Finance Committee on Dec. 3rd, 2009

[The Chair, Conservative, James Rajotte]

Mr. Paillé, you have two minutes.

[Daniel Paillé, Bloc, Hochelaga, QC]

A comment. I am assuming that neither your costs to come here nor the loss of income will be deductible. When you contribute retroactively and are therefore declared..., does the employer, the company who hired you and who most certainly deducted the fees associated with your company from its taxable income, also receive a notice of contribution in order to charge all of that back?

[Mario Sabourin]

No.

[Daniel Paillé, Bloc, Hochelaga, QC]

How can you explain that, other than to say that it is a horrible tax inequity?

[Richard Fahey]

That is why we are here.

[Daniel Paillé, Bloc, Hochelaga, QC]

A single department of revenue, now that would be much better, no?

[Some voices]

Ah, ah!

[Marlene Jennings, Liberal, Notre-Dame-de-Grâce—Lachine, QC]

You cannot be asking that of witnesses.

[Daniel Paillé, Bloc, Hochelaga, QC]

With all due respect, that was a statement.

[A member]

Mind you that was [Inaudible—Editor].

[Daniel Paillé, Bloc, Hochelaga, QC]

They thought that was funny.

[The Chair, Conservative, James Rajotte]

Thank you for your presentations here today.

Colleagues, we will suspend for a minute or two, and then we will bring forward the officials from the Canada Revenue Agency.

Thank you very much for being with us here today.

[The Chair, Conservative, James Rajotte]

Colleagues, can I ask you to find your seats, please? We will begin with the second panel here today.

We have with us three officials from the Canada Revenue Agency. We have Ms. Lucie Bergevin, director general, audit professional services directorate, compliance programs branch; we have Mr. Wayne Adams, director general, income tax rulings directorate, legislative policy and regulatory affairs branch; and thirdly, we have Ms. Susan Betts, director, technical applications and valuations, audit professional services directorate.

Welcome to all of you. You've obviously heard the previous panel and the concerns they've raised. I don't know if you do have an opening statement, but you certainly have the opportunity for an opening statement, and then we will have questions from members.

Do you have an opening statement?

[Lucie Bergevin, Director General, Audit Professional Services Directorate, Compliance Programs Branch, Canada Revenue Agency]

Yes, I do.

May I begin?

[The Chair, Conservative, James Rajotte]

Absolutely.

[Lucie Bergevin]

Good afternoon, Mr. Chair and members of the committee.

My name is Lucie Bergevin and I am the Director General of the Audit Professional Services Directorate.

With me today are Mr. Wayne Adams, Director General of the Income Tax Rulings Directorate, and Ms. Susan Betts, Director of Technical Applications.

A personal services business is defined in subsection 125(7) of the Income Tax Act, as a business that provides the services of an "incorporated employee" to an entity, where the "incorporated employee" would otherwise reasonably be regarded as an employee.

From a tax perspective, the critical issue relating to a personal services business is whether an incorporated individual is considered to be an employee of the client or an independent contractor, when providing services to a client.

Let's say an employee who is a resident in Canada resigns from his job with a corporate employer. The individual establishes a new corporation. He has his new corporation enter into a contract to provide his services back to his previous employer. The individual is referred to as an "incorporated employee".

In effect, the "incorporated employee" could be using the new corporation to convert employment income into active business income of the corporation, which would be eligible for the small business deduction. Consequently, the "incorporated employee" would benefit from the lower tax rates offered by the corporation.

Therefore, the key question is this: if it were not for the service corporation, would there be an employment relationship between the individual providing the service and the entity receiving the service?

In fact, the personal services business income tax legislation came into effect in 1981 to prevent employees from incorporating simply in order to gain access to the small business deduction and favourable tax rates.

In practical terms, the goal of this provision is to create a level playing field in that incorporated individuals, who are in reality considered to be employees, are treated the same way for tax purposes as a regular employee.

If an "incorporated employee" falls under the income tax definition of a personal services business, it is subjected to corporate tax at the full corporate rate.

In addition, subsection 18(1) of the Income Tax Act limits the deductions that a personal services business can claim to generally only those deductions that employees can claim. The corporation cannot deduct the variety of expenses that would be available to other types of businesses.

Examples of expenses that are not deductible by a personal services business include bank charges, office supplies, professional fees, repairs and maintenance, capital cost allowance and advertising expenses.

An exception is provided where the corporation employs more than five full-time employees. The business will not be considered to be a personal service business and it will therefore be eligible for the lower tax rate and usual business deductions.

In conclusion, whether a person is an employee or a self-employed contractor is a question of fact, which can only be determined following a complete analysis of the service contract. CRA has a guide RC4110, Employee or Self-Employed, which assists in determining the nature of the contract.

Thank you Mr. Chair, and we will be happy to take questions from members of the committee.

[The Chair, Conservative, James Rajotte]

Thank you for your presentation.

Moving on to questions from members, we will begin with Ms. Jennings.

[Marlene Jennings, Liberal, Notre-Dame-de-Grâce—Lachine, QC]

Thank you, Mr. Chair.

Let us take the example of an incorporated business that has filed a number of annual tax returns over the years. At one point, the Canada Revenue Agency wakes up and decides that it is not dealing with a small business but rather an employee. Therefore, you carry out an audit of the past three or five years and issue a notice.

At that point, do you get in touch with the clients, that person's business clients, to inform them that the contract they signed with the small business is no longer valid under the Canadian Income Tax Act? And will they be asked to pay employment insurance premiums? In Quebec, you have to contribute to the QPP. At the federal level, there is the Canada Pension Plan and Old Age Security. Do you do all that?

[Lucie Bergevin]

I will answer part of your question and then ask my colleague to follow up.

As a general rule, the CRA's auditor will contact the person who is being audited. Referrals of cases from the Quebec region are the exception. That issue was raised earlier. I cannot say whether contact is established in such situations. Besides, each audit is unique. That is why no single, general rule can apply to all audit situations.

[Marlene Jennings, Liberal, Notre-Dame-de-Grâce—Lachine, QC]

What you have just said reveals an unfairness. You say that you are unable to determine whether contact was made or not because you receive the notices from Revenu Québec. I think, however, that such an obligation should be included in the agreement. Moreover, you say that all cases are different. It is therefore possible that the large corporation be required to pay contributions and file tax returns for those same revised years, and that the person's status change altogether, ie, as an employee of the corporation. Under those circumstances, the person should receive all the benefits that he or she was not entitled to during those years. But you are telling me that no compensation is given.

[Lucie Bergevin]

As a point of clarification, I would like to say that what we are talking about is whether the person being audited was contacted.

[Marlene Jennings, Liberal, Notre-Dame-de-Grâce—Lachine, QC]

No. That is not what I asked you. Either I was not being clear, or you did not quite understand. I gave the example of a situation in which you would decide to audit a small personal business and, as a result of that audit, determine that the person could not be considered as a personal business under the law, but rather an employee.

Given those conditions, do you contact all the clients with which the small business dealt during the years covered by the retroactive audit, in order to notify them that you changed the person's status? Do you tell them that the person was in fact an employee of the company, and is required to revise its own income statements and submit to the Canada Revenue Agency the employment insurance benefits to cover those years or, for that matter, any other benefits that you collect on behalf of the agency? Is that something you do?

[Lucie Bergevin]

I will ask my colleague, the director of technical applications, to respond.

[Susan Betts, Director, Technical Applications and Valuations, Audit Professional Service Directorate, Canada Revenue Agency]

Sure.

First of all, in terms of any contact we would have with...I'm going to call them a service recipient, in section 241, the confidentiality provisions would prevent us from going to the service recipient and saying that we've had a look at your service provider and changed the characterization. So we'd be prevented from doing that.

The other question that I sort of want to address is to make a distinction between contracts between two parties and the impact those contracts have on the tax regime in terms of the tax effects those have. The distinction I want to make there is, if the person who's providing the service is a corporation, then we don't effectively say they don't have a corporation anymore, because in law they do have a corporation. So in terms of us going back to the service recipient and saying they have to contribute EI and CPP for this person, that's not the way the law works.

If they were not incorporated, there may be an issue where that is something we would have to look at from an audit perspective, but we can't legally change the effect of what is in place. And if they do have a corporation then--

[Marlene Jennings, Liberal, Notre-Dame-de-Grâce—Lachine, QC]

Excuse me for interrupting. One minute.

What you're saying is that while you say you cannot legally say they're not incorporated--because legally they are incorporated--the agency can say that their contract they signed with a client is not valid and therefore you are not going to allow the taxation, the reports, their

income tax returns, tax returns,

that they have filed diligently. You are not going to allow any of the deductions because you have deemed that the contract is not valid and therefore they're subject to a whole other rate of taxation with other rules regarding what's deductible and what's not deductible.

I have a difficult time on the one hand in that you can do that legally, the law allows you to do that, but you're saying at the same time that the law doesn't—