Evidence of meeting #121 for Finance in the 42nd Parliament, 1st Session. (The original version is on Parliament’s site, as are the minutes.) The winning word was year.

A video is available from Parliament.

On the agenda

MPs speaking

Also speaking

Trevor McGowan  Senior Legislative Chief, Legislative Review, Tax Legislation Division, Tax Policy Branch, Department of Finance
Pierre Leblanc  Director, Personal Income Tax Division, Tax Policy Branch, Department of Finance
Randy Freda  Senior Tax Policy Officer, Business Income Tax Division, Tax Policy Branch, Department of Finance
Pierre Mercille  Senior Legislative Chief, Sales Tax Division, Tax Policy Branch, Department of Finance
Carlos Achadinha  Legislative Chief, Sales Tax Division, Tax Policy Branch, Department of Finance

November 2nd, 2017 / 3:30 p.m.

Liberal

The Chair Liberal Wayne Easter

I call this meeting to order. Pursuant to Standing Order 108(2), today's meeting is on the subject matter of Bill C-63, a second act to implement certain provisions of the budget tabled in Parliament on March 22, 2017, and other measures.

We have quite a number of sections to go through. Hopefully, we'll get through them today. We'll have witnesses from various departments and areas within Finance Canada to explain the measures that are in parts 1, 2, 3, 4, and 5, and the divisions in the bill.

We'll start with part 1, amendments to the Income Tax Act and to related legislation. We have with us Trevor McGowan, who's the senior legislative chief, tax legislation division, tax policy branch. Also from the tax policy branch, we have the director of personal income tax division, Mr. Leblanc and the senior tax policy officer, Mr. Freda.

The floor is yours. You'll have an opening statement and then we'll go to questions.

3:30 p.m.

Trevor McGowan Senior Legislative Chief, Legislative Review, Tax Legislation Division, Tax Policy Branch, Department of Finance

Thank you, Mr. Chair.

I'm going to provide a brief overview of the items in part 1 of the bill, each of which relates to proposed income tax amendments.

Part 1 includes a number of amendments that were announced as part of the 2017 federal budget. These include removing the classification as Canadian exploration expenses of costs incurred in respect of a drilling well. They would instead, unless they're proven to be unsuccessful, be classified as Canadian development expenses. If unsuccessful, they would continue to be Canadian exploration expenses.

They would eliminate, for qualifying small oil and gas companies, the ability to re-characterize up to $1 million of expenses, which would otherwise qualify as Canadian development expenses, as Canadian exploration expenses. The difference being that Canadian development expenses are deductible at a rate of 30% per year, whereas Canadian exploration expenses are fully deductible in the year incurred.

They would revise the anti-avoidance rules for registered education savings plans and registered disability savings plans, aligning them with the current rules that apply in respect of registered retirement savings plans, registered retirement income funds, and tax-free savings accounts.

They would eliminate the ability of designated professionals to use the billed-basis accounting system. They would instead be required to use the general rules applicable to other taxpayers in the Income Tax Act for their tax accounting purposes.

They provide enhanced tax treatment in respect of eligible geothermal energy equipment. The enhanced treatment consists of accelerated capital cost allowance rates at 50% in class 43.2, as well as the ability to classify certain expenses in respect of qualifying geothermal projects as Canadian renewable conservation expenses, which can be deducted in the year incurred, or transferred to investors in flow-through shares.

It would extend the currently existing base for erosion rules that apply to foreign affiliates of Canadian taxpayers, and prevent them from inappropriately shifting income in respect of the insurance of Canadian risks offshore to a foreign affiliate. It would extend those rules to foreign branches of Canadian life insurers, which, for many purposes of the tax system, are treated in a manner similar to foreign affiliates of a Canadian corporation, including their, in very general terms, exemption from Canadian tax on their active business income.

It would clarify who has factual or de facto control of a corporation for Canadian tax purposes. This is intended to return the state of the law to what it was before a recent court decision, and requires that all relevant factors are to be taken into consideration in determining whether a person has factual control of the corporation.

It introduces an election that would allow taxpayers who hold eligible derivatives as income properties to be able to treat them as market-to-market properties, which would allow changes in the value of the derivatives to be realized for tax purposes on an annual basis. Otherwise, the default rule would be taxation on the realization basis.

It would introduce a specific anti-avoidance rule in respect of so-called straddle transactions. These are transactions that use somewhat complex derivative instruments, offsetting derivative instruments to achieve an inappropriate deferral of taxation from one year to the next.

It would allow mutual fund corporations, that are organized as switch corporations, but would now be more appropriately called multi-class mutual fund corporations, where each class of share of a corporation is a separate investment fund. It would allow them to effectively, on a tax-deferred basis, merge or split up into a number of mutual fund trusts. Each of those mutual fund trusts would constitute its own investment fund.

It would also improve the tax treatment of segregated funds. These are insurance products that in many ways, including through their tax treatment, are intended to be similar to ordinary investment funds. There are some minor differences. This bill would extend the ability for segregated funds to merge on a tax-deferred basis and as such achieve economies of scale. It also would allow the carry-forward of non-capital losses from one year to the next. Both of those can currently be achieved by an ordinary mutual fund operating through a trust. That would be extended to segregated funds of insurance companies.

On the measures announced in the budget, finally, there are enhancements to the protections afforded to gifts of ecologically sensitive land. It also implements a number of other income tax measures in part 1 by closing loopholes surrounding capital gains exemptions on the sale of a principal residence. These were released for public consultation in October 2016, and were mentioned as previously announced measures in the budget text in “Tax Measures: Supplementary Information”.

It extends a measure, announced as part of budget 2017, to provide additional authority for nurse practitioners—for many Canadians, they are the primary point of contact in the medical system—so that nurse practitioners can certify things for a number of purposes beyond the disability tax credit, which was announced in budget 2016.

It would also, following on a measure from budget 2016, provide that sales by farmers and fishers of their farming products and fishing catches to qualifying co-operatives would be exempted from the measures announced as part of budget 2016 that would prohibit the multiplication of the small business deduction, allowing each such farmer or fisher to have full access to the small business deduction.

It would also introduce a number of proposed technical amendments that were released for public consultation in September of 2016 and were also mentioned in “Tax Measures: Supplementary Information”, which accompanied the budget. These include measures that would extend the types of reverse takeover transactions to which the corporate acquisition of control rules apply and make a number of tweaks and improvements to the scientific research and experimental development rules. It would provide rules for the allocation of income for federal credit unions between provinces and territories that completely mirror the rules that currently apply to banks. It would make a number of changes to improve the operation of Canada's international tax rules.

Finally, it contains a number of measures that are technical in nature to improve the accuracy and consistency of the income tax legislation and regulations. These are technical amendments that are announced for consultation and included in bills from time to time to ensure the proper ongoing operation of the income tax system.

That's a summary of the measures in part 1 of the bill.

3:40 p.m.

Liberal

The Chair Liberal Wayne Easter

Thank you, Mr. McGowan.

The normal procedure here, which I should have explained at the beginning—a number of you haven't been on the finance committee before—is that we don't go with the normal rounds. If you have questions, just catch my eye and we'll go for it.

I see that John McKay, former parliamentary secretary to the finance minister, is here. There's a twinkle in his eye just to be back.

3:40 p.m.

Voices

Oh, oh!

3:40 p.m.

Liberal

The Chair Liberal Wayne Easter

Who wants to go first?

Mr. Sorbara.

3:40 p.m.

Liberal

Francesco Sorbara Liberal Vaughan—Woodbridge, ON

Thank you, Chair.

Welcome, gentlemen.

On the billed-basis accounting, how will contingency fee arrangements and pro bono work be handled with the new rules, please?

3:40 p.m.

Senior Legislative Chief, Legislative Review, Tax Legislation Division, Tax Policy Branch, Department of Finance

Trevor McGowan

As I said in the introduction, the elimination of the election to use billed-basis accounting would essentially align the tax treatment of the designated professionals—these are, as you mentioned, lawyers but also accountants, dentists, medical doctors, veterinarians, and chiropractors—to the rules that are generally followed by most businesses and taxpayers.

I would categorize those two separately. For pro bono work that's not intended to be billed....

I guess I should explain the general rules. You can value inventory at the end of the year either at its fair market value or on an item-of-inventory by item-of-inventory basis at the lower of cost or fair market value. That's the choice that's available to taxpayers generally, and that's the default set of rules that is considered to provide the truest picture of a taxpayer's income. Pro bono work that is not intended to be billed would have a fair market value of essentially nil because there is no intention to bill for it and there is not going to be a recovery on that time, so it would be valued at nil for tax purposes.

For contingency fees, the taxation is a little bit more complicated. There is case law and Canada Revenue Agency administrative guidance to the effect that, even in the absence of section 34, which provides the election for billed-basis accounting, certain contingency fees where your return on your time is not guaranteed.... A classic example might be that whether or not you're going to get paid at the end of the day is determined by whether or not you win a court case or by how much of an award is given for it, and there's real uncertainty as to whether or not that will be received. There is case law to the effect in those situations.

There is no ascertainable fair market value to the work in progress, so it would not be taken into account for tax purposes. Otherwise, you have for contingency fees the requirement to come up with a reasonable estimate of what the fair market value is. You can tell what you think the value is. Again, if there is a complete contingency fee and you just have no idea, perhaps it's not taxable because it's too uncertain. If it is sufficiently certain, then you can arrive at a reasonable fair market value, and that can take into account anticipated writedowns, end fees, and time that you don't think you're going to bill and so on. If after the end of the year you decide that you were wrong, you can do a writedown of that value for tax purposes.

Lastly—you didn't ask this—the next step is if you have bad or doubtful debts. There are reserves for those as well, so you're not immediately taxed on them.

3:45 p.m.

Liberal

Francesco Sorbara Liberal Vaughan—Woodbridge, ON

Okay. Thank you for that explanation, especially on contingency fees.

Now we'll move on to the small business deduction. In one of our prior budgets, we prudently, in pursuit of tax fairness, removed the small business tax deduction, the multiplication of that. In this budget, we have a measure put in place, and I think rightly so, for farmer co-operatives more so. I wonder if you could clarify that and ensure that we all are aware that farmers and folks belonging to co-operatives will not be penalized.

3:45 p.m.

Senior Legislative Chief, Legislative Review, Tax Legislation Division, Tax Policy Branch, Department of Finance

Trevor McGowan

Yes, of course. I would be happy to. I think it would be a good idea to provide a brief overview of the 2016 proposals.

We have a small business deduction that allows qualifying small businesses, on up to $500,000 of their active business income, to get a small business deduction, but it's commonly thought of as just a low rate of tax. It's currently at 10.5% and, as recently announced, is to be reduced down to 9%. In October, that was announced.

The general policy for the small business deduction is that you get one small business limit of $500,000 per business. The tax planning that had arisen for a partnership in a classic case would have one business where each of the partners—let's say there are 10 partners—would normally have to share that business limit, so instead, each of the partners would incorporate a side company that would provide that partner's services to the partnership, thus multiplying access to the small business deduction by the number of partners. With the 10 in my example, that brings it up from $500,000 to essentially $5 million.

The budget 2016 measure constrained that to provide that when there's one business, there's only going to be one business limit. That didn't just apply to partnerships. It also applied to central corporation structures, which could, in the corporate context, achieve the same multiplication results as you could have gotten in a partnership.

As part of our continuing consultation with stakeholders, we heard from a number of farmers and fishers who had dealings with co-operative organizations, and really, for co-operatives, they have membership interests in a co-operative that are for many purposes, including for the purposes of the small business deduction in the tax system. They're treated like shares, but they're not fundamentally the same as shares. They're different enough to be outside of the policy against the multiplication of the small business deduction.

For example, they often have one vote per member regardless of the number of shares, whereas if you're a shareholder and you're voting, that can allow you to elect members of the board of directors, for example, proportionate to the number of shares you have. Likewise, with a normal company, with the shareholdings representing more of an economic investment, you're looking to participate in the profits of the corporation, and your participation in the profits is going to be determined by your shareholdings.

With membership interests in a co-operative, it's a different system. In these cases where you have farmers or fishers selling their farm products or fishing catches to a co-operative, that would be called I think “specified co-operative income” and excluded from the rules that prevent multiplication of the small business deduction.

3:45 p.m.

Liberal

Francesco Sorbara Liberal Vaughan—Woodbridge, ON

Thank you, Chair.

3:45 p.m.

Liberal

The Chair Liberal Wayne Easter

Mr. Albas.

3:45 p.m.

Conservative

Dan Albas Conservative Central Okanagan—Similkameen—Nicola, BC

On the very same topic, last year at this time we had BIA 2. Specifically, we had radiologists who said they worked in shared practices but were denied the small business preferential tax rate because they were billing as a collective but disbursing it separately.... Pardon me. They were actually billing as one and receiving it, and the minister disallowed that in last year's legislation.

Are you saying that if those self-same doctors who used to use shared practices were to form a co-operative they would be able to get access to the small business rate?

3:45 p.m.

Senior Legislative Chief, Legislative Review, Tax Legislation Division, Tax Policy Branch, Department of Finance

Trevor McGowan

I'm trying to remember exactly how the radiologists would have organized their structure. As I recall, many medical practitioners were organized—

3:50 p.m.

Conservative

Dan Albas Conservative Central Okanagan—Similkameen—Nicola, BC

It was shared practice.

3:50 p.m.

Senior Legislative Chief, Legislative Review, Tax Legislation Division, Tax Policy Branch, Department of Finance

Trevor McGowan

Right, and the concern was that they were—

3:50 p.m.

Conservative

Dan Albas Conservative Central Okanagan—Similkameen—Nicola, BC

Each taken as an individual....

3:50 p.m.

Senior Legislative Chief, Legislative Review, Tax Legislation Division, Tax Policy Branch, Department of Finance

Trevor McGowan

Right. They were considered partnerships legally, and the rules apply to partnerships and central corporation structures. I don't know that they apply to...or they don't apply to true co-operative structures that are not partnerships. The concern, as I recall from 2016, was that for a lot of these structures, they would be characterized at law as partnerships, but if you don't have a corporation carrying on a central business or a partnership, and instead it's carried on separately by a number of people sort of co-operatively, then the rules wouldn't apply. They apply in respect to partnerships and central corporations.

3:50 p.m.

Conservative

Dan Albas Conservative Central Okanagan—Similkameen—Nicola, BC

If they have a co-operative structure, would they be able to have access to the small business deduction even though there was a multitude of them working within that?

3:50 p.m.

Senior Legislative Chief, Legislative Review, Tax Legislation Division, Tax Policy Branch, Department of Finance

Trevor McGowan

The difficult is in—

3:50 p.m.

Conservative

Dan Albas Conservative Central Okanagan—Similkameen—Nicola, BC

They each would get a share, though. That's what you're saying is happening for farmers and fishers.

3:50 p.m.

Senior Legislative Chief, Legislative Review, Tax Legislation Division, Tax Policy Branch, Department of Finance

Trevor McGowan

I think part of the difficulty is the terminology. If you have a co-operative, in this case for the purposes of the tax rules, it would be treated as a corporation, at least for the small business deduction rules. But if you're talking more colloquially and not in the specific technical sense that you have in the tax rules, they're carrying on.... I shouldn't say “carrying on business in common” because that's the technical legal test for interpreting a partnership, but if you have a number of people operating through a joint venture or in a somewhat co-operative fashion, then that's a different thing.

As I recall, the concern from a lot of medical practices was that, while they initially thought they ought not to be considered partnerships for the purposes of the rules, they might be considered partnerships legally, and, as such, would be into the multiplication of the small business deduction rules that way and not because they were legally organized as a corporate co-operative within the purposes of the small business deduction rules.

3:50 p.m.

Conservative

Dan Albas Conservative Central Okanagan—Similkameen—Nicola, BC

Okay. I'm going to take forward that, if they had formed a co-operative instead of a shared practice, then, in the same vein, they should receive equal treatment, because I hear that we're all about tax fairness in Canada, right?

We had a whole bunch of people last year who were hit on average, I think, $40,000. There were some, obviously, hit much harder than others and many of them faced a tax bill. To me, this seems to be completely contrary to what we heard last year.

Anyway, I'd like to go back to the elimination of the use of billed-basis accounting by designated professionals.

First of all, I have a quick question. In the summary of the bill, you list it in paragraph (d), yet it's the first provision in the bill. That doesn't seem to coincide. Maybe next year that might be a thing to consider to make it easy for members of Parliament to walk through the summary.

Now, in the proposed act here, it's called “work in progress” versus being called “billed-basis accounting” in the summary. Are they the same thing?

3:50 p.m.

Senior Legislative Chief, Legislative Review, Tax Legislation Division, Tax Policy Branch, Department of Finance

Trevor McGowan

Work in progress is your work that has been done up to a particular point but that is not yet billed. Billed-basis accounting versus accrual accounting are two different ways of treating for tax purposes your work in progress. Your work in progress is a thing, and the question is, how is it to be taxed?

The general rules provide for accrual accounting, but this provision in the act allowed designated professionals to elect into a billed-basis method, which would change the tax treatment of how work in progress is taxed. That's how they relate.

3:50 p.m.

Conservative

Dan Albas Conservative Central Okanagan—Similkameen—Nicola, BC

Okay. But you see how, when you say one thing in the summary and then another thing in the actual act, it can be a little bit confusing to the average person. Consistency is key, just so we're all on the same page.

When it comes to low-income individuals, say they end up in a car accident, and ICBC in my province says, “We're not going to pay you for things”. It happens all the time. Someone goes to a lawyer, and the lawyer says, “I'll represent you. It's not going to be free, but if we have a winning case, I'll get a percentage, a contingency”.

How does that work in that case? Would they be paying tax, about 20% per year, on something that may never result in money coming in the door?

3:55 p.m.

Senior Legislative Chief, Legislative Review, Tax Legislation Division, Tax Policy Branch, Department of Finance

Trevor McGowan

As I noted earlier, it depends on the specific facts. I'd probably need a bit more detail in your case, but I can say there is case law and CRA administrative guidance in support of the proposition if there's real uncertainty about the outcome of the case. If it's a contingency fee arrangement, that might—even absent section 34 billed-basis accounting election—be excluded from your inventory for tax purposes so you wouldn't be taxed on it in the current year.