Finance Committee on Oct. 31st, 2012

[Ted Cook]

I'll explain what is perhaps one of the most common strategies.

One first has to understand that it all hinges on the way RCAs are taxed. An RCA is generally a trust. An employer can make a tax-deductible contribution to the RCA.

An RCA is taxed in its own right; what happens is that 50% of the contributions to the RCA are taxed by the CRA, and 50% of the income earned by an RCA is also taxed; then that tax is refunded when payments are made out to the individual. The 50% tax was to get at the time value of money.

What the CRA has found, for example, is that an individual or an employer can make a $100 contribution to an RCA and pay their CRA tax of $50, and then the RCA can make a loan or an investment in essentially a shell corporation controlled by the same individual. Now the money would be outside the RCA and back in the hands of the original contributor.

The trick that occurs is that, since existing rules recognize that investments might lose value, when an investment loses all its value, the RCA can simply apply to the CRA for a refund of the tax, if they turn in all the money they have.

What happens is that this loan is made to a shell company, and that shell company moves the money out. Now the shell company owes money and has no assets, so the value of the RCA's asset is nothing. They get a refund of the RCA tax; they have just taken a circuit out of it.

[Hoang Mai, NDP, Brossard—La Prairie, QC]

Thank you very much.

[The Chair, Conservative, James Rajotte]

Thank you. Merci.

Mr. Brison, do you wish to speak on this point?

[Scott Brison, Liberal, Kings—Hants, NS]

Actually, I want to speak on employee profit-sharing.

[The Chair, Conservative, James Rajotte]

That's the next one.

[Scott Brison, Liberal, Kings—Hants, NS]

Okay. I'm sorry.

[The Chair, Conservative, James Rajotte]

Then we'll move on to employee profit-sharing plans.

Go ahead, Mr. Cook, please.

[Ted Cook]

Employee profit-sharing is a slightly different variety of tax planning that has been uncovered. As I'm sure everyone is probably aware, employee profit-sharing plans are used largely to align the interests of employees with those of their employers by giving them in some ways a stake in the business.

The way employee profit-sharing plans currently works is that the employer makes a tax-deductible contribution to the trust. Unlike an RCA, every year the trust allocates all the income and all the assets of the trust to the beneficiary of that particular trust, and then it's paid out in accordance with the trust document on a tax-free basis.

What has been observed is that these employee profit-sharing plans are being used to split income. A spouse may be a part-time employee or something of a business; amounts are paid into this employee profit-sharing plan, and effectively it's used to achieve income splitting, to avoid CPP and EI premiums, and to defer income tax, because there is no withholding tax.

To close this planning opportunity, this rule would impose tax at the highest rate once the amount allocated under the employee profit-sharing plan exceeds 20% of the employee's salary otherwise calculated.

[The Chair, Conservative, James Rajotte]

Okay, thank you.

Do you have any questions, Mr. Mai?

Mr. Brison is up next.

[Hoang Mai, NDP, Brossard—La Prairie, QC]

Can you explain to us why the treatment for Quebeckers is different from that for the rest of Canada?

As well, has the Government of Quebec been consulted? Has this been discussed in order to have everything in line?

Also, what differences would there be, or what would the impact be, for individual Quebec taxpayers versus individual Canadian taxpayers?

[Ted Cook]

I think what you're referring to is that the tax is an amalgam of the highest personal federal rate plus the highest rate for the province in which the person is a resident, and at zero in the case of Quebec. That's because Quebec is a non-agreeing province with respect to the personal income tax; they levy their own tax through a separate system.

In July, Quebec announced that it would be implementing the same tax, so generally Quebec will mirror the changes we've done. However, it can't be done directly in federal legislation; Quebec does it itself. What the effective Quebec rate is will depend upon what they have chosen.

Our approach has been to tax it at the highest personal rate for whatever the province is. I presume that Quebec would likely do the same.

[The Chair, Conservative, James Rajotte]

Mr. Brison is next, please.

[Scott Brison, Liberal, Kings—Hants, NS]

Thank you.

You were saying that typically these are used or, if you will, abused by people when there are family relations. Why wouldn't we simply deal with that, as opposed to...? Is it possible to identify related people within a small business and deal with that, if it's that specific? You were saying that this is the typical form of abuse.

[Ted Cook]

I'm just going to confirm here....

I believe you're absolutely correct. Our definition is actually of “specified employee”, and so this applies to specified employees. Specified employees have a particular relationship, usually a significant interest—more than a 10% interest—in their employer.

I'm just going to confirm that.

[Scott Brison, Liberal, Kings—Hants, NS]

Oh, I see. It's the definition of “specified employee”.

[Ted Cook]

Yes, it doesn't apply to all employees; it just applies to specified employees, cases in which there is a particular relationship between the employee and the employer.

I would note, though, that the 20% threshold is based on what we've observed. It's generally significantly higher than what is observed in arm's-length situations, such as in large corporations in Canada.

[Scott Brison, Liberal, Kings—Hants, NS]

You have said that this is to end the practice of income splitting, effectively.

[Ted Cook]

Yes.

[Scott Brison, Liberal, Kings—Hants, NS]

Is income splitting bad public policy? I'm just curious.

[The Chair, Conservative, James Rajotte]

I don't think he said that, but is that a general question?

[Scott Brison, Liberal, Kings—Hants, NS]

No, but it seems an interesting position for the government to be taking.

[The Chair, Conservative, James Rajotte]

Go ahead, Mr. Cook.

[Ted Cook]

Well, I think this is just in recognition that however a particular person earns their employment income, it should be their employment income.

[Scott Brison, Liberal, Kings—Hants, NS]

So it's to stop this income-splitting stuff. I understand.

[The Chair, Conservative, James Rajotte]

I'm not sure whether you may want to clarify that, Mr. Cook.