THE STANDING SENATE COMMITTEE ON BANKING, COMMERCE AND THE ECONOMY
EVIDENCE
OTTAWA, Wednesday April 29 2026
The Standing Senate Committee on Banking, Commerce and the Economy met with videoconference this day at 4:16 p.m. [ET] to examine and report on access to credit and capital markets for small- and medium-sized enterprises as the basis for growth and improved productivity in the Canadian economy.
Senator Clément Gignac (Chair) in the chair.
[Translation]
The Chair: Honourable senators, I’d like to welcome everyone watching us today, as well as those listening to us via the sencanada.ca website.
My name is Clément Gignac, I am a senator from Quebec and chair of the Standing Senate Committee on Banking, Commerce and the Economy.
Before we begin, I’d like to acknowledge that we are gathered on the traditional, ancestral and unceded territory of the Algonquin Anishinaabe Nation.
Before proceeding, I’d like to ask my colleagues to please introduce themselves.
[English]
Senator Varone: Senator Toni Varone from Ontario.
Senator Fridhandler: Daryl Fridhandler from Alberta.
Senator Henkel: Senator Danièle Henkel from Quebec.
Senator Loffreda: Senator Tony Loffreda from Montreal, Quebec.
Senator Yussuff: Hassan Yussuff from Ontario.
[Translation]
Senator Ringuette: I am Pierrette Ringuette from New Brunswick.
[English]
Senator McBean: Marnie McBean from Ontario.
Senator C. Deacon: Senator Colin Deacon from Nova Scotia.
[Translation]
The Chair: Honourable senators, this is meeting number 12 of our special study on access to credit and capital markets for small- and medium-sized enterprises as the basis for growth and improved productivity in the Canadian economy.
[English]
Today, we are fortunate to have a high-profile witness, Mr. Dan Daviau, Chairman and Chief Executive Officer of Canaccord Genuity Group Inc., the largest independent investment bank in this country.
Mr. Daviau, we want to thank you for your flexibility because initially you were supposed to be here in February, and, due to some circumstances, we postponed until today. We very much appreciate your flexibility.
I invite you now to share your opening statement. It will be followed by questions. The floor is yours.
Dan Daviau, Chairman and Chief Executive Officer, Canaccord Genuity Group Inc.: Thank you very much, chair and honourable senators. Thank you for the opportunity to appear before you today.
My name is Dan Daviau, and I am the Chairman and CEO of Canaccord Genuity Group. This is Canada’s largest independent — non-bank owned — investment bank and wealth management firm. We are a formidable underwriter of small- and mid-cap equities. We have been a leader in this segment since our founding more than 50 years ago. We are ranked first in the number of transactions that people do in this country and, quite frankly, among the top 10 for mid-market transactions globally.
What may not be obvious to you is that despite our excellent competitive position, our Canadian capital markets business is not our largest contributor of revenue or profitability, and it has not been for years. As you’ve heard other witnesses say, the equity underwriting environment in Canada has been in decline for more than 15 years, reflecting a greater tendency for companies to either stay private or not go public.
I appreciate the committee’s focus on the access to capital for small- and mid-cap enterprises. This issue is central to our business, and, more importantly, it’s central to Canada’s economic growth, productivity and global competitiveness.
Small- and mid-sized growth companies reinvest in innovation, talent and expansion. They build, they hire, and they spend within our economy. It’s a multiplier effect that extends well beyond shareholder returns. That multiplier effect increases productivity, improves GDP per capita and, ultimately, raises the standard of living for all of us. Without reliable access to domestic capital, as you’ve heard others say, they can’t scale.
The data is clear. You have heard elements of this data in this committee before. Since 2008, Canada’s public markets have sharply contracted. The number of listed companies is down by 50%. Capital raised through initial public offerings, or IPOs, is down over 80%, and in 2025 alone, $45 billion left public markets through companies privatizing or being sold. We continue to see a growing shift towards private markets to fund corporate growth.
Canada’s benchmark stock index, the TSX, is dominated by old-economy, mature sectors. The average age of the top 10 companies in the Toronto Stock Exchange now exceeds 100 years. Among them are Canada’s largest banks, financial institutions operating within a strong federal framework designed to promote stability. Now, while that stability obviously has served the country well from time to time, that aggregate head count in the big five banks has not changed over the past decade. The returns they generate don’t produce the same multiplier effect as high-growth sectors.
By contrast, the U.S. stock market, right next door, thrives on technology and health care companies, fuelling innovation and job creation. Approximately 30% of the S&P 500 is composed of technology companies, most of them founded after 1970. Canada’s broad market indexes have just 16% exposure to technology, health care and consumer sectors. As a result, the 10-year performance of the TSX has lagged significantly compared to the U.S. market and emerging markets.
As domestic capital concentrates in mature sectors, like oil and gas, financial institutions, real estate, telecommunications — you can continue to name them — growth industries face fewer domestic sources of risk capital. That limits Canadian growth opportunities for both companies and investors. When capital isn’t available at home, growth companies look elsewhere. Unlike domestically anchored businesses, the asset-based sectors I referenced earlier, these companies are highly mobile. As a result, Canada risks losing and is losing head offices, high-value jobs, intellectual property, future spin-off businesses and, ultimately, tax revenue.
Capital flows reinforce this concern. While Canadians are encouraged to support the domestic economy through consumer purchases, in 2025 alone, over $130 billion of Canadian money has flowed into foreign securities, while foreign investors have reduced their exposure to Canadian equities, further thinning liquidity for domestic growth opportunities.
At the same time, our major pension plans — a theme you also heard before — managing approximately $4 trillion, allocate only a tiny portion of that to Canadian equities. This erosion of domestic participation weakens the market’s depth and liquidity, increases the cost of capital, ultimately reducing companies’ valuations, and leaves these smaller companies vulnerable to foreign takeovers, which is happening.
From the perspective of an independent investment dealer like ourselves, we see strain across the ecosystem. Our firm and firms like us connect growth companies to investors. We support liquidity, and we facilitate retail participation. Seeing these pressures first-hand has led us to identify several targeted policies that this committee and the government could ultimately materially improve.
First, there need to be greater incentives and fewer tax burdens to stimulate investment in public-market growth sectors.
Second, there has got to be a regulatory calibration for smaller issuers to position Canada as a regulatory-friendly market in which to raise capital.
Third, there has to be greater participation in the market by long-term pools of capital, including the pension plans.
Finally, which is a particular point, we need reduced concentration in the capital markets among the large, risk-averse financial institutions. I’ll remind you our top five largest banks control the largest investment banks, access to most of the credit, 90% of retail investors in the market and four of the country’s five largest institutions that manage public investment assets. I’m happy to expand on all of these points in the Q & A.
At its core, this is about competitiveness. Growth companies can choose where to raise capital and where to scale. Canada has the technology, talent and innovation to win, but without deeper domestic growth capital, we risk losing our most prominent businesses and intellectual property abroad. Aligning policy, regulation and capital is essential if we want these companies to grow at home. Put simply, if Canada wants the most innovative companies to scale domestically, we must provide a compelling reason for them to stay. Rebuilding resilient capital markets in the ecosystem is not only a financial priority; it’s a national economic imperative.
Thank you, and I look forward to your questions.
The Chair: Thank you, Mr. Daviau, for your opening remarks. Very interesting.
Colleagues, I propose that, for the time we have, the first round start with four minutes each, starting with our deputy chair, Senator Varone.
Senator Varone: As always, when you depute, you take away my first question. I still do want to drill down on it because, in your 2026 fiscal statement, you stated that economic and policy uncertainty have affected transaction activity, particularly for smaller companies. In your statement, you elaborated on greater incentives and fewer tax and regulatory burdens, but how do you translate these things into policies? Is there a forum for you guys to participate where you’re actively advancing these types of reforms that you’re looking for?
Mr. Daviau: We’re trying to. It’s a complicated environment out there. Certainly, we are trying to articulate things. Having a more active market and more investment banks doesn’t necessarily serve my company well, but it certainly serves Canada well. I like being the largest independent investment bank in this country. I just don’t want to be the only one. And that’s what we risk here.
There are policies you could put in place. We need more money in the public markets. We need more investors in the public markets. That can easily be tax-incented. I can imagine a system where somebody writes a dollar into the public markets into these growth sectors — however you define them, which I could do — and they get 25 cents back from the government. That’s simple. If they make money, great. They will pay the 25 cents back. If they lose money, it’s 75 cents on the dollar. The spin-off effect of that 75 cents on the dollar or that dollar, obviously — there are things we can do. We are trying to argue with Finance and through the Canadian Coalition of Good Governance that there are things we can do.
The concentration in the banks is a big issue. Obviously, I compete. They are competitors, friendly competitors, but they control the entire market. If they decide that there is not going to be risk capital deployed, risk capital will not be deployed. For the most part, those banks are risk-averse. There are tied selling and other things that go on that the government can address, and they understand the issues. We have raised those concerns as well.
Senator Varone: In terms of tied selling, which was one of my biggest problems with respect to the banks, why does it go unnoticed? What is it that needs to be done in terms of oversight of the banks to shine a light on it? Because they do it constantly, and they do it with impunity.
Mr. Daviau: I want to be careful what I say, especially in a public forum like this. I am a lawyer, but I’m a dangerous lawyer. Tied selling means that you exercise dominance in a product. You use that dominance in a product to force your customer to buy something else. No one bank exercises dominance in a product. Five banks together exercise dominance in a product.
There tends to be a clubby environment in the banks, where those five banks all partner on loans and they use that dominance to get all the other business. It doesn’t technically fall within the definition of tied selling. Some would argue it’s not tied selling at all; it’s tied buying. A company will say, “Give me a cheap loan, and I’ll give you my other business.” That’s a company using that.
I don’t know if it’s tied buying or tied selling, but, either way, it destroys the competitiveness of the Canadian capital markets because you can imagine a situation where if there weren’t independent investment banks out there raising money for small companies, these small companies wouldn’t have a place to go. We need a competitive capital market. I’m not sure I answered your question perfectly, but it’s a complicated answer.
Senator Fridhandler: Mr. Daviau, thank you for joining us today.
I notice that you spent some time at CIBC World Markets as well. I also note that your firm, Canaccord Genuity, divides itself between wealth management and investment banking. I see the banks as wealth managers, and they are not in it for investment banking except insofar as it’s tied to wealth management. They don’t take risks. They sell their own products or the big companies only.
But you have wealth management too. Can you give me some insight on the balance and why that has been taken away from risk capital in the market?
Mr. Daviau: These are such good questions and so difficult to answer. If you run a 200-year-old institution with 30,000 employees, you have to manage risk differently. I don’t blame the banks. I would do the same thing if I were the CEO. You can’t let one or two individuals do something crazy and put the whole firm’s reputation at risk. I do not mean financially at risk. You set up a whole bunch of rules and regulations that don’t let anyone do anything. You solve for the lowest common denominator, so to speak.
A firm like ours is a little more entrepreneurial and smaller. We put our clients first — not that they don’t. I forget the hockey analogy: The name on the front is more important than the name on the back or vice versa, but it’s the same idea. We treat our clients’ priorities as the most important priorities even if that causes some reputational risk. We will underwrite a company. We will raise money for a company that could be bankrupt in three years from now, like a lot of developing start-up companies. There is no way a bank will do that, and rightfully so. I wouldn’t do it if I ran a bank either. It’s structural. It’s not that the banks are doing anything wrong. It’s that we need more people in the business like us.
Senator Fridhandler: If I go to the bank, fill out my “know your customer” form and say that I want 30% high-risk, they probably won’t accept that.
Mr. Daviau: They will put you in some riskier funds, but yes. And the regulator has not helped us. The regulators out there have new rules — not so new anymore — such as “know your product.” They say that you’re not allowed to sell anything you don’t know. It’s impossible to know everything. It’s really impossible to know the risky stuff. It’s an excuse: The bank says, “Well, the regulator said I can only buy what I know really well. I know Bell Canada Enterprises, or BCE. I know the other banks. I’ll sell that. I don’t know the little mining company or the little start-up tech company.”
Senator Fridhandler: So, back to liquidity, companies aren’t going public, but you’re still raising money for new ventures. So you have got private companies and some timelines on liquidity. We end up selling them all south of the border or someplace else. Do you have any thoughts on how we push more into the public markets or Canadian consolidation?
Mr. Daviau: I will take half a step back and then answer your question.
Economics 101 is about supply and demand. We have all these companies that want to raise money, and we don’t have any investors. By definition, you keep on lowering the price until you find an investor that will buy that company.
Those low valuations are what exposes the company because the guy in the U.S., India or Europe doesn’t have that low valuation. All of a sudden, he says, “Look how cheap that company is in Canada. I think I’ll go buy it.” Then they do buy it. Then the head office leaves, and the R&D leaves, and the marketing spend leaves. These are all the things that happen when a company is located here and then just leaves the country.
To fix the problem, you need more investors. It’s just that simple. You need more capital in the marketplace. Can you imagine if tomorrow $100 billion was invested in the Canadian marketplace? Guess what? All the prices are going up. All those stock prices are going up. They will trade at a better multiple. There is a reason why the Indian stock exchange trades at 10 times better than the Canadian market does. It’s because they have many investors there.
The main problem that this committee should be addressing is how we get greater participation in the public markets. Once we have that, and those prices are good — guess what? — that venture capital company that went and raised money and wants to go public will go public because the public markets represent the cheapest cost of capital at that stage. There is a reason they don’t go public now; it’s because the cost of capital is too high. Their share price is too low.
I’ve heard Mr. Ruffolo speak, and I’ve heard other people speak to the committee. At the end of the day — they say it’s all about the chain and every step of the chain — if you fix the end of the chain, the public markets, everything else naturally fixes. If you can fix the public markets, then everything else fixes.
The Chair: I have to interrupt you, Mr. Daviau. Thank you.
Senator C. Deacon: Thanks, Mr. Daviau. I have to tell you that I was cheering the whole way through your opening comments. It’s great to hear your directness.
I just want to challenge you a bit, though, about just getting more money into the structures that we have as they stand. The concentration and what you have described so well and the challenges about the big five, I’m a real believer we need to deconsolidate. We have to go back to 1984 — before banks were getting into insurance, payments and investments in addition to banking, because culturally these are such different businesses.
The other thing is that the regulatory calibration point is crucial because if we’re putting more money into the existing structures, then, yes, there will be more money to invest and the larger Canadian companies will have more money invested in them, but we will not get the changes we need in culture. Can you speak to that?
Mr. Daviau: It’s a nuanced question. We live beside the largest capital market in the world. It’s not that rule of 10 — that Canada is one tenth. Rather, it’s the rule of 40. It’s 40 times larger than our capital markets. Any large company with half an expansion mentality is going to go to the U.S. to raise money. You can’t stop that. It’s the biggest capital market in the world.
The big multi-billion-dollar companies, when they raise $1 billion, will go to the U.S. In fact, we have devised a security system that allows them to go there really easy. It’s called the multijurisdictional disclosure system. If you follow the Canadian rules, you’re allowed to raise money in the U.S. I’m obviously oversimplifying this, but that’s what the rules do.
As a result, our Canadian securities laws create a system in which they are allowed to do that, so we try to follow the U.S. rules, broadly speaking. We try to have the same kinds of rules as the U.S. so our Canadian companies can go and raise money in the U.S. That applies to all of the Canadian companies: those really big multi-billion-dollar ones and the little ones. The little ones are too small to go out of Canada. We should recognize what we are. Our exchanges and our public markets should service the entrepreneurial client, be a feeder system for the U.S. You’re going to lose these companies from a public market perspective. They are going to raise money in the U.S., but let them grow here. Let them get to a $1-billion, $2-billion or $3‑billion market cap before they do that.
We need a regulatory system here that acknowledges that, at the end of the day, if we raise $20 million for this start-up company, and in a year from now it’s bankrupt for all good reasons — it just didn’t work because the hole they were digging didn’t work — people don’t get in massive trouble for that. Because that’s what happens in an environment where you are raising money. You’re going to step on the odd rake.
The Ontario Securities Commission, or OSC, knows this. I talk to them regularly. I talk to a lot of the regulators regularly. Let’s design a capital market system here that services the entrepreneurial market, not the other guys.
Senator C. Deacon: Hear, hear. Thank you.
[Translation]
Senator Henkel: Since 2019, Canaccord Genuity Group Inc. has been supporting cohorts of women entrepreneurs through the Advisory Program for Women Entrepreneurs. To date, there have been six cohorts. What have you identified as the most persistent barriers to accessing capital for these entrepreneurs? What would you recommend to improve access to capital for women-led SMEs in Canada?
[English]
Mr. Daviau: Thank you for the question. You’re right. We have this phenomenal program for women entrepreneurs that we started years ago, and it’s working very well.
I don’t believe women-owned enterprises have materially different needs than men-owned start-up enterprises. I think they have the same needs. Why we started the program was because of an opportunity to collaborate together, to meet people, to get access. As is always the case, sometimes when women aren’t in the financial community to the same degree as we are, they don’t have that social network that we’ve had elsewhere.
We’ve done a very good job integrating them in, introducing them to all the people inside our firm, giving them access to people inside our firm and having that same formal and informal communication channel that we have elsewhere. It has worked very well. It’s really about preparing them for these transformative transactions.
Senator Henkel: Mr. Daviau, because you have this experience, because you actually mentored them, from your point of view, what are still the persistent challenges that do not give access to women entrepreneurs in reaching capital? That’s my question. What do you think are the main challenges?
Mr. Daviau: I think it’s that they don’t have the same social and other networks in the financial community as some of the men do, which is why we started the program, to be clear.
Senator Henkel: Is that the only challenge that you think they have at this point?
Mr. Daviau: No. I think all small companies have challenges. I just think it’s the only incremental challenge they have.
[Translation]
Senator Henkel: You said earlier banks aren’t taking risks and that the government needs to take action.
What measures are you referring to? Could you give us a few? What steps should the government take to encourage banks to take more risks?
[English]
Mr. Daviau: That is a very good question. Again, if you heard what I said before, if I ran a bank, I wouldn’t take the risk either. I don’t think they should take more risk, is the short answer. You can’t protect a 200-year-old institution and take a bunch of risk as well.
What I would do, to paraphrase what one of the other senators said, is I wouldn’t have the banks do as much as they do. They shouldn’t be controlling all the asset managers. They shouldn’t be controlling all the retail investors. They shouldn’t be doing tied selling together and lumping their products together.
The government has put in place many policies for cellphone companies where people can take their numbers with them and switch providers easily. If we had a similar system where investment advisers could leave the banks easily and go someplace else, that would change the environment. You wouldn’t have that same concentration.
If you’re going to put 90% of our financial and capital markets in the hands of five like-minded firms, you’re not going to have that type of risk. There’s a good reason to have the concentration; don’t get me wrong. It protects us in periods of financial instability, but there’s a cost for that. The cost is less of a competitive capital market.
Senator McBean: Thanks, Dan. This is an interesting conversation.
As you were talking — my brain goes in weird ways — I was reminded of the documentary Who Killed the Electric Car? I was trying to think, “Where did all the investors go?” What you’re saying is we need more investors.
Are Canadians just risk-averse to the core, or have we been trained this way? Was there some messaging 10 or 20 years ago that we bought into hard-core? Where have investors gone, and how do we get them back?
Mr. Daviau: The way capital markets have developed, public market investors, if you’re investing in indexed funds and into mutual funds, by definition, nobody likes to explain why they lost 10% of their money, so they don’t invest in things where they can lose 10% of their money. They invest in things that are going to track the index and be within 2% one way or another of the index. That’s where the money is. It’s not gone, gone, gone. It’s in these instruments. Again, depending on who your investment adviser is and where that investment adviser works, you’re going to be encouraged to invest in relatively riskless investments. That’s where the money is.
What we’ve lost is not the investor. We’ve lost the investor investing in risk appetite. There needs to be a change in the paradigm. They need to be incented to invest in risk capital — not because we want everybody to lose money but because it’s good for the Canadian economy. A company that doesn’t make money does not make money because it’s flushing its money down the toilet. It doesn’t make money because it’s spending it on R&D and marketing and hiring lots of people. Those are all great things for the country. That’s where we have to encourage investors. So the flow-through structure works. That’s a tax-incented structure, but other tax-incented structures encouraging people to invest in that element of the capital markets are important.
The investors aren’t gone. They’ve just been pushed towards less risky investments.
Senator McBean: This takes me to one of your first recommendations, which was greater incentives and fewer tax burdens.
How do we unlock Canadian capital and encourage investment and, even more particularly, reinvestment at a higher level into Canadian small- and medium-sized enterprises?
Mr. Daviau: It would be things I suggested. Literally, for every dollar you put in the market, you get 25 cents back. If you make the 25 cents, we’ll hand it to you — if it’s the risky part of the market, not if you invest in BCE or the Royal Bank.
To be honest, it’s not a huge market. There are 450 companies in Canada between, let’s say, a $100-million market cap and a $1.5-billion market cap. The aggregate market cap of those companies is about $200 billion.
We’re talking about $10 billion or $20 billion to move the market, to substantially change the valuation parameters. And $20 billion — if everybody lost all that money, it would only cost the government $5 billion. That sounds like a lot of money, but it’s not. Not everyone will lose the money. Half of the people will make that money, and most of that money will be invested back into the economy. It’s not even that expensive to change the paradigm. It just has to be realized. It’s really important and easy to do.
Quite frankly, if you improve the valuations in this market and you say it has to be for a Canadian-headquartered company that’s located here — you make the rules — we’re talking about technology companies, health care companies and sustainability companies. These companies can be based anywhere in the world. Tomorrow, they can pick up and move.
If they’re located in the U.S., the U.K. or Europe right now, and all of a sudden our market is the best market, and the only way to access that market is that you have to be a Canadian company, they’ll move here. It’s not only letting our own companies grow. It’s attracting capital and companies from all over the world. We can make it very exciting.
Senator McBean: Thank you.
Senator Loffreda: Thank you, Mr. Daviau, for being with us.
I really like your four recommendations to this committee. You didn’t have enough time to do a deep dive into them, so maybe you can elaborate on what you feel we should prioritize to align policy and legislation to improve — let’s not forget what we’re trying to do here — access to capital for small- and medium-sized enterprises. That’s what we’re trying to do.
We talk a lot about our banking system, but wealth is always created by entrepreneurs. It’s not created by government or banks. They support it — we support it, and banks support it — but it’s created by entrepreneurs. Where would you deep-dive?
Banks inherently mitigate risks because their primary responsibility is to protect the depositors’ money. We’re not going to get the banks to act as venture capitalist investors no matter how hard we try. Where would you deep-dive into those policies to align them with legislation to improve access to capital for small- and medium-sized enterprises?
Mr. Daviau: I’m going to answer your question, but I’m going to challenge one of the premises first: The banks protect access to deposits. The truth is that the federal government protects access to the deposits. You guarantee all of them. Quite frankly, you guarantee most of their mortgages, so you guarantee most of their liabilities too. The financial system is a very protected system. The government does that intentionally, and I understand why. I’m not challenging it.
How do we create more capital for companies? As I said before, we need more capital. How do we get it? You either have to force the pension plans — use a carrot or a stick, however you do it. You’ve heard good recommendations. You force the pension plans. They have $4 trillion. That’s the market capital of the Canadian market. That’s what they have. It would take nothing — maybe 2%, 3% or 4% invested into the right areas — to fundamentally change access to growth capital in this marketplace.
Again, the Canada Pension Plan, or CPP, is a great firm. I know them well, and I know why they don’t do this. It makes sense, actually, but they have $700 billion or $800 billion. One per cent of that is $8 billion. Remember, they make 8% or 9% a year. Putting 1% of their portfolio into growth equities would fundamentally change the equity landscape for this country. We’re not talking about big numbers.
The other thing is that if we can’t use the stick, then use the carrot. Stimulate them. Do what I said before. Change the return paradigm. If somebody told me tomorrow, “Listen, you can only lose 75 cents but you can make a buck,” that changes things. Sorry, my apologies, sir.
Senator Loffreda: On the tax incentives, that’s a good point. We tried it in Quebec. You’re probably aware of the Quebec Stock Savings Plan. They removed that because the high fiscal cost had a limited economic impact. There was market distortion. I have a long list here; I won’t go through them. You know them as well as I do. There was market distortion, concentration risk for investors and a shift towards more modern market tools, and the tax incentive was more important than the quality of the investment for many of the investors who were not as astute or didn’t know the market quality as well as most of us here do.
Do you believe the tax incentives could still be an initiative? How? Why didn’t it work in Quebec?
Mr. Daviau: In Quebec, for the most part, companies had to raise that money. You had to go out and raise money if you were a — I forget the acronym. You would invest that.
What I’m suggesting is to allow somebody to take a dollar, find the best companies to invest in on the public market, go buy it on the public market and get 25 cents back. If they make money, they’ll pay back their 25 cents. You’re just going into the market. All I’m trying to do is change the amount of capital. Add another $10 billion or $20 billion to the $200 billion that’s invested in all these small companies.
Obviously, because of the business I’m in, I take the less-government as opposed to the more-government approach to life, but let the individual investors choose. They can still lose beyond the 75 cents, and they can make everything above that. Let them choose what companies there are in the market, and you’re going to see significant participation in the market if that were the case. It’s investors’ choosing. If they lose money, they lose money. If they make money, they make money. You’re letting firms like my own recommend stocks that we think are good, and that little bump will get them there. That’s my view.
Senator Ringuette: Thank you for all your comments. I’m looking at the basics. Sixty-two per cent of the jobs created in Canada are from SMEs. Twenty per cent are from government — federal, provincial and municipal. That leaves only 18% of Canadian jobs in the hands of big corporations. I look at the mindset of the government in regard to strategic investment, and it’s in that 18% of job creators, the big corporations.
I understand what you’re saying. You want Canadians to be able to invest, but there’s no model coming out of the federal government. There’s no incentive to really look into SMEs.
You indicated roughly $5 billion to $8 billion would make an extraordinary difference in investment in your particular field. If that $5 billion to $8 billion could be identified and put forward, what measures could we also put in place to ensure that this investment of $5 billion to $8 billion — that these companies would stay in Canada and help the Canadian economy?
Mr. Daviau: That’s a great question.
First of all, I’d call something a “Canadian eligible corporation” or a “Canadian growth company,” CGC. Those are also the initials of my firm. We would identify what they are, and they would have to be Canadian companies. To be honest, I’d say they have to list only here. They can’t be listed anywhere else. There will be a time and place where these companies grow and are big enough that they should be listed in the U.S. You’ve heard me say that already. But if you want to get your U.S. listing, you give up your CGC. And a CGC means that when an investor writes a cheque for your company, they’re getting 25 cents back. Maybe they’re big enough that they don’t need that anymore.
It becomes self-serving. Companies can go out and list somewhere else. They can change, but they will lose the benefit. They’ll lose a big chunk of their investors, and that’s fine. You’re not going to fight that. You’re not going to keep the biggest companies here forever. They will access the largest market in the world, just south of us. Those are the companies, to your point, that we don’t want. Well, we do, but they’re not the ones growing and hiring people.
I have 1,000 employees in Canada. Next year, I’m not going to have 2,000. Maybe I’ll have 1,100. The tech company that has 40 people will, next year, have 80 people. That’s how they grow. Those are the ones we want to support. The big guys aren’t the guys that we should be worried about in terms of fundamentally growing this economy. It should be the small guys. When they’re big, they’ll leave.
Senator Ringuette: Thank you.
Senator Yussuff: Thank you, Mr. Daviau, for being here.
Given the frustration that you’re expressing — and we don’t necessarily disagree, but if we’re going to solve this problem in a systematic way, we have to be both strategic and deliberate at the same time. Given you’re a bank that is very specific around venture capital, should we be looking at licensing more venture capital banks, specifically with the objective of meeting the SME challenge in the country? This is not a new thing. It’s a consistent impediment to growing the economy and giving entrepreneurs an opportunity to have access to capital, where we know the big banks are not doing that.
Should the federal government be more deliberate in having five or six or whatever the licence number might be for venture capital banks to set up, and say, “Here is the objective; here is what we want to reach”? Obviously, we’ll provide some tax incentives for those who want to invest in that. Would that be a better way to try to get to this problem?
We seem to be talking in circles. The pension funds, the government and the big banks haven’t done what we were expecting of them. How do we get solutions to this problem? Otherwise, we’ll be in a worse situation than we are right now.
Mr. Daviau: To be clear on what we are — and then I’ll answer your question — we’re not a bank. We are an investment bank, but we don’t commit our own capital to anything. I run around and hear a good idea from a company and go to a whole bunch of investors. I find them, and I have them invest in the company. That’s what we do. It’s a great business. We have been doing it, as I said, for over 50 years. We are the biggest, and we’ll do hundreds of deals per year. That’s what we do. We don’t write cheques.
Again, the element of the market that we mainly participate in is the public market. My view, notwithstanding what you have heard from other people, is that if we fix the public market, if we make it more attractive and of higher value, everything else will fix itself. The guy who is doing venture investing will say, “I’ll write that venture cheque because I know I can exit through the public markets.” Right now, an investor who writes a venture cheque doesn’t have an exit other than selling to a foreign company, because they don’t think the public market is there.
I think we solve the whole investment chain once we fix the end point, the public market. I’m really focused on that and how to get more capital in the public markets. With everything else, there are incremental problems along the way. I just think they solve themselves once we have a good exit for people and once we provide that capital. It may be simplistic, but I think it’s the biggest problem the country has.
Senator Yussuff: Is there anything else you would recommend in addition to that?
Mr. Daviau: I have been doing this for 35 years; I have lots of recommendations.
I have raised them all. I have talked about getting more money into the public markets. I have talked about setting up a regulatory environment that allows small companies to actually go public without the aggravation that is there right now. That’s a very complicated answer to the question, so I’d prefer not to get into that. I have talked about “carrot or sticking” pension plans to invest in the risk elements of this market and the public markets.
Finally, as you know, the banks aren’t going to change, so don’t try and ask them to. They shouldn’t. What we should be doing is putting less concentration there and allowing other people to operate. Again, that’s a pretty complicated equation. If you’re an adviser at a bank and you have 100 or 200 clients and you manage $200 million, you can’t leave the bank for a bunch of very technical reasons. It’s very difficult for you to say, “These banks aren’t letting me do what I want to do. I’m going to take all my clients someplace else.” It’s very difficult for them to do. I think there are a number of measures where we can, as I said before, let a cellphone customer leave one of the big cellphone companies and go to a start-up. The same things have to be thought through. Those are very complicated questions, and, obviously, there are some large financial institutions that would feel significantly different than I do about that point.
The Chair: Thank you.
Before going to the second round, could you elaborate on the pension funds? We have had some debate. Letko Brosseau has been very loud regarding pension funds over time shrinking their Canadian exposure. It’s independent, so forget getting politicians involved in that debate. They have an independent board of directors.
What is your view on that? What could be done?
Mr. Daviau: I’ll start with the pension plans. I understand why they are not invested in Canada. I really do. They have actuaries and lots of work being done. They need to diversify their risk. Canada only represents, what, 2% of global GDP. That’s all they should have in Canada. I completely understand it.
That being said, they are supported. It’s a tax-driven structure. It’s here in Canada, ultimately supporting Canadian workers and the Canadian economy. I can make a policy case on why they should be here.
But, again, the market capital of all those public companies in Canada is about $4 trillion, maybe $5 trillion, depending on where we are on any given day. The size of their portfolio as the “Magnificent 7” or 8 is about $4 trillion or $5 trillion. At one point in their lives, they had 25% of their assets invested in the Canadian marketplace. A quarter of the market vanished because they don’t have that now; they have very little.
If you go to the pension plans and say, “You have to invest in Canada,” clearly, they are going to invest in roads, highways, airports and all those other good long-term assets. Quite frankly, every other investor in the world will also invest in those assets. That’s what they invest in globally as well. Then if you say, “We want you to invest in the public markets,” they will invest in the Royal Bank of Canada. That’s what I would do. It’s the only place you can put serious capital to work — in these huge-market-cap companies. They can’t be told or encouraged to do that.
So where do you go? It’s those companies under a $1-billion market cap where you need the investment. That’s what we need. That’s where the capital has to go. What their argument will be is that there are 450 or 500 of them. “There is no way I could put billions of dollars to work. I would have to hire 100 people just to figure that out.” And they are probably right. It wouldn’t be efficient to do that when you’re managing that much money, but they can appoint small-cap fund managers to help them out. There are some there. Many have disappeared. They will develop. If they all of a sudden say they want to put out $3 billion into the small-cap arena, guess what? Ten small-cap fund managers would pop up tomorrow and take that mandate from them. That’s their money, but it’s going, directly or indirectly, into that. There is a way to do that.
The question is why they would do that. That’s not what their actuaries are telling them. The only way to do it is to either financially encourage them, through some kind of tax structure, or force them. I know you can’t force all of them because you don’t control all of them. You control, arguably, maybe one or two of them.
The Chair: Exactly. Thank you.
For the second round, colleagues, I propose two minutes each maximum.
Senator Varone: You touched upon securities regulation and, again, the further that you touch on streamlining it to reduce the cost and complexities for smaller issuers, what is achievable? We have so many different governing bodies that have oversight of this, so how do you streamline one, and what does it do?
Mr. Daviau: There are a lot of governing bodies. No disrespect to the Quebec securities commission or the BC Securities Commission, but there is one commission that matters when it comes down to regulation in Canada. There is a governing body, the Canadian Securities Exchange, or the CSE, that manages all of them when they try to get partnerships between them, but the Ontario Securities Commission is the most relevant securities commission. In fairness to Grant Vingoe and the people who run the Ontario Securities Commission, they understand this problem, but they don’t want to do it simply because they want to make sure the big companies don’t lose access to the U.S. They’ve spent years designing a system that allows us to export our companies to the U.S. The money raising, that’s what it is.
It’s not even big. The test was built like 20 years ago. I’m making that up. It was a $75-million market float. With that market float, you’re allowed to go to the U.S. and use your Canadian documents. Who doesn’t have a $75-million market float? I’d increase that to $1-billion market float and then design a securities system that is exactly like the U.S.’s so those big companies could easily go to the U.S.
For everyone under $1-billion market float, you only need semi-annual reporting. They are experimenting on that. You don’t need as detailed a prospectus document. You don’t need certain disclosures around — it just becomes more user-friendly. You change the promoter rules a little bit; there are things you can do. Now, those companies will never have access to the U.S. until they graduate to the big system. But the OSC knows what it needs to do, and if it felt inclined, it could push forward some of those changes.
Senator Varone: Thank you.
Senator C. Deacon: Thanks again, Mr. Daviau. I have to tell you that this is a really interesting conversation with very direct responses from you.
Mr. Daviau: Too direct.
Senator C. Deacon: I want to throw a crazy idea on the table. What benefit to shareholders of banks would you see if Canada were to introduce a deconsolidation strategy that allowed tax-free spinoffs in the banks so that all their divisions that are in insurance, payments, investments, Interac could spin out and become independent companies in Canada? What benefit to shareholders would you see if that sort of an activity occurred? You’re unlocking a lot of value and a lot of potential growth in those organizations if that were to happen.
Mr. Daviau: Yes, a great question. I wish I could throw an answer on the table for you. I would really have to think through that. Obviously, the tax-free aspect of that would be important. You could probably do that now through a butterfly-type transaction using the existing tax code. You would create a whole bunch of competition in the marketplace because they would all have their own payment company go public. They would all have their own insurance company or investment dealer go public.
We would have a different environment than the one we have now. That’s all I can say. I’m not sure what the benefit to their shareholders would be. I would need to analyze that.
Senator C. Deacon: If you have any future thoughts on that, I would love to hear them through a note to the clerk.
Mr. Daviau: Thank you, sir.
Senator C. Deacon: Thank you.
Senator Fridhandler: I want to get to some micro-tax things. CIRO is not a government agency, but they control investments to investment bankers and deferred plans. I don’t know what the amount of capital is there, but it’s frustrating when you can’t invest your RRSP or TFSA into a private company. What are your thoughts on that?
Mr. Daviau: I’m no expert on this. I’m not smart enough. I don’t understand it well enough. My apologies.
Senator Fridhandler: We really need to create some asymmetries that favour Canada relative to tax — the United States or wherever — so that people keep their money here. For example, flow-through shares to expanded base into technology companies, rollovers and reduced rates into SMEs — there is a whole list of things, but if we don’t do it, and we keep on creating sovereign wealth funds that will invest domestically in roads, LNG and pipelines, we’re not going to get there. It’s not just the feds; it’s the provinces too. Is there anything else you wanted to add to that?
Mr. Daviau: I agree with you. If you force people to invest in Canada, the big pools of capital are going to invest in those types of projects. Quite frankly, so are all the other foreign government funds. Those are good long-term projects. There is no shortage of money for those projects.
The shortage of money is in the areas that we’re talking about, and some of the tax policies you’re recommending would help. I would do a little bigger of a bang. I have told you what I would do. I would strongly encourage investors to invest in the marketplace. The way to do that is to tax-incentivize them, grant them or do something like that. It’s not hard, and it’s not a big number. That’s the shocking part. It’s $10 billion of incremental capital into the marketplace. That will make a world of difference in the right area.
The Chair: Thank you.
Senator Loffreda: Thank you, Mr. Daviau. These are interesting conversations. I definitely agree that we need more capital in the public markets. You did mention that $45 billion left the public markets in 2025, and if you want to expand on that, how do we correct that problem? Is it regulatory burden or other issues? You have mentioned a few.
I go back to your recommendations. In the two minutes we have, if you were to leave us with one policy lining us up with some legislation to really improve access to capital and to small- and medium-sized enterprises, what would it be? I like your tax incentive, although I look back, and the fiscal cost in Quebec was far higher than the economic impact, so that’s why they removed it. You’re convinced it’s going to work this time. Why would it work this time when it didn’t work back then — the Quebec Stock Savings Plan, or QSSP? It would be a great solution.
The pension funds: We will not get them to invest in risk capital because your return — I’m not going to ask you — is in the mid-teens. Their investments have to be safe, like the banks’ investments. We’re not going to change that philosophy very quickly. I have 35 years in the financial industry. I have done every level of banking, so we’re not going to get that to change.
As government, how can we change the legislation and improve access to capital?
Mr. Daviau: I understand your concerns about the Quebec program. You have to define the companies correctly. You let the market decide. You let investors decide what they want to invest in. All you’re trying to do is push them into smaller companies. I’m not saying much else.
I’m talking about real companies that operate here, have a head office here and work here. You’re not saying, “Because you’re a Quebec company, you’re going to invest here.” The way I’m doing the cost in my mind is that if you make money, you have to repay it through the tax system. I don’t even think the cost will be significant. To be honest, I think the first people in the market will make lots of money because the multiples will go up very quickly. That’s not a good answer to your question because you understand this very well, and it’s very sophisticated. But I do think you can design it.
You have so many good panellists or witnesses come to this committee, so figure out how to get more investors. If you figure out how to get more investors into the marketplace, whether it’s my idea or other people’s ideas, the rest will solve for itself. The $45 billion that is gone is gone because the multiples are terrible and they were bought by other companies — foreign companies, for the most part — or they were bought by private equity — foreign private equity, by the way, for the most part.
That’s because of the multiples; they were trading at 9 times earnings, and somebody said, “I’m trading at 14 times earnings, and I will buy you at 11 times earnings,” which is a nice premium, and the company is gone. The head office is gone. It’s happening every day. It’s happening as we speak to our $1‑billion-ish and $500-million and $400-million market-cap companies. That’s what fuels the growth here. So that’s why it’s gone.
The Chair: This is an interesting debate. I remember my early days when I worked with Lévesque Beaubien, a small brokerage firm which was independent at that time, before the National Bank bought it. But I also remember the success of the Quebec savings plan, like Alimentation Couche-Tard Inc. They had some big failures, but they also had huge successes. That was one of them.
Mr. Daviau, we want to thank you. I know you’re a busy man, and you have taken the time to share your insights. Feel free to send us any written material or any suggestions for the Department of Finance that you want to share with us regarding fiscal measures or that kind of thing; it could be helpful for our study.
[Translation]
I’d like to welcome our second panel.
We’re continuing our study on access to credit and capital markets for small- and medium-sized enterprises as the basis for growth and improved productivity in the Canadian economy.
On behalf of the committee, I’d like to welcome Mr. Brian Ernewein, Senior Advisor, National Tax, KPMG Canada.
[English]
We’d like to thank you for making yourself available. As usual, if you have any opening remarks to share with us, please keep it to maybe five to seven minutes; it will be appreciated. The floor is yours, and welcome.
Brian Ernewein, Senior Advisor, National Tax, KPMG Canada: Thank you, chair, and good afternoon, honourable senators.
As noted, my name is Brian Ernewein. My background is in taxation. To give you a quick recap, I spent 35 years in the federal Department of Finance in the Tax Policy Branch. I recognize a couple of you from those days. Maybe that’s mutual. I retired — or I thought I had — at the end of 2020, but about 16 or 18 months later, I realized that turned out to be a sabbatical because I joined KPMG Canada and their National Tax office. That was nearly four years ago.
This is probably as good a time as any to make the point that I’m appearing in my personal capacity. Any opinions I may express here today are mine and mine alone.
When I was first invited to appear here, I was worried that I wouldn’t be a good fit for your line of inquiry. I thought you might be looking to verify whether there are, in fact, constraints on small- and medium-sized enterprises’ access to credit and capital markets. Having listened a little bit since I arrived, I think you may have reached a conclusion on that. In any case, I thought it might be the case you would reach a conclusion on that before perhaps moving on to the second stage if you thought there were such constraints.
I now understand you’re looking at both questions together. That does make it more sensible for someone like me to be here and that you look at the tax system, among other tools, to see what it does today in support of small- and medium-sized businesses with, I’ll say, a greater focus on the first.
Before I get into substantive matters, I’ll make one more point, which is that I did accept this invitation only yesterday morning. I was cloistered in the lock-up for the Spring Economic Update yesterday. I really haven’t had an opportunity to review submissions or prior witnesses’ testimony. I may be expressing different views, which I hope is fine. I hope I’m not repeating things you heard before. If I am, please jump in and cut me off.
To jump into the substance of it at a pretty high level, I’m going to identify and say a few words about what I think are the three biggest incentives in the income tax system in relation to small businesses and unpack those a little bit. Then, there are six or seven others that I would simply list so you have them in front of you, and if there are questions that come up on those, I’ll do my best to try to talk about them as well. Then, we can explore however you deem fit in terms of alternatives to the current system.
The first measure, I think, will be known to all of you, and that’s the small business deduction. It’s a preferential tax rate that applies at the federal level to Canadian-controlled private corporations, or CCPCs. CCPCs qualify for a preferential tax rate on the first $500,000 of active business income. More precisely, the reduced federal rate is 9%, in contrast to the general federal corporate tax rate of 15%. Those tax savings, obviously, feed into capital supporting small businesses, and I firmly believe that that was part of the purpose of it: to overcome obstacles to raising capital externally.
I’m going to mention the federal tax expenditure report, not to bore us all to tears but because it is helpful, in this context, to identify what the government itself identifies as the revenue they forgo from this. It helps give a sense of scale. In relation to the small business deduction, the federal tax expenditure report identifies the cost of that as contrasted to applying a 15% tax rate. Depending on whether you take 2026 or 2027, that’s $6.2 billion or $6.5 billion. In other words, that 6% differential, that 6% delta, amounts to about $1 billion a point at the current time.
I should also say that there are lower tax rates in all of the provinces in respect to the same kinds of small-business qualifying active business income. At the limit, it’s zero in Manitoba. Until this morning, I would have said that the highest rate applied is 3.2% in Quebec, but I believe Quebec announced this morning they are reducing their rate to 2.2%. That now makes the highest rates a tie between Newfoundland and New Brunswick at 2.5%. I don’t have to sum it for you, but the top federal-provincial tax rate that applies to this income is 11.5%, which represents considerable savings over an average of 27%, which is the general corporate tax rate, federal-provincial, applying to corporations. Those 15% savings amount to $75,000 of savings annually, as compared to paying the 15% rate plus the higher provincial rate.
The next one on my hit list is the Scientific Research and Experimental Development investment tax credit, which I’ll call the SR&ED credit. It provides a 15% non-refundable credit to large corporations and most public companies for expenditures they make in support of advancing their scientific research. For Canadian-controlled private corporations and, as proposed by the government, for small public corporations, they are entitled to a 35% refundable tax credit. It was on $3 million maximum expenditures. That has been moved up to $4.5 million in, I think, Bill C-15, which recently passed. It’s proposed to go to $6 million in the fall budget.
The tax expenditure for the SR&ED program, before you get to the increases and also the extension to small Canadian public companies, was estimated to cost around $5.5 billion total. Of that, the refundable portion is reported at $3.4 billion. That’s on top of the $6.5 billion for the small business deduction.
Finally, on my top-three list, again, is the lifetime capital gains exemption. It has been around since 1985, introduced by Michael Wilson and the Conservatives. It provides a capital gains exemption for the sale of small business corporation shares, shares of an active business and also for certain farm and fishing properties. The current limit is $1.25 million in exempt gains. The tax expenditure associated with it is $3 billion federally, plus the provincial tax savings.
I’m just going to provide a list of the rest. I’m happy to answer questions about them, but I’m trying to be mindful of my time and yours.
The seven others on my list are that there’s preferential treatment of employee stock options in Canadian-controlled private companies. There’s a greater ability to apply losses that you incur on investments in small business companies — greater flexibility applying that against other income, not just capital gains.
There are rules enacted fairly recently to accommodate intergenerational business transfers, turning off the application of an anti-avoidance rule that would treat that as a dividend rather than a capital gain. There has been in the system for some time a tax-free rollover for qualified farm property. There was recently introduced a temporary exemption for up to $10 million in capital gains on sales of private businesses to employee ownership trusts. Yesterday’s update proposes to make that permanent. There’s a capital gains deferral on the disposition of small business shares, where they’re reinvested in another small business company.
Finally, there’s a rule allowing shareholders of Canadian-controlled private companies to crystallize their lifetime capital gains exemption before going public, without having to do an actual share disposition. They can simply elect to write it up in an amount sufficient to use their capital gains exemption so they start as a public company the next day with a higher cost base for any future gains taxation.
I’ll stop there. Thank you again. I’m free to take your questions.
The Chair: Thank you again for being with us on such short notice and showing your flexibility.
Colleagues, I propose four minutes each, starting with the deputy chair.
Senator Varone: Thank you, Mr. Ernewein. Like you, many of us are in our second job or second career here at the Senate. We’ve all retired before, so we share that in common.
I’m trying to get an understanding because I just don’t know. All I know is my accountant tells me what cheque to write at the end of April, and I write it. That’s as much as I know about tax policy. Some of the comments you made are about small businesses and the manner in which tax policy allows them to retain capital.
I’m interested in the other side. How do we get small businesses to access capital, as opposed to the retention of capital? I think there’s a divide somewhere inside there with all these tax policies.
Say I’m an investor on the outside; I have a myriad of choices to make investments in. Why would I choose to invest in a small- or medium-sized enterprise here in Canada? What can incentivize me?
Mr. Ernewein: That’s the nub of the question, I think. I won’t lead you to believe that I think I’ve got the answer to that necessarily.
The kinds of provisions I’ve been talking about are, in some form, a sense of self-help. By reducing the tax burden on income that small businesses generate, it leaves them more to reinvest internally. For external investment, I’m not sure the tax system is the only answer to it or perhaps the answer to it, period.
What I heard at the tail end of discussion with Mr. Daviau was the idea of some sort of investment tax credit or something to induce people to look into investments. That has been tried in various forums before. The current approach seems to be to try to set up funds that will partner with private investors to do that.
Obviously, the more you provide by way of public support, the lower the returns need to be in order to make that investment work. That doesn’t answer whether the tax system is the best way to do that. I’m probably reflecting or projecting more of my Finance days than my current KPMG role. One of the things we often thought about when we were in Finance — my economist brethren would certainly do this — was how much extra benefit you got compared to how much would have already been done. I hope I can construct a simple example. If you create a 25% incentive to invest in something, and, as a result of that, you increase the investment in that thing from 80 to 100 — that is, there are 80 who would have invested anyway, and you’ve increased that by 25% — then there is a question. That extra 20 actually costs you 25 because everybody in the 100 got the benefit. The government would have been better off to buy the thing itself, in one view, than to create that kind of incentive.
That’s sobering, and people often don’t like to hear that, but I think it’s a relevant consideration; the extent you’re moving the dial with a particular incentive compared to the baseline of what you might have had in any case. There are also issues around possible distortion: You’re driving investment this way versus perhaps a more productive investment in something else, which is a consideration. I know I’m not answering your question. I’m just trying to identify the considerations that I think are relevant.
Senator Varone: No problem. I’ll wait for the second round.
Senator Fridhandler: I guess the first question is on your list of seven: I’m surprised I didn’t hear flow-through shares. The suggestion we’ve heard is we should expand the base because the utilization of capital cost allowance, or CCA, in an R&D company pre-revenue is no different than in a mining company. They’re all pre-revenue or start-up oil and gas companies because it’s limited. Your thoughts on flow-through?
Mr. Ernewein: I take your point. It is the case that flow-through shares are most commonly used for those in a non-taxable position, which are often start-ups and smaller enterprises. For larger enterprises, they have the income tax base already that gives them the ability to apply deductions for new investment against their existing income, reducing their costs. That same opportunity does not exist for start-ups or the second cycle, if you will, so point taken.
Flow-through shares have been in place for a considerable period of time. In cramming for this last night, I think the tax expenditure report said they started in 1992. I would have dated them earlier than that, but perhaps there was some other version of it before then.
They do kind of address a market failure, you could say, or a design feature — I won’t say flaw because that’s debating the point — in the tax system. The government takes a slice of income when it’s generated. The government does not provide a refund generally for a slice of losses as they arise. For firms like these start-ups, they can’t monetize that directly, and the flow-through share provides an explicit mechanism to allow them to do that by flowing out or allocating the deduction, the loss, to someone who can use it against their own income.
I have two points about that. I don’t mean to consume all your time, but I’ll try to be helpful. One view of that is it’s a fine idea, but it should be extended across the board — make losses refundable. There are some economists who firmly believe that’s the case. There are others, like me, who get the theory but worry a lot about the practice; that could almost be catastrophic in terms of some losses being partially refundable. I don’t necessarily join my economist friends who advance this view. I do think that maybe there’s a reason not to make all losses refundable.
The counterpoint to that is, “Well, if you believe that, Brian, you shouldn’t support flow-through shares.” My response is, “Yes, in theory, it makes sense that if I’m not going to refund losses generally, I shouldn’t refund in this particular case.” The counterpoint to that is, “No, it’s open to the government to decide that there’s a special case for mining and oil and gas, these kinds of start-up situations and some technology cases” and to extend that further.
My final point is just to say that then you’re back into the question of how far you take that and whether you’re backing into a policy of providing refundability generally.
Senator Yussuff: Thank you, Mr. Ernewein, for being here.
Given what you have listed, which is quite a suite of policy tools, obviously with different benefits and different expectations as to how they would be used, we still have this big problem. There is not enough capital on the market to deal with the challenges of start-ups and the risk required.
Do you think more tax policy will solve this problem? Or should it be recognized that it’s quite a suite of policy tools, and, obviously, they work to a large extent, but the reality is this is not meant to solve everything? What would you suggest otherwise that is not in that policy suite that might be of value?
Mr. Ernewein: I can give you a long answer that takes me back to what I’ve resolved never to talk about, the things that I did in the 1980s, because it makes me seem so old, but I’ll give you the shorter version.
I don’t think the question is about tax or no tax. I think the question is what incentives you want to provide. In some sense, I believe that using the tax system is just a question of the delivery mechanism. You can have a grant or a tax incentive. The tax incentive works very efficiently, and that is why it is often used — because it’s self-executing. If the law is written correctly, taxpayers can decide for themselves whether they’re entitled. There’s no envelope in the sense that a particular department has so much money, and once that’s exhausted, further applicants fall out of line.
There are several practical advantages to using tax as the delivery mechanism over grants, but I don’t think it’s the central question. I think the central question is what incentive you want to provide. Once you take tax out of the picture, for me, I think my expertise also kind of falls short. I’m not the guy to answer that question, per se.
Senator Yussuff: Based on your experience when you’re administering most of these policies, for those who are in the small business sphere, they benefit but also understand the benefit of using these policies to enhance and grow their companies at the same time.
Mr. Ernewein: I agree with that. I don’t know if this is where you were leading, but it prompted another observation for me, which is I get the sense that this committee is not perhaps interested or exclusively interested in the size of the enterprise to which most of these incentives are directed. Perhaps there’s an interest at a higher level in providing relief. I don’t know whether I’ve misjudged that or not.
To the extent that I’ve got it right, scaling some of these things up for higher-income, higher-value enterprises really does start to make the cost a prohibitive factor. That’s a challenge.
The second point is you then start to wonder — at least I would lead you to wonder — whether that means you’re actually talking about trying to do something more general, such as the top corporate tax rates or top personal tax rates, as the response to provide a more neutral incentive for additional investment.
Senator Yussuff: Too bad you didn’t enjoy your sabbatical and had to come back, but I understand you’re having fun doing this now.
Mr. Ernewein: I am having fun, thank you. This was not on my bingo card, but it’s all good.
Senator C. Deacon: Thank you for being with us.
I want to focus on a tool that is used in Canada but provincially, and that’s equity tax credits. Nova Scotia uses them. I think there’s a version in B.C. as well. The U.K. has a national version called the Enterprise Investment Scheme. They have 30 years of data showing tremendous impacts from their perspective, and they keep building on it. It’s a 30% tax credit at the time of investment and a capital gains exemption moving forward.
The beauty I see in that is we can have a national program, and it can be focused on a type of investment where we’re seeing a structural failure in the market. Right now, it may move up in terms of the size of companies, but it’s a way of addressing that.
Do you have any experience and insights looking at those? There was a view at the Department of Finance that there was a leakage involved in that. I look at it and say, well, no, you’re driving investment into an area where you desperately need it, and the government is not putting risk capital on the table; the private sector is. You have due diligence. There are many controls in that. It’s not a benefit for the rich; it is accessible to anybody. I just don’t understand the pushback.
Mr. Ernewein: I really am going back to my Finance days. I’m not going to breach any confidences, but I think I will draw on some of my experience from that to answer your question.
Yes, I have some experience. It’s fairly dated in relation to that. It has gone by different terms, such as the angel investor tax credit and the like. The idea is to enhance the returns by subsidizing the investment.
Senator C. Deacon: Or reduce losses.
Mr. Ernewein: That’s right. Loss sharing is part of that, or separately. That’s true as well.
I’ll key in on the point you talked about — identifying market failures. To me, that sounds kind of like the converse or the obverse — I’m not sure which — of picking winners. I guess we’re all a product of our times. I said I don’t like talking about things that happened in the 1980s, but I arrived at the Department of Finance in the 1980s. At that point in time — I should say I’m not trying to make any comment on the current situation; I’m trying to give a historical perspective — the idea of government intervention had kind of fallen out of favour. I can track from the 1987 tax reform through to 2000, with Martin through to Flaherty, different political stripes all working towards that boring but, I think, effective approach of a broader base with lower rates. The idea of trying for government to be prescient and identify where the market failures really lie — this, again, I want to emphasize, is a personal view — I struggle with. I just don’t know — I’ll put myself in the place of it — that we have the capacity to do that effectively.
If there’s some way of identifying or creating a set of criteria that do that without somebody sitting in a chair waving a wand, I’m all ears, but I do struggle to know for sure how that actually is done in practice.
Senator C. Deacon: I think we heard one from Mr. Daviau earlier. He certainly had a suggestion that way.
But where was the pushback on this? Back in the 1970s, we had flow-through shares in equivalent. They were done through limited partnerships. It’s what built the Alberta oil industry. We’ve done this in the past to catalyze growth in a strategically important industry in the eyes of the government. Growth companies based on IP that are so mobile that Canada is not turning our IP into wealth — that’s a pretty obvious structural failure.
What would be the pushback? I just want to get that from you.
Mr. Ernewein: Sorry, I don’t mean to take your time to get the views of Brian Ernewein. I’m just trying to map out different considerations. I really am just trying to make the point that I don’t see it as a question of pushback; I’m just asking a question about effectiveness.
Senator C. Deacon: That’s what I’m looking for. I want pushback.
Mr. Ernewein: Okay. How is it that — pick your group — can identify those particular areas where there is market failure and which require government intervention? What’s the right level of government intervention? Is it better to approach it that way, or is it better to take the money you might spend on that to reduce tax rates across the board, for example, and try to create an investment environment where the market decides? It may choose to invest in a spot where it thinks there are returns to be had that others aren’t recognizing.
Senator Ringuette: It’s a pleasure to see you again. I have to say I’ve missed you.
Mr. Ernewein: That’s very flattering.
Senator Ringuette: That being said, you said grants and tax incentives have their downsides and could distort the market. We’ve had almost 10 meetings, if not more, and we find that the market is currently distorted because billions of dollars of capital are flowing out of Canada, while we need that capital to grow our industries and our economy and hopefully be more resilient.
Tax policy is your expertise. Which tax policy is currently distorting the market to not favour capital being big in Canada and staying here?
Mr. Ernewein: I want to be careful not to get too far over my skis.
I think there would be some who would debate whether or not some greater investment or the level of investment outside of Canada, as compared to what’s invested inside of Canada, is a distortion. I think there are some who would say that’s based on where the greater returns lie, possibly. I think others would suggest that it’s a lack of investable assets in Canada. The debate, I understand, continues but is advancing with some of Canada’s pension funds in relation to infrastructure and certain government properties.
Let me allow more for your question. Perhaps we just want neutrality. Perhaps we just want to put our thumb on the scale to induce investment in Canada. Well, then lower tax rates would do that.
I would argue, costs aside, that a broad-based investment incentive that applies to a large measure of Canadian investments would still preserve neutrality to some degree. I’m putting aside any constraints of our trade agreements, et cetera, but just in terms of being a fairly basic economist, if you will, an amateur economist, I think if you incent something, you will get more of it. So it’s a matter of determining what it is you want to incent.
If the problem you want to overcome is inadequate Canadian investment generally, then you try to do something about Canadian investment generally. If it’s about some specific market failure, and we believe we have the capacity to identify that, then you can target that specifically.
Senator Ringuette: Right now, it seems that there’s a different mindset in the U.S. in regard to Canada and investing in higher-risk start-ups and IP and so forth. How can we compete? How should we address that competition to keep these companies in Canada?
Mr. Ernewein: Am I right to understand what you mean by that is that there’s a higher risk appetite in the U.S. than in Canada?
Senator Ringuette: It could be part of the situation. Maybe it’s also due to the tax system they have over there that compensates for the higher risk.
Mr. Ernewein: I can offer you views on the corporate tax systems. The tax advantage we enjoyed has essentially been eliminated, so there’s a question as to whether we should be doing something to restore that. However, that takes me back to tax rates and top tax rates.
If the question is separate from that and it’s the case that, as a generalization, Americans or non-residents have a higher risk appetite than Canadians, I don’t know how to solve that. I don’t know if it’s true, but if it’s true, I don’t know how to solve that, frankly, and I don’t know whether the tax system would do it.
Senator Ringuette: Everything being equal and leaving aside the risk appetite, how does the situation we’re facing in regard to capital for SMEs compare to what’s in place in the U.S. that we could look at and say, “This is going to help”?
Mr. Ernewein: In relation to SMEs specifically?
Senator Ringuette: To SMEs, yes.
Mr. Ernewein: It’s hard. To compare apples to apples is very difficult. The U.S. has a flow-through vehicle for so-called Subchapter S rules that allows owners of private companies, if they so elect, to flow the income and simply be taxed on a personal level. There’s a pass-through deduction that was part of the Tax Cuts and Jobs Act of 2017, which some people think is a bit flawed, but it provides the benefit on income being flowed up. There are other examples.
An observation I’ll make in closing is a generalization. I’m not sure that for many smaller enterprises — I think of my dad’s construction company or the like; it wasn’t that he was going to move to the U.S. with his small construction company. It was built, and he operated in a particular area. Probably, if you’re concerned about the mobility or transfer effects, I’d probably be more concerned about that at a higher-income level and in different sectors.
[Translation]
Senator Henkel: Welcome, Mr. Ernewein. You speak French, am I right?
Mr. Ernewein: Not really.
Senator Henkel: No worries.
I’d like to discuss business succession. Several witnesses who appeared before the committee insisted business succession could be a significant growth driver for SMEs, but that it remains limited in Canada. What are the main tax barriers to business succession, particularly for acquisitions or transfers of businesses when it comes to SMEs?
[English]
Mr. Ernewein: If I may ask for clarification. Are you asking about the tax treatment when a company is bought or sold?
Senator Henkel: When it’s sold.
Mr. Ernewein: Okay. In the case of a sale, the vendor may qualify for the $1.25 million lifetime capital gains exemption, and, depending on the ownership of other family members, that might be multiplied. There could be stock option benefits that are relevant, but I’ll skip over that.
If it’s sold to an employee ownership trust, this recent vehicle that has been announced and is now said to be made permanent, it will allow another $10 million in capital gains to be potentially exempt from tax. That’s total. That cannot be multiplied.
There’s the ability of that seller, that vendor, to reinvest the proceeds from selling that into other small business companies and obtain a rollover to effectively defer the capital gains until a later sale of that subsequent property, assuming it too is not reinvested.
After all of that is exhausted, then capital gains could apply. This is a general rule now. Only half of capital gains are included in income. If we’re talking about an actual person selling, tax rates in 8 of the 10 provinces are in excess of 50%, but, very generally, half taxable at a 50% rate means 25% of the sales proceeds that represent a gain but did not qualify for those other exemptions would be exposed to that tax.
[Translation]
Senator Henkel: I’d like to draw on your international experience. From 2013 to 2020, you represented Canada on the OECD’s Committee on Fiscal Affairs. Therefore, you have a much broader perspective on international affairs.
I’d like to ask you about tax reforms among our G7 or OECD partners that have had a real impact on SMEs’ access to capital. Do you think Canada could use some of these measures as models, those that apply not only in terms of regulations, but also given the size of our market?
Thank you.
[English]
Mr. Ernewein: Thank you, first of all, for acknowledging that.
I would actually challenge the premise. I think that the changes that we had under discussion at the OECD, some of which are still unfolding, are more at the multinational level and are very large corporations. The changes in relation to limiting interest deductibility, yes, they can reach down, but there are exemptions under the Canadian rules that the OECD rules contemplate. The larger firms are more targeted. Same with rules relating to so-called hybrid mismatch arrangements; the global minimum tax, which is still rolling out, applies — I’ll say only, but I don’t know if that’s a helpful qualifier or not — to multinationals, so operating across borders, that have revenues of greater than €750 million, which is about C$1.1 billion.
Senator Henkel: Countries that are similar to ours, do they have any reform that works for them for the small and medium companies that we could maybe benefit from or, at least, be inspired by?
Mr. Ernewein: Thank you. I don’t have a very good understanding of the rules for small businesses in other countries. I did make mention of the U.S. rules: the ability to have a flow-through of income out through the so-called Subchapter S rules, as opposed to having separate taxation on a corporation in the United States. Their personal tax rates are considerably lower than ours at the federal level when you take into account that many U.S. states do not impose their own taxes, so that obviously has an impact.
To sum up, if you were to say that back in a different way, I don’t really have much knowledge of small business rules apart from a passing familiarity with the U.S. In the U.S., it is this flow-through mechanism, but there are also lower tax rates, which inform the question.
The Chair: Thank you.
Senator Loffreda: Thank you, Mr. Ernewein, for being here with us. You spoke about the lock-up yesterday. I was in lock-up too. I have Canada Strong For All, the Spring Economic Update, here.
Our goal is to identify the gaps in financial support for SMEs. That’s what we’re trying to solve. You are a tax expert. I agree with you that the economic impact may be far smaller than the fiscal cost when we start to incentivize investors into investing in stocks, because it’s hard to determine. History has proven that the fiscal cost is high.
I just want to make a point here. If you look at pages 8 and 9 of the Spring Economic Update, it says that direct investment into Canada is at a 20-year high. We have a summit in September 2026, the first Canada Investment Summit. So what incentives could we put forward before the investment summit to invest in SMEs?
“Canada Leads the G7 in Direct Investment Inflows Per Capita,” which is nearly double that of the U.S., which is second. I’m taking this from the Spring Economic Update. On page 9, we talk about the lowest marginal effective tax rate in the G7, at 15.4%, compared to the U.S., which is at 16.9%. They are second. It goes all the way to 31.7% in Japan.
Given that information, why are we not attracting more investment in the SME sector? Is it risk? Is it access to capital markets? You were in lock-up; I was in lock up. These are actual numbers.
Mr. Ernewein: I’m trying to be concise. The marginal effective tax rate, or METR, analysis is valid. It measures the pointy end of the stick — what the tax rate is on the next dollar of investment as opposed to the average return or average tax rate, which can mask differences. So things like accelerated capital cost allowance, fast writeoffs or immediate writeoffs for manufacturing and processing buildings — I think those all help at the right end of the point. That’s a challenge or a criticism of something like a general rate cut, which doesn’t just benefit new income, but also returns from old investments. So it’s less direct.
I have more trouble with focusing, as you want me to do, on small- and medium-sized enterprises. For small businesses, it’s often the case that they are a localized thing. There is a price taker, if you will. They are operating or not as they choose in a particular location.
For medium-sized enterprises, it depends on the business. If they are selling into the U.S. and there is a tariff in place, I don’t think anything the tax system can do will overcome that. So I kind of place a priority on the resolution of the outstanding trade questions ahead of the income tax questions.
If those are resolved, then I think you work down to trying to figure out how much tax affects your return. That’s a question of how we compare with, for example, the United States. We did have something in the order of a 10-point rate advantage before 2018, but the Tax Cuts and Jobs Act essentially eliminated that, with the U.S. moving its federal rate from 35% to 21%.
I was at Finance at the time. I think the evaluation made then was that it wasn’t clear that was going to stick. The Democrats were saying they were going to move the rate up, and so the reaction was not to try to adjust the rates at the time, but to do other things, to, as I say, implement these faster writeoffs and immediate writeoffs to match the U.S. on that front, which contributed to us having this low METR, accentuated by more recent actions.
But now we are close to 10 years later, and the U.S. rate has not gone back up, so that the Canadian rate advantage we had has now essentially evaporated. I know this is not the thesis you’re testing necessarily, but I’m more inclined to argue for or to add to the debate the idea of looking at our broad-based corporate tax rates to see whether or not that’s the way we can be more responsive in a more neutral way.
Senator Loffreda: Thank you for that.
The Chair: Before going to the second round, I have a question. I don’t know if you have been involved in this new approach of the Carney government to have two buckets: the operating and spending and the capital investment. So what I notice, for example, is the productivity super-deduction is a tax incentive, and, in fact, you go to capital investment. So when we talk about flow-through shares, have you any thoughts regarding that? Have you been involved? If you go to an incentive to encourage people to invest in small and medium companies, which increases GDP potential down the road, is it a concept that you classify as a capital investment?
Mr. Ernewein: I have not had any involvement in any of that. My Finance days were before that. In my KPMG days, I’m not involved in that.
I would struggle, however, to understand how a tax saving to an individual from having a flow-through share deduction passed out to them would be classified as a capital investment. It strikes me that within the tax system it would be accounted for on a current basis, probably without the question arising. That is my guess.
The Chair: It’s okay. We’ll have the Finance Department. Colleagues, we have 7 minutes. Three minutes each, please.
Senator Fridhandler: I don’t have to ask two questions quick, although I do have two questions. You talk about the capital gains role in reinvestment. Just for information purposes, other than farms, where does that exist? I didn’t know that we had that. Does it exist in small- and medium-sized businesses, or is it otherwise narrow? We have been pushing that as a possible addition to our tax. Take it away.
Mr. Ernewein: I’m looking for the income tax reference. It’s 44.1. It has been in place for — when I say 10 years, I’ll probably look back and find out it will be 15 or 18 years. That’s the way I operate.
It allows a small business corporation that grows to any size but is, I think, still required to be a private corporation, if sold, to invest the proceeds in another small business corporation, but the reinvestment limit is — I don’t know if it’s a size test or a revenue test — $100 million. You can turn your small business into one like Microsoft. It could be worth $100 million, and if you sell it and invest in 50 other small businesses, I believe that qualifies. The test for the sold corporation is whether it’s an active business and, I think, still private. The test for the replacement property is a smaller private investment business.
Senator Fridhandler: In theory, just for my information on grants versus credits, I assume that a grant is when you tick the boxes and you get it, so there is no government subjectivity. For the same matter, a tax credit — are they equal cost? Are they weighted the same, or are we better off with credits versus grants?
Mr. Ernewein: Projecting, again, from my old days, I would say it’s better as a grant because then you don’t have to clutter the tax system with it.
Being a little less parochial, I’d say they operate largely to the same effect. For the tax credit, as the person seeking the benefit, you form your own judgment based on enacted legislation whether you are entitled to it or not, and you take the risk that the CRA may disagree with you.
In the case of a grant, you form your opinion as to whether you qualify for it; then you make an application to whoever is administering that program. They will almost certainly judge in advance whether you qualify for it before writing the cheque. There is that timing difference that can arise.
In theory — I talked about this before — there is not much difference. Sorry, that envelope, that potential program cap, can be more relevant to a grant than others, but the practice can be quite different because you’re relying on enacted law, as I say, in a tax incentive.
The Chair: Thank you.
Senator Loffreda: Mr. Ernewein, it has been a very interesting discussion. Thank you for being here and for your expertise.
Getting back to grants, what would you think of this idea? Maybe it’s not easy to answer, but I’ll put you on the spot for this last question. The idea is to lower taxes across the board and eliminate grants and subsidies altogether. Wouldn’t that be a bigger benefit to the economy? We see grants. Sometimes, the grants are not made efficiently. I don’t want to mention names here. It’s not a debate. We all know certain grants turn out to be total losses.
The other issue is the economic impact has to always be larger than the fiscal cost. We’re looking for tax incentives to invest, but you would have to do it for SMEs. That’s where it’s required. You have to have a level of capital where if it’s below that level of capital, you get the deduction — only if it’s below that level of capital. That’s why creating jobs will be a fiscal cost, but it’s finding that right balance between — I don’t know; those are ideas I’m throwing in the air here, but what do you think? I would like your opinion on that given your tax expertise.
Mr. Ernewein: I agree with your general idea. Coming back to Senator Deacon’s points from before, I don’t mean to suggest there is no role for government in trying to address market failures. I think there is. I think Scientific Research and Experimental Development is an example of that where we provide assistance because the firm doesn’t capture all the benefits of its research. It’s for the benefit of the broader community, so we need that to enhance the incentive. That’s the first point.
The second point is that I do have a personal preference for neutrality, so I’m more inclined to something like a broader rate or a broader investment incentive — if it’s affordable — than something more targeted. If it is more targeted, then you do have borderline issues: Why your business qualifies and Senator Ringuette’s does not? That’s a challenge.
Senator Loffreda: If it’s not targeted, everybody will invest in bank shares. They’re the least risky, and you get 25%. That’s not what we want. We want the SMEs, right?
Mr. Ernewein: If you’re going down this road, it’s necessary — and I take your point — for what you are targeting to have very thoughtful borderlines that are defensible and that do distinguish between the case where there is, let’s say, a market failure and where the investment does not require support.
Senator Loffreda: Thank you.
The Chair: Mr. Ernewein, we want to thank you for your flexibility on short notice to be in person with us today. We appreciate it very much. Your testimony will be taken into consideration.
Colleagues, our next meeting will be tomorrow at 10:30 a.m. On your behalf, I want to thank our interpreters, our analysts, the clerk and all the staff and the operators in the back for making that happen.
(The committee adjourned.)