mr. Moody: If you're familiar with when they eliminated the income trust rules back in 2005, effective 2006, they came out with the general rate income pool. GRIP as it's called in private corporations. The rules provided that you had to do an opening balance to be specific. It is 89(6) of the act, where you had to do an opening calculation. I can tell you that outside of geeks like me, because those rules are bloody complicated, the amount of compliance in that opening balance calculation was pretty bad and rarely audited, frankly.
Senator Marshall: So this is what we're talking about, the complexity now of administering what the government is proposing?
Mr. Moody: Yes.
Senator Marshall: You also talked about something that has been raised in this committee before, I think we discussed it yesterday, the small business rate being reduced. Then you're talking about the increased taxes that are going to be put on the dividends.
Senator Marshall: Is it dollar for dollar? Just explain that because I don't have a good grasp on the numbers.
Mr. Moody: It depends by province, but it is pretty close to dollar for dollar.
Of course, the idea is you get the lower rate upfront in the company and then you can defer the payment of the dividend out down the road. When you eventually pay that dividend out, it will be taxed at a higher rate. It is almost dollar for dollar. That's the theory, and it's different by province, though.
Senator Marshall: But the government hasn't said it's going to increase the taxes on dividends.
Mr. Moody: They put it in a footnote to their announcement.
Senator Marshall: So it's definitely going up.
Mr. Moody: Oh, it's definitely going up.
Senator Marshall: Is it also possible that the tax increase could be more than what you would anticipate?
Mr. Moody: I don't think so.
Senator Marshall: Thank you.
Senator Jaffer: Thank you very much for coming here a second time.
Mr. Moody: My pleasure.
Senator Jaffer: I want to continue with what Senator Marshall was saying on passive income. I find it so arbitrary to say that it will be $50,000 for a company. There are so many questions. Is it a one-person company? Is it one shareholder? Let’s say it's four brothers. Do they then have to form separate companies to be able to take advantage or are they stuck with just the $50,000? How will it work?
Mr. Moody: That's a great question. How are capital gains going to be computed? Are they going to average it out? Because capital gains tend to be lumpy. Is it going to be on a related test or is it going to be easy to step around the rules by simply incorporating another company, for example; which it definitely won't be because that's too easy? How are they going to measure? Is it going to be a related test? Will it be an affiliated test, for which there's a distinction in the act? I have no idea.
Senator Jaffer: I may not have the right terms, but if they form a separate company, would the butterfly rule apply, because they're transferring all the moneys to separate companies?
Mr. Moody: So if I understand your question correctly, will the traditional butterfly rules apply to the extent that they impose these passive rules? I have to think that the butterfly would not be impacted by these proposals, off the top of my head. That's a great question, though.
Senator Jaffer: How will they tax -- well, there are so many questions. We don't know.
Mr. Moody: There are tons of questions.
Senator Jaffer: I want to take you to another subject, if I may, and that's the reasonableness test and the splitting.
When the CRA appeared they said, if I understood them that it would be a bit complicated, but I would like to hear from you. I think you may have covered it last time too, but about how is the reasonableness test going to be carried out when the splitting comes?
Mr. Moody: Those proposals, as they currently stand, are some of the most complex proposals I've ever seen in my career. Now, what I've seen as speaking points recently is that -- well, the Income Tax Act has had a reasonableness test for a lot of years.
Two examples of that are in paragraph 18.1(a) of the act, which is no expenses deductible unless -- well, actually the more common one is section 67, which says that no expense is deductible unless it's reasonable in the circumstances, which the courts have ultimately viewed to be an arm's length standard-type test.
I can tell you that applying that standard is relatively straightforward in the whole scheme of things, and the courts have laid out pretty good standards for that over the last roughly 50 years.
The proposals, though, for tax on split-income are much more specific, where you've got to look at the labour contributions, the capital contributions, the historical contributions, et cetera. When you have to apply that reasonableness standard to those four pillars, that's asking a lot from somebody who is not a tax expert.
Senator Jaffer: To take that further, say Mr. A has a business and he allocates some money to his wife, he pays his wife, she's given capital and at the end CRA doesn't accept it?
That's the challenge because that happens a lot further down the line. In other words, there's no way of knowing whether or not they'll accept something.
Mr. Moody: No. The way our system works, and I understand why it is this way, the taxpayer is pretty much guilty until proven innocent. So the taxpayer has the onus to prove that it is reasonable. When you have administrators at the CRA, and they're just doing their job, who ultimately deny the deduction because from their analysis they don't believe that it's reasonable, I think that's asking too much of them, to judge what's reasonable with those four pillars.
It's one thing to ask what's reasonable. For example, if I pay my kid $25,000 to empty wastepaper baskets, whereas I pay an arm's-length person five bucks, that's a pretty easy analysis in the whole scheme of things. It's another thing to apply it to those four pillars.
By the way, if any of you have kids, especially boys, 21 year olds, I wouldn't pay them $21,000. They're just not that bright. That's supposed to be funny.
Senator Pratte: You talked about the Santa Claus week of press releases, which I think is a bit unfair. We've heard a lot that the government did not consult and did not listen. Obviously, they've listened because they have made some changes. They're not detailed changes, but it does show that they've listened to the uproar that followed their announcements. Obviously the details are not there, but the principles to the changes that they want to make, that they've announced, are there. Aren't you somewhat reassured by the principles, at least, that have been announced?
Mr. Moody: Oh, sure. But do I stand by my comment? Absolutely I do. It was a three-month period of torture full of rhetoric, and you can't tell me that they looked at 21,000 submissions genuinely. Frankly, do I appreciate the climb-down? Of course we do. But do I think that we needed to go through this whole process and have Santa Claus week? No. We should have had true engagement right from the start. Now, I recognize where we're at today and that we can't turn the clock back, but I can tell you that that was torture for the tax and business community, and frankly still is.
So do I stand by that Santa Claus comment? Absolutely.
Senator Pratte: On passive income, I understand you would prefer that the whole proposal disappear, but from my understanding of what the government has said, they will move forward with the proposal. If many witnesses seem to believe that the $50,000 threshold is too low, impractical, too complicated or probably too restrictive, are there other ways that we could recommend where the government could meet its goals while not hampering small businesses, giving them the flexibility that they require in using those passive investments to invest in their business, in other businesses.
Are there alternative solutions that you can think of if the government moves ahead with this proposal? If it's not a threshold, are there other possibilities where the government could tax passive investment, passive income, and yet give small businesses enough flexibility to use this passive capital.
Mr. Moody: There certainly are, and certainly we've thought about that. I tend to share your views that they're going to move forward, which is unfortunate because of the complexity and all the things that you probably already heard already. Around our office we've debated what some better measures might be.
First, I'll say it again, I wholly disagree with the policy, what they're trying to do. Frankly, I don't even know what they're trying to do because I think their views in terms of where the mischief is are just not right.
That aside, if they're going to move forward, and it sounds like they are, the easy thing would be to set a number that's really high, but not too high, so that they can still achieve their perceived objectives. I don't know what that number is. But would 200,000 be a decent one? Probably 250 would be better.
More targeted approaches would be things like two times retained earnings or three times retained earnings. Some sort of function like that. Maybe a measure or a multiple of revenue or profits. Something that more targets what they perceive to be the mischief.
Right now with the one size fits all, I just don't see any logic to that whatsoever other than the trumpeted line of it's going to take away 97 per cent, I believe the statistic is, of small business owners. Well, that doesn't do it for me, certainly.
Senator Pratte: If we take the government at their statements, their goal, their target is CCPCs that use passive investment strictly for fiscal purposes, such as retirement only, not for business purposes, not for other investment and other businesses, and they target specifically professional firms such as yours, doctors. They talk a lot about doctors. Do you disagree that this is a legitimate goal?
Mr. Moody: I totally disagree. I mean, I'm open. I like to think I'm pretty open minded, notwithstanding my bluntness. Using me as an example, I've been a small business owner for 22 years. When I first started my practice 22 years ago, the profits were pretty slim. I couldn't put money into my RRSP until I finally was able to start making some money, which was well into my career.
All those foregone years come at a price, but you always keep plowing forward thinking that, hey, the Government of Canada is encouraging me to do this, to create jobs -- I've created a lot of jobs over my career -- and to ultimately use the tax system to help me retire.
I don't find that offensive in the least. But now they're going to put a limit on, of let's say, $1 million, using their mathematics, to basically help me retire. What? But anything beyond $1 million is going to be punishing to me. I don't find that fair in the least bit. This whole concept of neutrality, which is trumpeted by a number of economists, in my view is a very warped definition of neutrality.
Senator Tannas: I have a couple of questions. First, you mentioned your practice and the amount of activity around clients preparing to take their money out of the country. You will know how big they are relative to the Calgary tax community, the Alberta tax community.
Have you given any thought as to what in dollars this exodus kind of looks like on any kind of a macro level, whether it's here in the province or by extension across the country?
Mr. Moody: I can only answer that question from my own experiences, and I can tell you that I'm on record for saying this numerous times: that in my own practice the amount of capital that's left since 2015 is not in the millions of dollars. It's more than that in my practice, and that a lot of it has to do with just being fed up with high tax rates. That's the first issue. I can tell you since July 18 I've had a lot of renewed vigour in that interest, if you want to call it that, for at least exploring the issues.
There's two camps. One says, “That's it, get me the hell out of here.” I have a whole bunch of those files. Then there's the other that is kind of saying, “Get me ready because if this goes like I think it's going to go, I want to be ready.” So there's the people who are sitting on the fence.
I would say right now it's about half and half in my file. To extrapolate that to other practitioners -- I mean, the tax community in Alberta is very tiny -- I can say that the experiences are similar. To extrapolate that to a number would be foolish of me because I just don't know.
Senator Tannas: You mentioned that the process here was a disaster, or just terrible. You've been in your practice for a long time. What was the best tax-raising program that you ever saw? Is this always destined to be a mess? Can you think of a time when it wasn't? Who does this well and who did it well? Is there a jurisdiction you can point to or a particular event where you thought it all went beautifully?
Mr. Moody: Nobody likes to pay more taxes, right, so you're always going to get the gripers.
Senator Tannas: Right.
Mr. Moody: No question about it. Even the 2005 and 2006 income trust changes; yes, that hurt a lot of people, no question about it. But was it anything at all like what we've experienced this time? Not even close.
Frankly, there were good policy reasons, in my opinion, to require those changes. With this one, I struggle to see the good policy reasons. Then they combine that with rhetoric and misleading statements and finally the Santa Claus week where they realize that, “Hey, we've got it.” So that would be an easy example.
A less visible example would be when they decided to change the testamentary trust rules, which some of you may or may not be familiar with, but they did announce a consultation in 2013 I believe off the top of my head. They allowed for a six-month consultation and then, you know, received a bunch of submissions. They were nothing like 21,000, of course, because it's a pretty benign topic in the whole scheme of things. Then after a period of about -- I'm trying to remember here -- roughly four months of reviewing the submissions, they came out with draft legislation.
Now, was that consultation satisfactory in terms of the result? No, because they didn't listen to us. But at the end of the day was it more transparent and open and genuine? No question.
Senator Tannas: Thank you.
Senator Oh: It is nice to see you again, Mr. Moody.
The consultation initiated by this Senate standing committee is probably one of the most intense ones to date. The committee has been listening to the concerns of Canadians who are speaking out about these tax reforms.
In fact, two weeks ago I went with Senator Anne Cools to a small village just outside Ottawa. We were surprised to see that approximately 40 people showed up to an informal round table discussion. They were all farmers and small business owners. They voiced their concerns about the short consultation which lasted about 75 days. They told us it was not enough and asked the government to do proper tax reform.
The tax act currently permits the distribution of income of a private corporation by allowing dividend payments to the spouse or the adult children of a shareholder regardless of their participation in the business. Do you believe that family members should be involved financially or through their work in order to receive revenue from the private company?
Mr. Moody: I'll answer your question in a roundabout way. Do I think it's intuitively appealing to suggest that family members who don't contribute to a business shouldn't be able to have those amounts in their hands? Of course it is. If you talk to the average person who doesn't understand property law or tax law, or even business for that matter, I think the answer would more than likely be, “Why should that person have the ability to receive $20,000 of dividend income if they haven't earned it?” So it is intuitively appealing to apply a reasonableness standard to that.
I think the better answer, though, is that do I have to earn my dividends if I buy Telus stock, for example? And the answer is a clear no. If it's a clear no, why is that so? Well, it's because tax law follows property law. There is no reasonableness standard, nor should there be, because ultimately dividends by definition are a return on investment. The same thing for family members.
Now, in that context, do I think that there has been some abuse of income splitting with certain family members, especially what I call “adultolescents?” You know, I tease about my 21-year-old boy. I love him to death, but does he legitimately contribute to my business? No, he doesn't. Is there abuses in that area of using adultolescents? Yes, there probably is.
So do I understand what the Department of Finance is trying to do in tightening that down and making it more equitable? Yes, I do. Am I sympathetic to their objectives? Somewhat. I'm somewhat sympathetic.
But I'm sympathetic to a point. You can't apply a reasonableness standard to my 21-year-old kid, for example, because maybe he is a bright kid. No, sorry, I take that back. He is bright.
Senator Tannas: You would be in trouble.
Mr. Moody: I would be in trouble. Maybe he is legitimately, you know, contributing to my business? But how do you employ that standard? If you're going to try to cut down that abuse, notwithstanding the inconsistencies with property law, then at least make it a bright line test.
With spouses, I don't agree whatsoever. For example, in my case, if I get divorced is my wife entitled to 50 per cent of my property? Of course she is. So is she entitled to a return on that property during her lifetime or does she have to wait until we're divorced? Well, I think that's a nonsensical question, frankly. So, in my view, she is entitled to a return on property during lifetime. To suggest that a payment of a dividend to a non-active spouse is somewhat abusive I think is, again, intuitively appealing, but it fails intellectually.
Senator Oh: We have the U.S. tax reform coming out. If we carry on with this tax reform, are you worried about capital going down south?
Mr. Moody: Absolutely, I am.
You may not know this, but half my office is U.S. tax lawyers. About half of our work is Americans investing into Canada and Canadians investing into the United States. I can tell you with the amount of files on capital fleeing to the United States since the tax rate increases of 2015 and the interest since July of 2017 and now with the U.S. tax reform stuff that was announced last week, we have clients going “Do you think this is really going to happen?” We're saying, “Well, we'll see.” But if it does happen with the 20 per cent corporate tax rate, for example, and a 25 per cent so-called flow-through rate, oh, my God. I mean, you would be crazy not to look at it.
Senator Oh: Plus the carbon tax coming.
Mr. Moody: Don't get me going on that.
Senator Andreychuk: I just want to follow up on the Santa Claus idea. When you say that, it sounds like it's a gift back. Yet we've heard from other witnesses who say it's going to make it even more complex. So where's the gift?
Mr. Moody: I'm being sarcastic, of course.
Senator Andreychuk: So why would you use that language? Even what has been taken off the table, this intergenerational issue is not off the table permanently. It's off the table now. Most people have told us that it's worse now than before. You seem to say it's a Santa Claus gift.
Mr. Moody: I'm saying Santa Claus sarcastically, right, for the reasons you just said. It's almost as if we're supposed to be thankful that it was taken off the table, when, frankly, if they had done their job correctly, they would have consulted with the tax community in advance. They would have consulted with a broad spectrum of academics, not just a few. So I say Santa Claus week sarcastically because it's almost like we're supposed to be thankful for this gift. Well, we shouldn't have to be thankful for this gift.
Senator Andreychuk: Just following up, because it is ultimately a Canadian issue that will either play out in other fora or it will play out in an election. We have had the question: Why should someone who makes $50,000 as an employee have a different tax rate and a different situation than someone who runs a business and gets $50,000 out of it? I note that all the witnesses have told us that that's not the right way to look at it.
Mr. Moody: And I agree.
Senator Andreychuk: They told us that we should not try and compare the risks and disadvantages or advantages of an employee vis-à-vis someone who is running their own business, and that defining risk is different in both.
Mr. Moody: Absolutely.
Senator Andreychuk: The capability of navigating that risk is different. That one has been sort of worked out, I think, and there's some reflection on that. But another thing you're talking about is family units. I haven't heard it expressed that way, it's whether the son should get something. Your poor son. When you go home I hope he has a talk with his father.
Mr. Moody: I love him to death.
Senator Andreychuk: On the spousal thing, in the old days when I practised law, way back when, if the husband owned it, it was his. If the wife owned it, it was hers. Certainly the women's movement and others have pressed for a family unit. We got that. We weren't going to weigh your contribution in the kitchen, as we used to say, compared to out in the field, or wherever.
Mr. Moody: Right.
Senator Andreychuk: So we fought to get that recognition of 50/50. You said why should we wait until a divorce to have it. I remember going around and saying with all my worldly goods I thee endow. Don't believe it because what's mine is mine, what's yours is yours.
So aren't we going against what I thought was good social policy, to recognize contributions within a family unit so that they maximize their resources to raise the children, to be productive in a society, and we weren't going to stereotype jobs? I haven't heard much comment about that.
Mr. Moody: Well, actually, senator, my colleague Kenneth Keung and I wrote a blog on this, which was then turned into a Financial Post op-ed at the end of July on that very topic. The Carter commission, and I know all of you are reading the reports on flights and what have you because they're great reading -- that's sarcastic, by the way -- came out hard in 1966 to suggest that because the family is the basic economic unit of society, it should be the taxing unit. And then after many debates the Government of Canada at the time, in 1972, decided, no, that they were going to retain the individual.
Economists like Jack Mintz have trumpeted for years that that's a mistake and ultimately Canada should adopt the family, or a limited form of the family, as the taxing unit, like our neighbours to the south have done. I wholly agree with that, and that was the whole point of the op-ed piece.
I agree with you. To put a reasonableness test on spouses goes away from the social policy objectives that ultimately our society has worked hard to improve. This to me is a step backwards in the context of a spouse.
Senator Andreychuk: In this very turbulent world, how do we turn this around? It's become divisive in Canada. Most people don't know tax law. Most lawyers don't know tax law, except for those specialists. We rely on all of the expertise, but we hear things -- it's fair, it's unfair, et cetera. One segment of society is now saying it's unfair. Others are even more convinced that that segment had some sort of advantage that they shouldn't have had.
I don't know how the government is coming at which voice to listen to. We're hearing the one voice that says that these taxes are bad, but I do hear other voices who say go after them. How do we put the country together? We shouldn't be wasting our energy on this debate, since July, when we've got so many other factors that make us vulnerable in an economic sense in this world.
Mr. Moody: That's a great question. If I had a great answer, I guess I would be a miracle worker. My thoughts are that part of the solution is for transparent, all stakeholder engagement on comprehensive tax reform. Now, will that solve income equality issues that we currently have in society in general? No. Will it solve the attack on the wealthy, the release of the Paradise Papers and Panama Papers, for example? That's just, no doubt, an attack on the wealthy with all of its related politics.
So do I think it's going to solve things like that? Probably not. I agree with your premise, if I'm understanding you correctly, that we have a very fast moving society with a lot of competing objectives and things coming at us. But as far as tax goes, which is only my world, of course, I do think it's overdue for a comprehensive, true engagement tax reform.
Senator Mockler: To conclude, Senator Jaffer.
Senator Jaffer: Mr. Moody, you can see that we're all listening to you very carefully. This may not be a fair question to you just now. I don't expect you to answer right away. But one of our jobs, I believe, is to make recommendations to try and fix the system, to continue with what my colleague Senator Andreychuk was saying.
I have two questions for you. One is on split income and kiddie tax. I understand from all I read that there is a clear line and now we know. So that's clear. Is there a way that we could make it clearer with the split income?
Second, what could we say to the government? What recommendation could we make, besides saying scrap the passive income? Is there any suggestion we could recommend to the government?
Mr. Moody: Those are great questions. On the first one, I would answer that we have a model in the United States that is not perfect, but certainly appears to be closely aligned with the objectives that the Government of Canada appears to be interested in. It's worked. It appears to have worked from all the research that certainly I've done and talks to my U.S. colleagues. Why wouldn't you at least look at that as a model? So that would be my first recommendation.
The second question, without suggesting to scrap it, because you told me not to --
Senator Jaffer: It's just that they may not.
Mr. Moody: Right. My suggestion would be, and I saw somebody else recommend this -- I believe it was to your committee, but it might have been somewhere else -- to at least study this with the tax practitioner community, with academics who come from a wide variety of backgrounds, and maybe former government bureaucrats as well, and the government before you implement these proposals and before you release draft legislation, which I know they're fiercely working on. Get together. Engage with the community so that you can at least get it partially right. I don't think you'll ever get it right with these proposals, but at least get it partially right by having some engagement.
Senator Mockler: Mr. Moody, thank you very much. It was very informative. As we proceed to tabling our report in the Senate of Canada on December 15, if you feel that you want to add additional information, please do through the clerk.
Mr. Moody: Thank you.
Senator Mockler: Honourable senators, we now welcome our second panel of witnesses to this meeting of the Standing Senate Committee on National Finance. The order of reference from the Senate of Canada authorizes the committee to take two trips: Western Canada and Atlantic Canada. Also, in Ottawa we've held 13 public meetings. We heard from close to 60 witnesses and we received more than 30 written submissions coming in. There is a lot of interest in this study and the committee felt more consultation was needed. We decided to go across Canada to hear from Canadians and representatives of different associations and the industry and the sectors.
To the witnesses, thank you very much for accepting our invitation to appear before the Senate Committee on National Finance to share your opinions, comments, views, and recommendations as we go forward in tabling our report.
We have with us, from Ernst & Young LLP, Mr. Warren Pashkowich, Partner, Transaction Tax; and Mr. Barry Munro, Partner, President of Ernst & Young Orenda Corporate Financial Inc. and Ernst & Young Corporate Finance (Canada) Inc.
Also, from Catalyst Group LLP, we have Mr. Cam Crawford, Partner, and Mr. Carl Scholz, Tax Partner.
Mr. Pashkowich, please proceed.
Warren Pashkowich, Partner, Transaction Tax, Ernst & Young LLP:
Honourable senators, it is my sincere honour to present to you today. By way of background, I am a chartered professional accountant and a national leader of Ernst & Young's transaction tax practice. My area of specialization is the taxation of corporate mergers and acquisitions of both public and private corporations.
In the interest of full disclosure, you should know that I carry on an active accounting business as a partner in the firm of Ernst & Young and that I carry on that business through a Canadian-controlled private corporation that I own personally.
Over the past few weeks you have heard from a great number of Canadians about their perspectives on the new rules, how complex the new rules will need to be to work properly, how difficult it will be for the CRA to administer and enforce the rules nationally on a consistent basis, how increasing the taxation on private companies will negatively impact small businesses and their owners. Small businesses will have higher borrowing costs because there will be fewer assets to pledge to lenders. Small businesses will be less able to weather a cyclical downturn, thus the retention of the workforce for longer periods will be more difficult. Higher taxes will mean there will be fewer investable assets overall. In the fullness of time, less money will be reinvested in our economy, our national productivity will suffer, and counter to the government's objectives, there will be fewer opportunities for middle-class Canadians.
In my view, each of these statements is inherently true for the reasons you have already heard. Rather than rehash those reasons, I want to focus my comments on two areas: tax fairness and Canadian competitiveness.
I began practising tax in 1987. Over the last 30 years I've seen a number of significant tax changes enacted into our Tax Act. I can truly say that I cannot remember any particular policy change that has evoked so much outrage by those most impacted by it. Much of that outrage was fueled by the fact that hard working, successful, honest tax-paying small business owners were being cast as tax avoiders who were not paying their fair share.
There would be few Canadians that would quarrel with the ideals of tax fairness in making sure everyone is paying their fair share. Having a tax system that is clear and equivalent for all taxpayers and that looks to limit the amount of tax legislation and rules that benefit one segment of the tax-paying population over another is simply the right thing to do.
The ideal of tax fairness is inherently subjective and can be viewed in both absolute and relative terms. An employee and a small business owner face different risks, earn different types of income, each is allowed different deductions in computing income, but each is taxed on a full flow-through basis at the exact same tax rate. Each system may be called unfair according to who benefits or who is treated differently and could be considered fair in the sense that they are consistent and apply a rational approach to the taxation of each source of income. Both systems have significant tax and non-tax advantages and disadvantages that aren't available to the other, and that may prevent absolute fairness. But when one looks at each system on the whole compared to the other, relative fairness is possible and, in my view, is largely achieved today. In other words, the current system is imperfectly perfect.
The tax on split income and the passive investment income rules are intended to address real or perceived inequities in our tax system. From a tax policy perspective, the soundness of the tax on split income proposals turns on one's opinion of the correct tax unit. If the correct tax unit is the individual, then the proposals may advance reasonable tax policy objective. However, if the correct unit is the family, then the proposals are entirely inappropriate. Reasonable, informed people can and will disagree as to which unit ought to be preferred.
However, it would be hard for any Canadian to quarrel with the proposition that a household with two working spouses, each earning $50,000, should have materially more disposable income than a similar household where one earns $90,000 and the other $10,000, but that is in fact what our current system does.
The tax strategies to split income, such as dividend sprinkling, were developed by tax advisors to eliminate the relative unfairness that exists in our tax system. While it could be argued that the tax-planning strategies went too far when income is being split with minor children, it is undeniable that our current system has not achieved either absolute or relative tax fairness.
I would remind the honourable members of this committee that the taxation of the family unit was debated before, in 1999, and rejected for a number of reasons, including lost tax revenues. I would submit to this committee that if the policy objective of the tax on split income is rooted in fairness, then the tax unit should be reconsidered in the context of broader tax reform and the cost to government coffers should be addressed through other means.
The tax on split income proposal as it is currently written would introduce an absurd level of complexity and subjectivity into our tax system, impose administrative and compliance burden on taxpayers without achieving any incremental relative fairness in our tax system. If the government does not want to reconsider broader tax reform, then my strong recommendation is to limit any changes to the current system to children aged 18 to 24 and leave the balance of the system unchanged.
The second proposal deals with low taxed corporate retained earnings as a source of passive investment. According to the government's white paper, the low rate of tax on active business income on private corporations “was never intended to realize higher personal savings.”
While many would find it incredulous that successive governments for 45 years did not know and accept that was exactly what low-tax income could and would be used for, I think the more important question is whether this advantage available to private companies is unfair relative to the tax system as a whole.
The tax deferrals that apply to business allow private companies that do not require all of their after-tax income for immediate reinvestment in business, to accumulate portfolio investments that may be used to weather future downturns, to fund future business expansion, or to accumulate retirement funds for their owners. I would submit that these advantages, relative to other advantages that exist in our tax system, are not so disproportionate as to render them relatively unfair.
Similar to the split-income rules, the proposals would introduce a further absurd level of complexity and subjectivity to our tax system and impose a significant administrative and compliance burden on taxpayers without achieving any incremental relative fairness into our tax system.
The government talks repeatedly about the need for fairness in the tax system. As many commentators have suggested, let's take those statements at face value and start a discussion about what would constitute a fair system in 2017 and beyond.
I want to make a couple of introductory comments on the importance of competitiveness before handing this over to my colleague. Our Canadian corporations are most significant creators of employment and economic growth and prosperity for middle-class Canadians, compete globally for financial, intellectual, and human capital. In today's world, capital, regardless of its form, is highly mobile. Inevitably capital will flow to the jurisdiction that offers the highest risk adjusted after-tax return. This flow of capital was evidenced in the 1970s and 1980s when our manufacturing industry left Canada for lower cost jurisdictions. Most recently we witnessed the loss of our fledging LNG industry as the capital to build new liquefaction facilities moved to lower cost jurisdictions such as the U.S. and Australia.
As more experienced Canadians, we know that capital is critical to growing an economy and creating long-term benefits for Canadians. Capital creates employment for middle-class Canadians and allows Canadian businesses to adopt the latest technology, provide tools for workers, and develop new products and services for the global economy. When a business chooses to make investments, it is expecting the investment to support operations for many years. Thus when capital is attracted to Canada, it generates years of income for workers and suppliers, as well as tax revenues for governments. Last week the U.S. tax administration released its long-awaited tax reform proposals. The extent of those reforms is simply jaw dropping. The administration's tone toward business is in marked contrast to Canada's.
If the U.S. is successful in these tax reform efforts, the corporate tax rate will be lowered to 20 per cent, down from 35 per cent, and the tax on “hard earned business income of main street job creators” will be reduced to no more than 25 per cent. Countries such as Canada currently have a competitive advantage compared to the U.S., but will need to reconsider and make changes to its tax system in order to compete for capital in the future.
The full impact of the decisions we make today regarding the taxation of private companies will manifest themselves for years down the road. Ask yourself will our financial institutions continue to lend to businesses that are thinly capitalized because it was no longer advantageous to retain earnings in a business? If Canada's tax system unfairly penalizes its main street job creators, will capital be formed and accumulate in the future in more favourable jurisdictions, such as the United States? Will our children choose to form a business in Canada or will there be more incentive to move to the U.S. or elsewhere? As technology advances and our jobs can be performed anywhere, anytime, will our professionals, our doctors, our lawyers, our accountants, engineers choose to practice in Canada or in other jurisdiction that allows them to retain more of their hard-earned dollars?
Thank you for this opportunity.
Senator Mockler: Thank you.
Mr. Munro.
Barry G. Munro, Partner, President of Ernst & Young Orenda Corporate Financial Inc. and Ernst & Young Corporate Finance (Canada) Inc., Ernst & Young LLP: I appreciate the opportunity to meet with you today. I feel this is a special moment. In 1980, in the spring, I went to the Forum For Young Canadians. I don't even know if it still exists, but a policy-driven organization. As a young, naive person from Swift Current, Saskatchewan, that seemed like a big world. It taken me almost 38 years to get to speak about some policy matters.
I, too, am a chartered accountant, like Warren, and I have been blessed that I have been recognized as a fellow of the chartered accountants. I have almost 34 years’ worth of experience working with Ernst & Young, none of which is in the tax practice. So my perspective advantage point is going to be quite different today.
I currently lead what we call our corporate finance business, which is our mergers and acquisitions business, our capital-raising business, our transactions, real estate business, and our infrastructure advisory business across Canada. So I regularly interact with people from Victoria all the way to Newfoundland and travel extensively.
I've previously served as our oil and gas leader for Ernst & Young in Canada and visited I think about 25 different countries around the world in that context. I worked with global players investing into Canada, and I've served as the managing partner of Ernst & Young in Calgary.
In addition, from a community service perspective, I work with the YWCA, the United Way, Calgary Economic Development, and the Calgary Stampede Foundation, all to say that I believe what I bring is a broad context of what's in the hearts and minds of Canadians around this particular issue and people as I think carefully, in a very trying time, about what's going on in the world and watching a very divisive and dynamic world elsewhere. My vantage point, as I said, is not as a tax practitioner. I spend almost all of my time advising entrepreneurs these days around the key choices they make around capital: the cost of that capital, the allocation of that capital, and the price of that capital, and throughout the transaction's lifecycle from business formation to ultimately when we sell businesses. We primarily serve mid-market companies. We don't get engaged typically with one- or two-person employed companies, but businesses of between $25 million to $250 million of value; businesses, when we sell them, that attract global players to the table.
In the interest of disclosure, like Warren, my interest in the Ernst & Young partnership is held through a professional corporation, of which I'm the only shareholder.
My interest is in this debate and dialogue and the important role that I believe that the Senate is playing. In part, I'm going to try and answer the question which was asked of Mr. Moody, which is really so what should our recommendations be.
It seems to me, as Warren just noted, that despite the significant revisions that were made in October -- I believe that those were made not from a policy perspective, but from the political pressure perspective -- we missed the point. We missed the point of this great debate because at the fundamental core we're talking about an important choice around policy, and those many important policy questions. I'm going to talk about three of them that I think remain untested. And perhaps the Senate committee can capture those policy questions as part of challenging the right process on behalf of Canadians. In some ways I think the Senate's responsibility in that regard might be the greatest that it's ever faced recently because this issue is so significant across the country.
My three big policy questions are really around fiscal strategy, and I'm going to give you some more questions. They are the collection and timing of tax revenues, global competitiveness. Warren talked about that and I'm going to add to that as it relates to the role of tax in creating a globally competitive country. Third, and it’s near and dear to my heart, and too many of yours, the notion of how we support entrepreneurship, which is really job creation and ultimately wealth creation and country prosperity. That really drives to this notion about how tax impacts business investment and growth.
It seems to me that when I think of each of those three there are some important questions that I would like to table today as part of my debate. Again, I don't believe that I'm well suited to answer the questions about the detailed proposals. I would rather focus on the policy issues.
On the fiscal strategy, I don't know the answer, but the question is: Is there clear evidence that there's significant leakage in the current system, which is well understood, to warrant changes that go beyond what seems to be a system that, as Warren said, works?
Second, you asked the question, and Kim Moody addressed it: If there are abuses in the current system, what role can enforcement play in focusing on the abusers? If we have a system that does not work, perhaps we really have a question about whether our enforcement provisions are properly focused.
Last, around the fiscal policy perspective, I would say in the context of Canadian demographics, where structurally we are facing a rapidly aging population, what's the right balance of a higher tax base today versus higher tax revenues in the future? In all cases, what we're really talking about is when income is taxed ultimately, so in all cases, ultimately tax will be paid. It's just a question of where it gets accumulated and when it gets distributed. In my mind that really becomes a question of when that tax gets paid and at what time.
With respect to the notion of support for entrepreneurship, it would seem to me that evidence suggests that most jobs and most real economic growth are generated by small- and mid-size businesses. I think everyone would generally accept that. I'll call those the entrepreneurs. So the question from a tax policy perspective should be, in my mind, what role should government play and what role should tax policy play in supporting entrepreneurship? What does that entrepreneurship look like? What role should tax policy play in ensuring that there's adequate capital available to invest in the risk takers and entrepreneurs take and how ultimately can supportive tax policy create a competitive advantage for Canadian entrepreneurs when they have to compete on a global stage?
From a global competitiveness perspective, I would make an observation: It would seem to me, and I'm sure all of you would agree, that disruption is accelerating. Disruption around the world is accelerating at a pace that none of us have seen, but ultimately what we're moving to is a knowledge-based and a service-based economy. That has a profound implication on where services are provided. So capital in these economic models doesn't see borders as a constraint because capital can reside wherever it chooses to and move across borders and in a knowledge-based or a services-based economy have less ability to tax the physical assets.
What's also been happening in Canada is that all jurisdictions have been raising taxes. We hear that when we go from places like the United Way to ask for donations, because the donors there often say that they believe they're funding critical social services in a period of time when their tax dollars are going up. But all jurisdictions in Canada have been raising taxes at a time, as Warren pointed out, when globally the push is on actually reducing taxes. So every jurisdiction around the world is actually reducing taxes at the same time that Canada has turned its attention to raising taxes.
Add to that the challenge in Canada, that we've been on a path of increasing regulation across all sectors and all industries in multitudes of ways at all levels of government. Again, at the same time many of our biggest competitors are busily streamlining regulations and trying to create greater competition.
The questions that really flow out of that context of global competitiveness from a tax policy perspective are: One, what role does tax policy play in ensuring that Canada remains competitive and that we can attract the very best and retain the very best talent and, therefore, capital will support that talent? Second, what role does tax policy play in stimulating business investment and reinvestment? Warren referred to the LNG industry. That would be a critical one where you can use tax policy to enhance the strategies. In fact, there were revisions, if you recall, during the process where the rules were changed for CCA deductions as part of that. How does that tax policy then encourage risk taking from a global competitive perspective? Last, how can tax policy be effectively used to create a globally leading innovation ecosystem? If the world is going to this knowledge-based economy where the difference is not going to be who owns the physical assets, but who has the intellectual capital to actually take advantage of those assets, how can tax policy drive the retention of the knowledge that will drive that? So I think those questions fit into the three.
On an overall basis, I guess my hope or my ask of the Senate committee would be -- like Mr. Moody, many other people and Warren referred to – a recognition that there is a critical, essential need for us in Canada to stop, particularly in the context of what's happening in the U.S., and have a vibrant and thoughtful tax policy debate. What is it we are trying to achieve? How are we trying to protect Canadian jobs and Canadian individuals? We need to have that dialogue and debate prior to implementing any changes. Effectively, what has happened because of the changes in October is that entrepreneurs across the country are more confused today than they were the day before, in early July, when they didn't realize that the world was going to be turned upside down because we're half-baked on a number of proposals. We've backed off on some provisions. We said there's more details to come. So you create uncertainty.
What uncertainty does is it stalls decision-making. I think there's this critical need and a great opportunity for the Senate to drive a thoughtful and thorough tax policy conversation for Canada that probably hasn't happened since 1972, when Warren and my former partner Walter Gordon brought the tax act in.
Thank you.
Senator Cools: He was a very famous and well-loved man, Walter Gordon.
Senator Mockler: Mr. Crawford, please, to be followed by Mr. Scholz.
Cam Crawford, Partner, Catalyst Group LLP: Thank you very much for the opportunity today, and I appreciate all the work that you folks are doing on behalf of the people of Canada. I'm going to try to compress my remarks a bit, because I know we want to leave time for some questions from the committee.
I've practised in southern Alberta for about 35 years. Our client base at Catalyst is virtually exclusively privately owned, small to mid-size businesses, most of them family owned. They have been significantly impacted by the proposed tax changes.
Like Mr. Munro, I'm not a tax expert, but I do access the services of tax experts in trying to do my work, which is principally buy/sell transactions, planning for business succession, advising on strategic projects, again, most often with private businesses and in the context of the family.
So I'm not here to comment on the technical chapter and verse. Rather I would like to share with you my thoughts on the general state of paralysis that has been brought on by the uncertainty, and it has gripped private businesses as a result of these changes. I want to share some views on what I see is the current sentiment of business, in this part of Canada at least, regarding these changes and perhaps in a bit broader context.
As a consumer of professional tax advice, I've got six professional designations and over 35 years' experience. I've got to be honest, I find myself overwhelmed by the current situation regarding what I think is arguably a relatively innocuous element of taxation. I think it's been extremely overblown. You can imagine how clients feel trying to work in that context.
A couple of examples. I have a client situation involving an intergenerational transfer of a significant agricultural operation, and that is now on hold because we cannot interpret the tax changes and understand what the impacts are. And as a direct cause and effect, there's now relationship issues that have emerged between members of the family, in part as a result of that delay.
I've got a matrimonial property settlement involving a restructuring of a very small private business, a couple of million dollars’ worth. This situation is now on hold. Related to the business aspects of this matter is a custody situation involving two young children. That is now on hold as well. I have a major business sale that hangs in the balance, in limbo, because of the uncertainties regarding the effect of these proposed tax changes. I'm here to tell you is that these impacts are real. The impacts are hurting real people. They're hurting real Canadians at so many levels that are significantly inappropriate.
The best description of the current mindset of our clients is one of anxiety and an ever increasing distrust of the government. With respect to this process, I understand that over 21,000 submissions have been made in response to the tax changes, most of them authored by very smart people. I can only imagine where we would be today if that effort had gone into consulting with these highly qualified folks prior to the release of the proposed changes, at a minimum, and now with the subsequent backtracking that we're experiencing.
I did a bit of quick math. I think 50 people could have worked for a year in the amount of time that's been invested in putting these submissions together. If we had 50 of the smartest people in Canada with the best interests of Canada at heart working for a year on fundamentally reviewing principles of taxation, I think we would have been a lot better off than we are now.
I've got six things I would like to share with you. Probably most of them you've heard.
The first one is fair is not identical. And I believe there's a fundamental flaw in what appears to be much of the reason behind the proposed tax changes; namely, that an individual in a business that is owned by that individual should be treated identically for tax purposes to the individual employed by a business that they do not own. Both of these taxpayers need to be treated fairly, but that does not mean identically. To me the contrast in these two situations is stark. I know you've had many submissions on this point, but I believe it is a point worth repeating.
The employee-only individual for the most part has no risk, other than perhaps a loss of their job due to economic downturn or their own misconduct. Otherwise things are pretty secure. These individuals often have the umbrella protection of a collective bargaining agreement, wages are guaranteed, benefits are significant and assured, holidays and vacations are certain, workweeks are set, pensions are provided, and these individuals enjoy many other aspects of certainty and stability.
The employed individual who has his or her own business is in a very different position. Most, if not all, of the family net worth is on the line and at risk, remuneration is most often based on profits and is uncertain, benefits are often non-existent, and most would answer, “What are those?” if asked about holidays. Hours are often 24/7, and generally these individuals face a great deal of uncertainty and instability.
I'm not saying that an owner employee should be entitled to lucrative tax breaks. I'm simply submitting to you that these situations are very different. To categorically claim that these two constituencies of taxpayers need to be treated identically and base tax rules on that presumption is a flawed logic, in my view. Let's try for a tax policy that's fair to both of these constituents of individuals. I submit to you that that will not be identical.
My second point has to do with a sledgehammer and a finishing nail. From what I have read and gleaned from discussions with colleagues who practice tax, I understand some of the arguably legitimate concerns of the proposed changes could have been addressed with relatively minor changes to existing legislation. The proposed changes have been described as using a sledgehammer to drive in a finishing nail. The sledgehammer, of course, does a lot of damage in the process, like an income tax rate of 70 per cent in certain situations, it appears.
The justification for use of the sledgehammer also appears to be government rhetoric about closing loopholes and that small business owners are tax cheaters. Although perhaps popular with certain audiences, this positioning is, of course, preposterous. Business owners have simply availed themselves of tax-planning strategies clearly as permitted by the legislation. I submit to you that there is no crime in that.
My third point is getting pretty deep, and I appreciated the senator's question to Mr. Moody in the earlier session in looking for what are the systemic, deep, societal issues that we seem to be confronting with this backlash. So my point number 3 is titled respect for the Canadian business community. It seems to me that the introduction of these tax changes and the accompanying government position is a stark example of systemic demonization of business that seems quite popular in this country at present.
I would like to quote something that was written by one of Calgary's pre-eminent business leaders recently.
. . . I refuse to sit idly by when the people and organizations who have invested heavily to . . . create jobs, and generate economic growth are disrespected and chastised.
In this economic environment, we can't afford to continually elect politicians who don't see [members of] the business community for what they truly are: partners and allies.
The only way to move . . . forward is . . . to work together and treat each other with respect. This clearly does not exist today.
. . . Don't buy into the line that . . . the business community is somehow bad. At the end of the day, we are all in this together, and we won't pull out of this economically challenging time by bashing people who give their blood, sweat and tears to grow their business, pay taxes, provide jobs and grow our economy, not to mention generous philanthropic giving.
So as a society, it seems to me, that Canadians are bending over backwards to make sure everyone's voice is heard and that we are treated with fairness, dignity, and respect. That's fantastic, and that's a hallmark of Canada's identity on the world stage, I believe. But I submit to you that the business community in this part of Canada, and perhaps elsewhere, is not feeling the love. These tax changes are potentially just another part of that.
My point number 4, and you've heard about it: certainty, predictability, and clarity. Those are three things that are essential for Canadian business to operate successfully. I submit to you that we couldn't have a greater time of uncertainty, unpredictability, and a lack of clarity than we do now.
Point 5: You've heard it, and I'll call it a silver lining. I don't understand all of the chapter and verse of the tax law and the tax code, but if there's any good that's come of this situation, this great hue and cry and all these objections that have been raised, may be the straw that broke the camel's back kind of stuff. What we are seeing is this pent-up outrage to the patchwork of legislation, interpretation, process, and politics that make up the Canadian tax system. I submit to you that it's time for a major overhaul.
My final point is, again, nothing new, but I'm calling it my optic indifference. That's my firm belief that the primary driver for Canadian tax policy should be ensure competitiveness. You've heard lots about that. Good things that in my view all feed into a healthy societal prosperity emanate from a healthy economy, and tax policy has a lot to do with achieving that competitiveness.
We've heard lots about the situation going on south of the border with tax rates changing. If that gap in tax rates between the U.S. and Canada widens, we will see a flight of capital out of Canada, and it will be significant. Job-creating and prosperity-building capital will seek jurisdictions that have competitive tax policy and it will leave jurisdictions that do not.
Thank you very much for the opportunity to speak with you today.
Senator Mockler: Thank you.
Mr. Scholz, please.
Carl Scholz, Tax Partner, Catalyst Group LLP: Good afternoon, and thank you for inviting me here today. My name is Carl Scholz and I'm a tax partner with Catalyst LLP. I'm here on behalf of my clients who can be regarded as small to medium-size private corporations. Our clients trust us and look to us for advice as it relates to taxation matters.
I can say in the almost 20 years that I've been practising tax that it is becoming more and more difficult to advise our clients given the level of uncertainty in the system and also the complexity in the system. Those are the two items that I would like to talk about today: uncertainty and complexity.
First with respect to uncertainty. As we know, some of the July private corporation proposals were either scaled back or eliminated in the announcements made by the government the week of October 16. However, there have been other changes in the tax landscape besides those announced in July that have had a significant impact on private corporations.
Effective April 21, 2015, the government amended various aspects of the tax rules that allow or prevent related corporations from paying intercorporate tax-free dividends. The amendments resulted, similar to the current private corporation proposals, in submissions to the Department of Finance pointing out issues with the amendments and areas for improvement. Amongst other things, the amendments created uncertainty as it relates to discretionary dividend payments between related corporations. In response, various technical interpretations were provided by the Canada Revenue Agency. The CRA conclusions in some of the technical interpretations were unexpected and for a period of time there continued to be uncertainty as to whether a tax-free intercorporate dividend could be paid without risk. This risk was assessed as so substantial that one large accounting firm advised their clients not to pay intercorporate dividends until there was more clarity on the rules.
Now we have the July private corporation proposals, along with announcements made the week of October 16. We know that the income-sprinkling proposals are moving forward effective January 1, 2018, but we do not know exactly how the government is proposing to simplify the reasonability requirements or whether other controversial provisions in the draft legislation will also be enacted.
With regard to uncertainty and with reference to the proposed income-splitting rules, should we not know exactly where we stand, given that in 54 days these rules are to be effective? Our clients are looking to us to advise them, and we can't.
Taxpayers and their advisors are looking for clarity and certainty.
Next, the matter of complexity. In the context of investment income earned by a Canadian controlled private corporation, there are various concepts in the Income Tax Act that work together in an attempt to achieve integration. Some of these concepts are: refundable portion of Part 1 tax, Part 4 tax, refundable dividend tax on hand, dividend refund, and the capital dividend account. Let's call this the current system for investment income earned by a CCPC.
Now, introduce the passive investment rules, where a corporation, and indirectly the shareholder, are limited to $50,000 per year of investment income such that they are not subject to the punitive 73 per cent tax rate. In order to achieve this result, the $50,000 of investment income earned by the corporation would have to be subject to the current system. Investment income in excess of the $50,000, would be subject to a different or expanded system yet to be designed by the Department of Finance.
The legislative complexity to adequately manage this is concerning. In my opinion, it has been made worse with the introduction of the $50,000 threshold. The legislation governing passive investments would have to very generally track returns on investments in place at the time the passive investment rules are enacted since the government has indicated that it will grandfather existing investments from the rules; allow for investment turnover and substitution to ensure grandfathering of the investment capital; differentiate between different sources of the investment capital; specify the types of income included in measuring the $50,000 threshold; presumably create rules to prevent the multiplication of the $50,000 threshold where there is more than one holding company in the corporate structure; create ordering provisions when dividends are paid; allow for the conversion of operating businesses into investment-holding companies that were in existence at the time the passive investment rules were enacted; create exceptions to the passive investment rules where investments are made in other operating companies, i.e. the start-up situations.
There are many other technical aspects that would need to be included in such an endeavour. The point being, however, that the complexity just keeps building.
In closing, private corporations, their shareholders, our clients, will continue to face an unprecedented level of complexity in administering their tax affairs. Since April of 2015, our clients have had to navigate the amendments to the intercorporate dividend rules and amendments to the small business deduction rules. They will now have to navigate effective January 1, 2018, the income-splitting rules and eventually the passive investment rules.
Perhaps it's time to hit the pause button on all of this and assess if there is a better way.
Thank you.
Senator Mockler: Questions will start with Senator Marshall, to be followed by Senators Pratte, Jaffer and Tannas.
Senator Marshall: I almost don't know where to begin. Somebody in their introductory remarks used the word “overwhelming,” and as you were speaking I was overwhelmed too with what you were saying. I also found it kind of frightening. I know we're looking at small businesses and at just these tax proposals, but what you were saying was really broadening. Last year, we saw the individual tax rate on high income earners go up to 33 per cent. I know that the tax rate for what they consider middle income went down, but their taxes actually increased, because the Fraser Institute did a study. So that was for the individuals.
This year, we're seeing these tax proposals for small businesses. So I would expect sometime soon we will see something targeting the large businesses.
I think all of you talked about competitiveness in Canada, about capital being mobile and about individuals and companies looking to move south of the border. I'm looking at all this and I'm thinking it's not just the tax proposals, it's everything now -- it's NAFTA, it's the uncertainty, it's what happened with the individual taxpayer.
I'm also looking at the publicly traded companies in Canada. A lot of them have some business in the States, Australia or Mexico. We have all these pressures with regard to tax rates: NAFTA, regulatory reform, and even what you have referred to as the government’s attitude toward businesses, the environment, and what they're saying about businesses being tax cheats. It's not just small businesses. From what you're saying, this affects everybody. It's going to spill over. We've already had our issues with individuals. Now we have small businesses. I can see all this spilling over into big businesses.
What's your opinion? Do you see that as almost like a trend? It's not isolated to just small businesses, it's bigger.
Mr. Crawford: That was a part of a lot of our comments. All I can do is bring my practical experience to this table on what's going on. I have a situation with a client that's involved in a wonderful conservation design development community plan in the Calgary area. We have a multinational partner that currently, up until recently, had $125 million in capital invested in Alberta. This project was going to take another $75 million. This company was going to have then $200 million of capital invested in Alberta. They've now been instructed to reduce their capital investment in Alberta to below $100 million. Is that an isolated incident? I don't believe so. That's all I can do, is bring you my practical experience. I know in that case $100 million in capital is disappearing out of Alberta.
Senator Marshall: So it's all bad news. So you're just talking about certain things. I'm thinking about the pipelines that aren't going to be built. Where is our economy going in the long term? Are we going to be like Jeff Ban? Jeff Ban has been stagnant for decades now.
Mr. Crawford: Your introductory comments were perfect because it is a number of issues. In my remarks I talked about the straw that broke the camel's back, and that's what this feels like. There are just so many things that don't seem to be getting addressed, and we're dealing with this tempest in a teapot of these small business tax changes, which really at the end of the day aren't that big of a deal, but they've become such a lightning rod of discontent.
Senator Mockler: Mr. Munro.
Mr. Munro: Yes. I think you, again, Cam talked about this, about the issue of a policy perspective. If the question came up about how to create a competitive Canadian economy that would attract capital and jobs and create wealth so that everybody benefits, you would not have created a complex tax structure that benefits the four of us, to be perfectly blunt, because the complexity means that the professional services time to support that is great.
I would say, like Cam, in almost all jurisdictions of the country in the last six months we've seen a stall on inbound capital investment, along with the increased angst amongst business owners about who's going to buy their business, how can they afford succession planning, how do they finance growth, what’s the total return for the risks that they're taking on. So we've created a great deal of uncertainty partly driven because we have not had a robust policy conversation about how we create a competitive economy. We've done that in an environment where our biggest trading partner is busy unwrapping everything we historically believed to be true. So why would we go first in that debate, because we don't have to go first?
I negotiate for a living. I help people buy, sell companies. You would always have a negotiating tactic. You would not table your position when you don't have to. So we can watch what happens in the U.S. It would be the most logical place for our capital to flow. Respectfully, Carl or Warren can live in Montana and serve their clients because the Internet allows you to do that.
So I just don't know why from a policy perspective we would move first. We ought to be concerned. Cam, you're right. We ought to be really concerned. That's why I think the job of this committee and the importance of it has probably increased in the last three weeks as we've thought through what the implications are.
Senator Marshall: I'm not so familiar with the other company that's represented here, but Ernst & Young is a big company. You're dealing with, you know, not just small businesses, but individuals and large businesses and publically traded companies. So you're seeing the whole gamut. What are you seeing? Are you seeing that there's a contagion, you know, where everybody is on edge now? Is everybody on edge?
Mr. Munro: I can only watch the flow of capital. Every global oil and gas company has sold their large assets in this marketplace. Our largest pipeline companies have made acquisitions in the U.S. and elsewhere.
The Canadian banks are deploying their capital elsewhere.
Senator Marshall: They're getting ready.
Mr. Munro: So everybody is doing that for a reason. They're thoughtful people. They care.
The business risk you have is when you start losing head office talent. You lose the wealth creators and the generators, and that's a great risk that we face
Senator Marshall: I would like to hear from all the members of the panel. Mr. Pashkowich, you were the first speaker. You sort of made me sit up and listen initially. I would really appreciate everybody's comments because it's more than just small business owners.
Mr. Pashkowich: In my line of business, I act for a number of private equity firms out of New York. Private equity firms are simply large buckets of capital looking to invest in a business. If you go back over the last five years, it was probably the single largest source of capital for Canadian businesses. In the last year, things like the carbon tax and the extent to which carbon tax would be applied to business; the increase in corporate tax rates, both in B.C. and Alberta, to the highest in Canada now; the increase in taxation of individuals and executives, all have caused the flow of capital into Canada to just take a pause. They're taking a step back and they're looking at what the environment is doing.
A number of large businesses with large amounts of capital wanted to come to Canada to create an LNG industry. However, slowly but surely, either through regulatory hurdles, protests by a minority of folks in Canada, municipalities, we no longer get pipelines built. We no longer get LNG facilities built. Capital again has another hurdle to go over before it can come to Canada. Now, private equity is simply taking a pause and saying, “I don't know if I want to invest in Canada today.”
Mr. Crawford: I don't have much more to add, other than one piece, which I don't think has been touched upon. That's this notion of if U.S. tax policy succeeds in implementing a flat tax, 10 per cent is what I've heard, on repatriation of capital that's now parked offshore -- we've learned a lot more about that in the last 48 hours, thanks to some releases -- if that capital is allowed to be only taxed at 10 per cent and comes back into the United States, there is going to be this massive block of capital that the United States is going to use to fire up the engine. It's going to be fuel in the tank. If we have a competitive tax environment, amongst other things, in Canada, some of that capital might find its way here. I submit to you that it won't under the current regime.
Mr. Scholz: I'll just add my comments very quickly. The clients that I work with are pretty small. They're small private corporations to mid-sized corporations. The majority of them are family businesses. So family circumstances keep them in Canada. They don't want to necessarily move abroad. I don't think they will move abroad just because of the taxes. Usually it's warmer climate rather than the taxes.
I can tell you, and it's completely unrelated to the private corporation proposals, it was when the federal income tax rate was increased to 33 per cent. Just before that we had a change in government in Alberta with the NDP coming in where the top rate went to 15 per cent. We had several meetings with a very wealthy client that was looking at moving down to the U.S. – because it’s completely fed up with paying these exorbitant tax rates. The only thing that really kept them in Canada was that if they moved to the United States, there would be exposure to U.S. estate tax.
Senator Pratte: I have a couple of specific questions, but I would just like to make the point that I understand the concern and the anger with the language used by the government on July 18 and in the following weeks about that money and so on. However, we do have to acknowledge that the government has changed its language, and the proposals changed significantly in the week of October 16. The details are not there, but there has been a change, and I think we have to acknowledge that.
Mr. Crawford used the expression that the government was using a sledgehammer on a finishing nail. I think it has been made pretty clear by the minister, who appeared in front of us last week that the government will go ahead with what is left of its proposals on passive income and on income sharing or income sprinkling.
I wonder if you would have some recommendations that we could make to the government on other tools they could use instead of a sledgehammer, something that could be useful in reaching their goals that would better target the kind of income, people or companies that they're aiming at on income sprinkling, for instance, and also on passive income.
Mr. Crawford: I'll make a quick comment since you directed the question to me, but it will only be on process. I'll turn it over to my colleagues to talk about the technicalities of what could be changed. It's this whole notion of the lack of consultation that got us to where we are. I frankly do not understand how tax changes like the ones released July 18 could have been released without some sort of consultation from all of the bright people that have been contributing input in the last short while as to the problems.
The point is that we didn't need to have a sledgehammer. It needed a nice little finishing hammer to drive in the finishing nail. Somebody should have figured out a long time ago that it should have been a smaller hammer, not a sledgehammer.
I'll ask my colleagues if they have any thoughts on the specifics. I think your question was what other mechanisms could be used to accomplish that result.
Mr. Scholz: I knew that question was going to come so I gave it some thought. I don't know if I have the answer with respect to the passive investment proposals. A number of years ago we had a taxable capital tax where the capital of a corporation was subject to a small tax rate. I belong to various tax study groups, and we met and discussed what the possible proposals might be. I thought there might be a taxable capital type concept. Obviously, it existed for large public companies at one time, and someone smarter than me concluded that was not a good tax and it was abolished. I query whether it makes sense to raise it now in respect of the private corporations. That would be my best answer in respect to the passive investment rules; notwithstanding it may not be feasible. It would be a type of calculation that tax accountants have seen before, for example, rather than recreating a new system. Frankly, the taxable capital calculation still exists within the act, because to the extent your capital base in your private corporation is in excess of $15 million, it grinds down your access to the small business production.
With respect to the income-sprinkling proposals, I completely agree with what Kim said. I think it makes sense to target the 18- to 24-year-old individuals. The government released a graph or a chart in its consultation paper showing a spike in terms of income allocated to those age groups. To me, it would be an easy target. It would a bright line test based entirely on the age of the individual.
I have trouble, though, including spouses in the income-splitting proposals. Spouses do so much behind the scenes now. Then, of course, you have the family law aspects as well. I find it difficult when a spouse who, for example, stood by the other spouse and supported that business for, say, a 15- or 20-year period as that business was growing is now subject to these adverse tax consequences; it just doesn't make sense to me.
Mr. Pashkowich: Just a couple of comments. I laid it out in my introductory comments. I think the proper tax unit in Canada is the family, exclusive of minor children. I think that if a husband and wife or a couple is looked at as a single tax unit, it takes away and neuters the entire benefit of income sprinkling.
I think that there is an existing tax on split income that applies to under 17 year olds. Just simply expand that to include the 18 to 24 year olds. I think that that addresses the vast majority of the policy issue concerns that they had going into this.
When it comes to the passive income, short of abolishing exactly what they're proposing to do, if they're going to bring something in, I think the most important thing to do is to limit the damage. By limiting the damage, I mean, at $1 million. A million dollars seems like a lot of money, but relative to some of the businesses that are out there, $1 million is not that much. So increase that cap to something that hits the uber-wealthy. They always like to point fingers and say that it is the rich who are avoiding taxes. Look at bringing the level up to a point where it impacts fewer people. The people who will be most significantly adversely impacted by these rules and the complexity of the rules are people who don't have the ability to understand what the rules are. They don't have the resources to pay for people to help them understand what the rules are.
That complexity is, one, going to breed a whole bunch of non-compliance because they just don't understand; and, two, it really is going to force people to prematurely distribute their income out of their corporation so that they can avoid the issue in its entirety.
So target it at fewer people and increase the threshold.
Senator Pratte: It has been suggested, for example, that we could have a threshold that is a percentage of something, a percentage of retained earnings or a percentage of revenue or something. Would that be a possible avenue in your mind?
Mr. Pashkowich: Again, any time you start to put sliding scales or percentages, it's subject to manipulation, it creates further complexity in the system. I just think you pick a threshold number, $15 million, $20 million of retained earnings. I remember a time when people thought that it was a good thing to have retained earnings in a corporation. It showed a solid business, it showed a successful business and it showed success. Today it seems like it's being turned around as being a bad thing.
Senator Jaffer: Mr. Scholz, on passive income, you set out various details as to what you thought it should be. I followed what you said, but I couldn't then put it down to what the recommendation should be. Our great experts will. If you could see how that could be turned into a recommendation, that would be very useful. Mr. Munro, I unfortunately have to leave, but you have talked about debate. When you say debate do you mean a royal commission? It would be good to hear from you about that.
Mr. Munro: I personally would go to a royal commission. This is an important issue about the competitiveness of the country, and we should take advantage of a structure that we believe in to allow people to properly debate that, and you'll get to the right answers through that process.
Senator Jaffer: Thank you very much.
Senator Mockler: Senator Andreychuk, before you leave, you had a question.
Senator Andreychuk: I just want to thank the speakers. They've very calmly put out some of the issues and have done so in a constructive way. What we're really struggling with is how to make the government understand how important this is. It's not a question of trapping the government or embarrassing the government. We have had other people say they genuinely were trying things, but the unintended consequences are so severe. That's what the committee is going to struggle with. How do we convince the government that this is important, important to get it right, not just because of the tax and the families involved, but Canada strategically?
The government is doing some very good things in other places. I'm on the foreign affairs committee, where we're looking at competitiveness with other countries, we've looked at trade agreements, and how to bring up the small enterprises into the mid-sizes to be able to work in the world market.
So there are all those good pieces the government has put out, but this is going to unwind everything that they've done. I guess we have to give some thought to how do we convince the government that this is as serious as it is? Perhaps it means that all four of you should be talking to the Prime Minister or the minister rather than us; but, thank you.
Senator Mockler: Senator Cools, and then I also have a question.
Senator Neufeld will follow Senator Cools.
Senator Cools: I would like to thank you gentlemen for extremely coherent and clear-minded presentations. It is my opinion that your statements today are the finest that we have received to date on this subject matter.
This thing, whatever it is, that has taken hold of Canada and the Government of Canada is extremely serious. I believe that unless we can find an approach or a door to open the way to some solutions we will be full-fledged into, one, an economic crisis; and, two, a constitutional crisis. The business of taxing, after all, is one of the major constitutional duties of any government. From what I see and sense everywhere in the public, and I'm going past the anger and the rage that was first expressed, is just simply inertia and paralysis. Nobody seems to know what to do.
We took up this cause and decided to study this matter some weeks back because we thought that we were in a position to do so, that it was necessary and that somebody had to do it. This matter is an extremely serious one and, I have to tell you, it's causing us a lot of worry. No one wants to see any government fail, nor do we want to see any government collapse under public disregard or public disrespect.
I hope I haven't sounded too dramatic, but this is very real.
Senator Mockler: Any comments on the senator’s comments? I thought we had a question.
Senator Cools: Well, I can give you one or two or three.
Senator Mockler: Mr. Munro?
Mr. Munro: I would say, on behalf of all of us, that you're absolutely right. This is a critically important issue.
Senator Cools: Serious.
Mr. Munro: I actually think the task in front of you is greater and of greater importance today than it was two weeks ago.
Senator Cools: Two weeks ago, yes.
Mr. Munro: Or three weeks ago. What happened two or three weeks ago was in reaction to intense political pressure, respectfully and honestly spoken. The challenge now is that it has left us halfway through. Carl when talking to his clients still can't give them any of the important answers.
We in Canada we're proud of our trust of governing institutions. If you lose the trust of governing institutions from a vital portion of your economy, you do so at great peril, I believe. We do have to propose a path to the governing party to restate the key questions because they ask some good ones.
As I said, I believe the questions are: How do we create a competitive economy, how do we support and grow entrepreneurs and what should our approach be to our fiscal system? What do we tax? What do we not tax? When do we tax it? How does that play into our rapidly aging population? These are important questions that should not be taken lightly.
Senator Cools: Thank you very much.
Senator Mockler: Senator Neufeld, please.
Senator Neufeld: Thank you.
This has been a very interesting discussion. I got some of the same feeling that Senator Marshall had, that this isn't just about small businesses, this is a huge thing.
Mr. Crawford, you had said there were some minor changes we could make to fix the problems. You don't have to answer today, but if you could provide to the clerk what you, or any one of you think what those minor changes would be, I would appreciate that. If you provide it to the clerk, we all get a copy of it.
We've talked and heard about the language that was used when this proposal first came out, and we recognize that the language has changed. I asked the question, just to light fires: Why was it used in the first place?
When you folks were talking, it reminded me of what happened in the 1990s in British Columbia. I'm from British Columbia. I live in Fort St. John. An NDP government came in, using much the same mantra, business has to pay its fair share. We went to a corporate capital tax in the 1990s. We went from the lowest personal income tax rates to the highest personal income tax rates. These are the things that you've talked about. We went from the lowest corporate and small business tax rate to the highest tax rates. We had the lowest per capita debt of any province in Canada, and we went to the highest under that administration, and business left en masse. One example, Finning International Inc. which had its head office in Vancouver for so long we can't remember how long, picked up, left the building, and moved to Alberta. I know people who were born and raised in Fort St. John whose their family businesses were started by their parents and they ran them, and they moved those businesses to Grande Prairie. The busiest business was the moving man. They took us to a have-not province in eight years. That's what happens when somebody says “Well, somebody has to pay their fair share.”
We're experiencing some of that right now. It bothered me when you folks laid out what takes place, and I think it was very good testimony.
Mr. Munro, what do you think about the cancellation of the Energy East Pipeline? How does that relate to the Kinder Morgan pipeline that's going to British Columbia? You talked about LNG and those kinds of things. What do you think? Is that a result of not just the price of oil or other things, but as a result of some other things? Maybe you could enlighten us a bit.
Mr. Munro: Well, we've missed a glorious opportunity with Energy East, and it had nothing to do with the price of oil. It had to do with strategic choices about where Canadians wanted to buy their oil from.
TransCanada didn't approach the project lightly. They put $1 billion of shareholders' capital into a regulatory process that continued to evolve. The reality is that TransCanada has the ability to allocate its capital in multiple ways. It has a U.S. pipeline business. Effectively, what we've done is we've shifted, through a policy decision, profits to the U.S., because U.S. refineries are happy to have us ship the oil through Keystone. So there will be a pipeline built and the oil will flow through that and sold at a discount. So that's the great challenge.
With respect to Kinder Morgan, it's complexity what we really ought to be concerned about is whether people believe the democratic institutions and the regulatory process works, because we went through that and the pipeline was approved. Ultimately what will happen is that assets will be bought and sold in Canada. They just will be worth less. They will trade at a discount. The world is awash in capital. So assets will trade at a discount in Canada ultimately if you have a higher tax rate and higher costs because people just look to a return and they'll just price the asset. It's the old adage that it's the third time a restaurant is owned that it finally makes money.
The challenge is, from an economic wealth creation point, that when your assets are worth less, you make less money and then you have less money to share.
I visit Fort St. John twice a year. We have a series of clients for whom we run entrepreneur round tables.
Senator Neufeld: You have to call me up sometime.
Mr. Munro: I understand Fort St. John very well. I just think that, again, what you've seen happening on the energy file is really the capital allocation on a global basis playing out firsthand in front of us.
Senator Neufeld: Thank you.
Senator Mockler: To the witnesses, your presentations have been very informative, educational and enlightening. Please feel free as we go forward, as we table our committee report on December 15, to add additional information.
Mr. Munro, I have a question for you. It was touched on a bit by Senator Neufeld, and that's Energy East. I'm from New Brunswick, which has the biggest refinery in Canada. I was also answering questions when I was wearing another hat in the Legislative Assembly of New Brunswick, on the government side. They were about an LNG facility in that part of Canada. I think Canada is strong when all its regions are strong collectively. It's the best country in the world.
There is discussion between the new administration and the U.S. There's discussion also with the politicians in the northeast U.S.A., that there could be an energy corridor that would come into Vermont and northern Maine -- bypassing Quebec and New Brunswick. The pipeline, that energy corridor, would go more or less from Vermont to Calais, Maine; and from there, it would cross the border to St. Stephen, New Brunswick. The pipeline would be 99 kilometres long. Our Canadian resources would finally come to the biggest refinery in Canada. We know the role that they play in the Canadian economy.
That said, do you think that the energy corridor, given the new administration and the politicians, such as the governors in other states, are supporting this project or will embark on getting the facts of this project?
I've certainly looked at and been debriefed on the taxation or revenue taxes that it would have brought to Quebec -- being mindful of the environment, based not on hearsay but on scientific-base data.
I'm asking you, sir, what went wrong and is it possible to justify the energy corridor in northern U.S.A.?
Mr. Munro: My God. It's a fascinating topic.
Here's the challenge today. We know only one thing for certain about the U.S., one thing for certain that we cannot lose sight of, in my mind, is that they're acting completely out of their self-interest. Every decision they make and every action they take is going to be driven by their self-interest. Maybe there was a gradual process underway, but that is fundamentally where they are today. We're going to face that in NAFTA. We're going to face that in every single energy project.
So the challenge with cross-border energy corridors, from a Canadian perspective, is that we'll always be on the back of our heels because our trading partner will act faster, with lower regulatory burdens and lower costs, and act in self-interest. If it's about exporting Pennsylvania natural gas to Atlantic Canada, they will be all in favour because they see the economic benefits to them.
From a Canadian perspective, our self-interest unfortunately isn’t about our country, it's about individual regions. And it appears to be shifting towards municipalities that are driving around their self-interest. There's a great risk of that in a world of increasing competitiveness.
Senator Mockler: To the witnesses, thank you very much.
(The committee adjourned.)