Evidence of meeting #109 for Finance in the 42nd Parliament, 1st session. (The original version is on Parliament’s site, as are the minutes.) The winning word was system.
A video is available from Parliament.
Partner, Poole Althouse, As an Individual
I practise in Corner Brook, Newfoundland, so no, not there.
Partner, Poole Althouse, As an Individual
I'll be honest. In my small community, I'm seeing six and seven figures moving now. What the ultimate destination will be, I can't say. From a town a 20,000, millions of dollars are moving. I would say that, nationwide, that can scale up pretty quickly to be billions.
Liberal
The Chair Liberal Wayne Easter
I'm sorry, Mr. Poilievre.
We're going to have to pack it in there.
Mr. Boulerice.
NDP
Alexandre Boulerice NDP Rosemont—La Petite-Patrie, QC
Thank you, Mr. Chair.
I thank our witnesses for being with us this morning for these important discussions and our work on this.
I think we can agree that the principles of fairness and justice must be the cornerstone of our taxation system. Clearly, according to the current measures, the advantages are not the same for a wage earner as for a person who incorporates, or a small business. The latter have tax reduction opportunities that salaried people do not have access to.
In addition, all of these small entrepreneurs, whether farmers or doctors, tell us that they have depended on these measures for years. In the case of farmers or small local businesses, the children may indeed have contributed to the business's success. It is also possible that physicians may have been to some degree encouraged to incorporate because we did not have the necessary funds to increase their salaries. It is also possible that some small entrepreneurs do not have access to a pension plan, and passive investments are for them one way of preparing for the future.
Mr. Goulet, as parliamentarians, as legislators, how should we find a balance between these two poles, in your opinion?
Prof. Guy Goulet
That objective is indeed difficult to reach. In reality, the reason for lower corporate tax rates is to allow and facilitate reinvestment. According to what I understand, the government now wants to prevent people from putting money aside in order to fund various plans, as you quite rightly said, rather than reinvesting it.
What can be done in those circumstances? I don't know. However, as someone said, rather than applying the measures to everyone, we could probably target certain activities, perhaps those of professionals who do not generate any economic activity, given, for instance, the number of people they employ. We could start with that, rather than targeting everyone. I must say that this is quite broad for the moment.
I might also mention that among the three categories of tax measures, this is the only one where nothing has been proposed. According to what I understand, there is a consultation going on. However, measures are being proposed regarding income splitting and the conversion of dividends into capital gains. The table has been set, so to speak, in those categories. In the case of this other category, it would probably be advisable to fine-tune things a bit and proceed step by step.
NDP
Economist, National Office, Canadian Centre for Policy Alternatives
I agree that the goal of the small business tax rate is to do one thing, and one thing only. It's to incentivize reinvestment of profits in the business, if profits are made. It was never designed to be a retirement savings plan, although that's how it's been used. That use has been allowed, so people are planning towards that, which obviously creates a problem.
We already have very generous systems of retirement outside of the small business envelope. They're called RRSPs. They're called TFSAs. They have a separate set of rules. They have particular limits that need to be abided by. When people retire, there are conversion rules around the conversion to RRIFs, for instance. All other Canadians have to abide by those rules, which are more restrictive than the rules that exist for small businesses.
Also, for small business use you are allowed much more flexibility in terms of how much money you can put in. You don't have to abide by the RRIF rules. You don't have to abide by contribution limits on RRSPs and TFSAs, which at present are a maximum of $31,000 a year. That is a lot of retirement savings.
Only 12% of private sector employees have a pension, so I'm glad small businesses are concerned about pensions, but it's not just an issue for small businesses. It's an issue for all Canadians.
Let me leave it there.
NDP
Alexandre Boulerice NDP Rosemont—La Petite-Patrie, QC
Mr. Poitras, in certain regions, physicians are having a strong reaction. They say that they were urged to incorporate, and that now we want to change the rules of the game when they have become used to this tax structure.
Moreover, certain nurses' associations say that it might be time for doctors to have a regime comparable to theirs, since they work in the same offices, but are not taxed in the same way.
How do you view this situation? How could we make these changes?
Prof. Stéphane Poitras
The health care system represents 40% to 45% of costs at this time. Fortunately, this rate is no longer increasing and has stabilized. That percentage, however, only takes public expenditures into account. If you add to that the tax advantages given to incorporated companies, this translates into enormous amounts. They have increased exponentially over the past years.
This is now a political choice. The issue is probably more of a provincial matter. We have to ask ourselves where we need to invest to get the best return on investments in the health care system.
As for physicians, we hear about many benefits. Certain physicians prefer to have benefits rather than to incorporate.
We know that most associations offer a type of bulk purchase of benefits at very low rate, because that population is relatively healthy. They have a lot of benefits such as disability insurance, wage-loss insurance, life insurance and so on.
Overall, this remains a political choice.
Liberal
Francesco Sorbara Liberal Vaughan—Woodbridge, ON
Thank you, Mr. Chair.
Welcome, everyone.
We will have been having this discussion for almost 75 days when it comes to an end on October 2, and it has brought forward a lot of good ideas. As well, tax fairness is something that was in our platform, something we ran on, and something that needs to happen. We want to avoid any unintended consequences. We want to ensure we do it right. That's why we are consulting, and we encourage everyone to submit their briefs in due time.
When I think of it, there are a lot of good things happening in our economy at this time. We have a very low unemployment rate, we've had a lot of good job creation, and we're going to lead the OECD this year, so we're on a very strong footing. Tax reform, or tax fairness, is something we need to do.
I have a question, and I'll start with Mr. Goulet.
Mr. Goulet, thank you for your discussion. How do we ensure that private businesses and private corporations that are generating capital—and we have very low tax rates, so they are generating a lot of cash—are investing that money back into the economy and, for example, not just putting it in passive investments? We can quibble about the definition of passive investments, but are they investing that money back into the Canadian economy?
Prof. Guy Goulet
Thank you for the question, Mr. Sorbara.
What you are proposing, that is to say not taxing income, is one way of doing things. The same tax rate would apply, and there would only be additional tax, which would not be returned, when the money is taken out of the corporation. That is when you see tax rates of 72% or 73%. That is one way of doing it.
Here's another way: let's say the low income tax rate would only apply if you reinvested those funds, otherwise you would be subject to the general tax rate. All of this complicates the Income Tax Act, because it is more difficult for SMEs to comply. There is always a cost to pay. You have to chose between simplicity and fairness.
You could also set a threshold. If you want to target the richer group, you could set the first tranche at $500,000 of invested capital in passive income, and it would not be affected by the rules. The $500,000 is equivalent to the maximum amount of business generated that allows a corporation to benefit from the lower tax rate. That figure could be a guide.
Liberal
Francesco Sorbara Liberal Vaughan—Woodbridge, ON
Thank you, Mr. Goulet.
Mr. Merrigan, the TOSI rules already apply—kiddie tax, if you want to call it that—to income, so this would be extending the TOSI rules to dividends. If your child—son or daughter to use better terminology—is working on the family farm, as the gentleman from New Brunswick so eloquently put it.... We love those farmers and we want them producing food for Canada and becoming an agricultural leader in the world, which we basically are. But if your child is still working on the family farm or the family business, a restaurant maybe, we can quibble about what reasonableness is and how else you're able to interpret that, but let's assume that we can overcome that hurdle and we avoid those unintended consequences, effectively what we are doing is only extending the rules onto dividends where there are no rules on dividends right now, and basically where there is a preferential tax treatment. Some may call it an advantage, but I'm not going to use rhetoric this morning. I'm just going to say that there is preferential tax treatment on dividends for that 18 to 24 cohort versus where it is on income.
Is that not correct, and is that not something we can actually fix and is the right thing to fix, without getting into any untended consequences of having some CRA officer come into the family farm and say what is continuous, what is reasonable, and all that, putting that aside?
Mr. Merrigan and Mr. Macdonald. Ms. Lahey, you can jump in too. I think you were nodding.
Partner, Poole Althouse, As an Individual
I'll step off quickly.
The problem with that approach, again, is that you're applying a different test to a family member than to an arm's-length person. That is where the TOSI rules become problematic as a tool for achieving this policy outcome. It's attractive, because on the surface it looks very simple and straightforward, but the implementation of extending the TOSI rules impacts all family businesses. That's why I don't think that the TOSI is the way. I think you need to do this in detailed regulation to set out thresholds, as my colleague Mr. Goulet suggested would be a good approach.
Liberal
Francesco Sorbara Liberal Vaughan—Woodbridge, ON
Could we go to Mr. Macdonald and then finally to Ms. Lahey?
Thank you.
Economist, National Office, Canadian Centre for Policy Alternatives
It's certainly true that the reasonableness test is not new. In fact, it already applies to salaries and fees, so there's a long experience in CRA. In fact, it's not a particularly arduous process. CRA provides a lot of flexibilities to families in terms of salaries and fee payments. The idea that CRA auditors are going to go down to people's businesses and check to see if they're doing three hours of work versus four is ridiculous. That's not actually what happens.
Extending that same rule on the dividend side takes a rule that's well understood and applies it to a different type of income, which is going to be the dividend income. I think from that perspective, the idea that people working on a family farm somehow will never be able to receive dividends, and if your mother and father work at the restaurant they would be forced into one person's hands, is scare-mongering frankly. That's very unlikely to happen. Since it doesn't happen on the salary side, there's no reason to think it's going to happen on the dividend side.
Prof. Kathleen Lahey
I would agree, but there are two problems here. The first is that the reasonableness test is really well litigated and will work in this situation, but it basically then buys the change in justification for the small business corporation rules in the first place, and says that they're intended to provide educational funding, retirement plans, and so on.
The second thing is that the reasonableness test will no doubt reflect the existing nearly 28% income gap between what women are reasonably considered to earn on average in this society versus men. It would build in a lot of gender differences in a very unintended way, in a way that is still being litigated in the courts today with respect to people being hired to work in unincorporated businesses.
Conservative
Dan Albas Conservative Central Okanagan—Similkameen—Nicola, BC
Thank you, Mr. Chair.
I'm shaking my head because, first of all, the TOSI rules have been well established. The government says, in its own consultation paper, that it just isn't winning at court enough. When we talk about the reasonableness test, that's usually used in tort law and that's usually used in criminal law.
You're a lawyer, Mr. Merrigan. Who decides what is reasonable? A reasonableness test usually indicates someone of average skill and judgment within a certain situation. Is that correct?
Partner, Poole Althouse, As an Individual
Yes, but I'll point you in another direction. One of the consequences of this approach to TOSI is that a married couple will be able to income-split upon divorce, and a spouse can be compensated for her contribution in the business better upon divorce.
That will vary by jurisdiction. For instance, in New Brunswick they have a test that considers the contributions of the spouse at home. That has its antecedents in some very strong feminist legal theory to say that this enables a woman to be compensated for valuable work that enables the man to earn money. Fortunately, we're at a point where I have a colleague whose husband hopes to stay home and raise their children when that time comes. But you will be better able to income-split and divide the business, with less oversight and with more generosity, upon divorce. In New Brunswick the home contribution is considered. In Newfoundland it is not, so in Newfoundland the reasonableness test that is applied in the examination of your contribution to the business does not consider contributions at home. It considers strictly contributions to the business.
Therefore, you're going to ingrain a two-tiered system and you're going to create an economic incentive towards separation of the family unit in order to achieve.... Do I think people will do this? Some people will—not many, but if you're on the cusp under economic distress, it is something that will be considered.
Conservative
Dan Albas Conservative Central Okanagan—Similkameen—Nicola, BC
Again, if this ends up being where a lot of these decisions will be decided at court...because it will be the courts who determine what's reasonable, not CRA. I don't think it's scaremongering to say that CRA will do its due diligence if it's going to contest something in court, and it will document why it believes something is unreasonable.
Would you agree with that, Mr. Merrigan?
Partner, Poole Althouse, As an Individual
I would agree with that. I would also say that if you're a small business owner, the uncertainty of the harvest is one thing. The uncertainty when you're deciding how much to pay to your spouse or child for their work on the farm, knowing that in four or five years you could be spending money on litigation to determine whether it should have been $20,000 or $50,000, is a level of uncertainty that is not helpful to a small business person.
