Finance Committee on May 8th, 2014

[The Chair, Conservative, James Rajotte]

It's Fralick, okay. Welcome back to the committee.

From the Canadians for Tax Fairness, we have Mr. Dennis Howlett. From GrowthWorks Atlantic Limited, we have the president and CEO, Mr. Thomas Hayes. As an individual, from Victoria, British Columbia, we have Professor Lindsay Tedds.

Ms. Tedds, can you hear me okay in Victoria?

[Prof. Lindsay Tedds, Assistant Professor, University of Victoria, As an Individual]

Yes, I can. Thank you.

[The Chair, Conservative, James Rajotte]

Okay, welcome, and thank you for being with us today.

You will each have five minutes for an opening statement, and then we'll have questions from all the members.

We will begin with the Canadian Cancer Society.

[Pamela Fralick]

Thank you very much, Chair.

Honourable committee members, we do thank you for the invitation to testify today.

We strongly support the tobacco tax increase included in the federal budget and in Bill C-31. This measure will reduce youth smoking and it will save lives. It is that simple. Higher tobacco taxes are the single most effective strategy to reduce smoking, especially among youth. We want no new smokers.

We urge all parties to support this measure. In fact, the increase to federal cigarette taxes in Bill C-31 of $4.03 per carton of 200 cigarettes is merely an inflationary adjustment, though a very much needed adjustment. Prior to this change there had not been a net increase to federal tobacco taxes since 2002, a stretch of fully 12 years. This meant that the real federal tobacco tax rate was actually decreasing once inflation was factored in. There is a vast body of worldwide evidence that confirms the obvious. As tobacco prices go up, tobacco consumption goes down. The studies show that a 10% increase in the after-inflation price results in a decrease in tobacco consumption of about 4%, and even more with youth.

The tobacco tax increase is a win-win, benefiting public health and public revenue. Tobacco use and tobacco-caused disease and deaths will decrease, and almost $700 million in incremental annual federal tobacco tax revenue will be generated.

Let me address the contraband issue. Many associations funded by the tobacco industry responded to the federal tobacco tax increase by referring to contraband. These organizations have a long history of opposing tobacco control measures. Here are some facts.

Contraband has decreased substantially in Canada, as admitted by the tobacco industry. In our binder, which I hope you have, tab 1, a graph from British American Tobacco says that Canada-wide contraband was 17% in 2006; 22% in 2007; 33% in 2008; and then down to 19% in 2010. A graph on that same tab from Philip Morris also indicates a declining trend. As well, federal and provincial government tax-paid sales data for these years, as well as subsequent years, confirm a dramatic decrease in contraband.

Tab 2 of our binder shows a massive growth in price-discounted cigarettes sold legally by tobacco companies. The tobacco industry has reduced prices by $20 or more per carton on some brands, and the federal tax increase of $4 per carton counters only part of this.

Tab 3 of our binder contains a graph showing provincial and territorial tobacco tax rates. Tobacco taxes are far higher in western Canada than in Ontario and Quebec, yet contraband volumes in western Canada are minimal. This graph illustrates that the cause of contraband, as we have it in Canada today, is not high tobacco tax rates. Higher tobacco taxes and low contraband are both possible, as the western provinces have shown.

There's no doubt that additional contraband prevention measures would have a further beneficial effect. We support the announcement in the budget for an additional $92 million over five years for contraband enforcement, and we continue to endorse Bill C-10, the tackling contraband tobacco act.

As well, we have other recommendations for contraband prevention.

First, the RCMP should pay more attention to blocking the supply of raw materials, such as leaf tobacco, cigarette paper, and cigarette filters intended for illegal factories. Second, the federal government should modify plans to move the Cornwall border post to a new location in Massena, New York. Instead, there should be a two-part border post with checkpoints in both Massena and Cornwall to better intercept contraband. Third, the federal government needs to persuade the U.S. government to shut down the illegal factories on the U.S. side of Akwesasne.

The tobacco tax increase and contraband prevention measures in the federal budget are essential components of a comprehensive strategy that should also include, one, a ban on flavoured tobacco products; two, plain packaging, as has been implemented in Australia; and three, sustained, well-funded programs by Health Canada.

Tobacco use remains the leading preventable cause of disease and death in Canada, killing more than 37,000 Canadians each year. Smoking is still responsible for 30% of all cancer deaths, and there are still five million Canadians who smoke, and too many children.

I will finally comment, as I close my presentation, and express support for another measure in the federal budget, lotteries and the proposed legislative change to allow charities to use computers and other modern technologies in their lottery ticket sales and operations. It will reduce administration costs and allow the Canadian Cancer Society and other charities to direct more money to their important program services and research.

Thank you so much.

[The Chair, Conservative, James Rajotte]

Thank you very much for your presentation.

Now we'll hear from Canadians for Tax Fairness.

[Dennis Howlett, Executive Director, Canadians for Tax Fairness]

Thank you for this opportunity to comment on the parts of Bill C-31 related to tax havens.

We support the implementation of several measures that aim to go after tax cheats using tax havens that were announced in the 2013 and 2014 federal budgets, which are contained in Bill C-31. But we feel these limited measures do not go far enough in dealing with what is a growing problem. We would like to suggest some additional measures that should be considered if the government is serious about going after tax cheats using tax havens.

First of all, we welcome the improvements to the Canada Revenue Agency's ability to provide feedback to the Financial Transactions and Reports Analysis Centre of Canada and to law enforcement agencies. These are fairly minor changes, but they will help make enforcement more efficient. There may be some reduced privacy aspects here, but we feel they are justified in view of the social benefit as a whole.

Second, in terms of reporting, some of the changes on tightening up provisions and the regulation of electronic transfer of funds are also a welcome step, especially including casinos, which are a preferred method of money laundering. Tax cheaters and organized crime syndicates are always trying to find ways to circumvent the regulations, so it is logical that the government should be always trying to stay a step ahead and close off any holes in the monitoring system.

Third, on the offshore tax informant program, information from informants is one of the ways in which tax authorities are able to lift the veil of secrecy that is the hallmark of tax havens and identify individuals and companies that are evading paying their fair share of taxes. But we should not expect that this program is going to result in that many convictions.

The IRS Whistleblower Office in the U.S. just published a 2013 report that shows the U.S. collected $367 million as a result of whistle-blower information from just six cases last year. There were 12 cases in 2012, and a slightly larger amount of money was collected. Canada is roughly 10% of the U.S. economy, so we are not likely to see more than a few cases in a year.

The U.S. Whistleblower Office annual report also notes that cases typically take five to seven years from receipt of submission to be settled and claims paid, so it may be a number of years before we will see any tangible benefits to Canada.

Maybe the most important aspect of this measure may be the deterrent effect, which will be hard to quantify. But in order to maximize the deterrent effect of this measure, the government needs to do a more energetic job of public promotion and education. This is one program where spending some public advertising dollars, raising awareness about this program, would be justified.

The other issue that needs to be addressed is the protection of confidentiality of whistle-blowers coming forward. I have personally been contacted by several potential whistle-blowers who were seeking information on how they should go about accessing the offshore tax informant program, but were very worried about their safety. I know there are some provisions to protect tax confidentiality, but the CRA website does not give adequate assurance, and the government needs to do more to reassure potential informants.

The tax haven problem is growing, as we have recently shown in a Statistics Canada report on direct offshore investment abroad. They are up 10% over last year.

On some of the additional measures that we feel are needed, one would be to provide the CRA information needed by the Parliamentary Budget Office to complete a tax gap estimate. Second, increase the capacity of the Canada Revenue Agency to go after tax cheats. Third, make amendments to the general anti-avoidance rule to include a clear statement that economic substance is required in any transactions to be considered. Fourth, Canada needs to support substantive reforms of the international corporate tax rules that are being developed through the OECD base erosion and profit shifting process.

I'd be happy to answer questions about that, if you like.

[The Chair, Conservative, James Rajotte]

Thank you very much for your presentation.

We'll go to Mr. Hayes now, please.

[Thomas Hayes, President and Chief Executive Officer, GrowthWorks Atlantic Ltd.]

Thank you, Mr. Chair, for the opportunity today to appear before you and your colleagues to address important issues that relate to the venture capital ecosystem in Canada.

In its March 2013 budget, the federal government announced a surprise phase-out of the long-standing 15% federal tax credit for Canadian investors who have chosen to support budding entrepreneurs across Canada who want to start and grow their businesses. This federal tax credit has resulted in the levering of billions of private dollars of risk capital from over millions of Canadians who have been available to our early-stage companies since the early 1980s. In fact, since the program was created by the Mulroney government, well over one-third of all venture capital available in Canada has come from labour-sponsored venture capital funds in British Columbia, Saskatchewan, Manitoba, Ontario, Quebec, New Brunswick, Prince Edward Island, Nova Scotia, and Newfoundland and Labrador.

Despite the best efforts of many individuals across the country to convince the federal government to reverse its decision to phase out the federal tax credit, the industry is now faced with the reality of moving forward and dealing with a number of challenges that result from the withdrawal of the tax credit. The biggest of those challenges is fund liquidity and the adverse impact that issue may cause for existing shareholders in our funds and for the portfolio companies in which our funds have already made investments.

The Department of Finance has indicated there will be changes made to some of the rules governing federal investment pacing obligations for labour funds that want to exit the program, which at first glance appears to be helpful during the transition process. However, these same funds have provincial pacing obligations, which are not forgiven on the same basis as the proposed federal changes, so funds are still obligated to invest their shrinking capital base, which further exacerbates the liquidity issue. It would be helpful if the federal Department of Finance would work collectively on this matter with its provincial counterparts.

We also know the federal government is changing its approach to ensuring an adequate supply of venture capital is available to Canadian entrepreneurs and companies by directly investing $400 million of new capital into the industry. Many of us in the industry have been supportive of this initiative, now known as the \/CAP program. It's my understanding that further positive announcements will be made by early fall about additional private sector funds that will be chosen to participate in the VCAP program.

While these announcements will be welcomed by the industry, a word of caution is in order. The choice of additional funds that will qualify for federal \/CAP funding is only the first step in creating new pools of capital for Canadian entrepreneurs. These chosen funds then have the significant challenge of seeking matching private funding before they are in a position to actually write cheques to Canadian entrepreneurs seeking risk capital. How long this process of raising private capital will take and how successful these funds will be in this endeavour is anyone's guess. On that basis alone I would ask the federal government to reconsider an extension of one to two years for the existing federal 15% tax credit to ensure there is a continued adequate supply of venture capital while the VCAP program gets up and running.

In closing, the particular fund I manage operates in Atlantic Canada and I want to say a word about the Atlantic Canada Opportunities Agency and the positive impact it's making in our region in the start-up community. We like to say that if you think it's difficult for an entrepreneur to raise venture capital in central Canada, come on out east and see how challenging it is in our region. ACOA has become a very important source of non-dilutive capital for very many local companies, and an excellent partner for those of us in the private sector who are also investing in these companies. We appreciate their good work and I just wanted to make sure your committee is aware of this fact.

Thank you for your time and I will be pleased to answer any questions you may have later in the session.

[The Chair, Conservative, James Rajotte]

Thank you very much for your presentation.

We will now go to Professor Tedds in Victoria, please.

[Prof. Lindsay Tedds]

Thank you. Good afternoon.

I assume you can hear me?

[The Chair, Conservative, James Rajotte]

Yes, we can.

[Prof. Lindsay Tedds]

Thank you.

My name is Dr. Lindsay Tedds. I am an associate professor of economics in the school of public administration at the University of Victoria. My primary area of expertise is Canadian tax policy, with a particular focus on design and implementation.

With that, I would like to thank the committee for allowing me the opportunity to share my views on two tax-policy measures that are contained within Bill C-31. This is mainly the elimination of the need for individuals to apply for the GST/HST tax credit, allowing the Minister of National Revenue to automatically determine if an individual is eligible. I'd also like to talk about yet another one-year extension of the mineral exploration tax credit for investors in flow-through shares.

With respect to the GST/HST credit, one of the biggest challenges levied against the tax itself is that it is regressive. However, there are features of the implementation of this tax that offset its regressivity, and a very important part of that is the GST tax credit. This tax credit puts money in the hands of low- and middle-income households to offset the tax that they are paying on their consumption.

Without the passage of Bill C-31, the status quo for applying for this important tax credit will remain and that is very unfortunate. The current administration of this tax credit requires individuals to apply for it every single year by checking a box on their tax application. By using this opt-in method, low-income individuals who overlook the box, or more importantly, do not understand the box and do not check it, miss out on this very important tax credit. Through Bill C-31, the federal government is making a very significant and very important reform to the administration of the GST/HST tax credit by eliminating the need for individuals to apply for the credit and allowing CRA to automatically determine if an individual is eligible for the credit, as we do with most credits in the tax system.

I applaud this move away from an opt-in method towards an assessed method because the credit is an important way to get money into the hands of low- and middle-income Canadians and this simple change will actually increase the money going to these households.

With respect to the mineral exploration tax credit, in form and function this tax credit dates back to 2000 when it was called the investment tax credit for exploration. The impetus for this 15% non-refundable investment tax credit for investors in flow-through shares in mineral exploration companies was the low prices of metals that occurred in the 1990s, and those low prices caused a significant contraction in mineral exploration. Now, metal prices have rebound significantly since 2000 and that tax credit, which originally was set to expire in 2003, has unfortunately been continually renewed since that time. The METC was last set to expire on March 31, 2014, but Bill C-31 extends it for yet another year. This is despite the fact that mineral taxes are at historically high levels and in fact have increased threefold since the tax credit was implemented.

Not only have the conditions that prompted the creation of the tax credit disappeared, there is actually no evidence to support the existence of the tax credit. There is no evidence that the credit induces increased exploration activity over that stimulated by commodity prices. On the investor side, the credit subsidizes high-risk investments that are used predominantly for tax planning purposes by high-income taxpayers rather than for calculated investment purposes.

The dire consequence of it is that the tax credit channels investment money away from other more lucrative but unsubsidized investments. In fact, the rate of return of investments that qualify for this tax credit is very poor, suggesting that the tax regime is the sole purpose for these investments. On the administrative side, the METC regime is associated with high administrative and compliance costs benefiting only tax lawyers and accountants.

It is time to end this tax credit that benefits wealthy investors and subsidizes poorly performing investments. Doing so will help restore fairness to our tax system and close a loophole with little discernable benefits for the taxpayers who fund it.

In closing, I'd like to thank you for providing me with an opportunity to provide you with my views on these two measures, and I look forward to your questions.

Thank you.

[The Chair, Conservative, James Rajotte]

Thank you very much for your presentation.

We'll begin members' questions.

We will begin with Mr. Caron.

You have seven minutes.

[Guy Caron, NDP, Rimouski-Neigette—Témiscouata—Les Basques, QC]

Thank you very much, Mr. Chair.

I want to thank all of our witnesses for their presentations.

I will first go to Ms. Tedds.

I'll do it in English because I know the distance from translation might be problematic.

I'm looking at your presentation, which seemed to be well researched. You talk about two issues: the GST credit and the flow-through shares. Both of them are actually tax expenditures in their own way. They are basically a way for government to provide some benefits to groups or individuals that decrease their revenues, correct?

[Prof. Lindsay Tedds]

Correct.

[Guy Caron, NDP, Rimouski-Neigette—Témiscouata—Les Basques, QC]

I note that you've done lots of work not only on this presentation but also, in the past, on the issue of tax expenditures. I'd like for you to explain to us the difference between the type of tax expenditures we have with the GST/HST tax credit and with the flow-through shares, or any other tax credit, per se. There are some tax credits I understand you are in favour of, and others that you are not in this case, right?

[Prof. Lindsay Tedds]

It really boils down to the rationale for the tax credit. The benefit of the GST tax credit is predominantly to overcome the regressivity of a tax measure that we have implemented. So consumption taxes are known to be highly regressive; that is, they affect low-income households on a greater proportion of their income than high-income households. Through the tax credit, we are crediting these individuals for the tax they are paying, as a way to overcome this regressivity. We are putting the money back into the hands of low- and middle-income households to help overcome the regressive nature. This helps address issues related to poverty, particularly. So you are benefiting low- and middle-income households.

With respect to boutique tax credits like the METC, they are targeted to high-income individuals, individuals who do not need income support in order to increase their well-being. So with the METC, we're looking at a tax credit that solely is there to subsidize an investment that would not take place without that tax credit. It's very questionable whether there are any discernable benefits to taxpayers from that particular tax credit. That is true for tax credits such as the children's fitness tax credit and other boutique tax credits. The benefits accrue in the hands of high-income individuals at the expense of low-income individuals.

[Guy Caron, NDP, Rimouski-Neigette—Témiscouata—Les Basques, QC]

I'd like to go on with this because I have a column, an op-ed, that you wrote on the issue of the fairness in Canada's tax system. You refer to this, and I'll quote you:

Some of these tax expenditures may be popular with tax payers, but their popularity is misplaced. For example, research has found that the Child Fitness Tax Credit and the Public Transit Amount, directed $107-million (70 per cent of the value of these tax credits) in tax relief to the top 25 per cent of tax filers. Because these tax credits are non-refundable not all households that claim them actually derive any benefit at all, demonstrating the complexity these credits add to our tax system.

We had Madam Presseault, from the CGA, who came and talked to us about the complexity of the tax system.

Could you tell us what a good guideline would be to decide if a tax credit is appropriate and useful, and which ones would be less efficient?

[Prof. Lindsay Tedds]

As an economist, efficiency is a dangerous word. What exactly do you mean by efficient?

[Guy Caron, NDP, Rimouski-Neigette—Témiscouata—Les Basques, QC]

That it would not be more efficient to provide some kind of direct subsidy if we wanted to reach some direct goal of public policy, for example.

I'll just tell you what I'm aiming at right now. We have tax expenditures that are usually invisible, and many of them are aimed at some kind of public policy, which you could achieve by making the action more visible, like having a subsidy, or having it on the books and the budgets, for example. What should the guidelines be to decide what should be a tax credit and what should be a direct expenditure?

[Prof. Lindsay Tedds]

One of the most important things to consider is whether or not what you're doing is going to produce any incremental benefit. Let's take the child tax fitness credit. The goal of that was to increase the number of kids in athletic sports. What we do know from the evidence is that it has had no discernable impact on the number of kids participating in sports. It is instead subsidizing parents who are already putting their kids in sports.

If the vehicle itself doesn't deliver on what is a very admirable policy goal, then it isn't the appropriate tool to use to achieve that goal. In that case, subsidies toward low-income households, or at least toward supporting reduction in fees of low-income households to participate in sport, would have a bigger incremental effect. It induces those households to enrol their kids in that sport because they get the benefit right away. They don't have to wait a year or a year and a half after they have enrolled their child to get the money back from that expenditure.

I wouldn't say there's a carte blanche rule. It's this matter of what you are trying to achieve and whether the tool will achieve that. In most cases when you're looking at incremental benefits, if you're trying to get more people doing something, the tax credit isn't the way to go.

[Guy Caron, NDP, Rimouski-Neigette—Témiscouata—Les Basques, QC]

Thank you very much.

[The Chair, Conservative, James Rajotte]

You have 30 seconds.

[Guy Caron, NDP, Rimouski-Neigette—Témiscouata—Les Basques, QC]

I'll go to Mr. Hayes.

Very quickly, you know about the elimination of the tax credit on labour-sponsored venture funds. It was voted on and adopted last year.

How is the capital venture industry right now adjusting to these changes?

[Thomas Hayes]

The retail industry, the labour fund industry, is very concerned about the impact that this will have on liquidity in the next few years. It has sent a message that 50% of the tax credit is going to be eliminated for investors. It has created great doubt by those of us in the industry, as well as the investment advisers who support the industry by recommending the asset class to their investors.

Of course, it has also caused great concern for the portfolio companies who are relying on our funds for follow-on investments and entrepreneurs who are looking for new investment in their companies.