Chair and members of the committee, I would like to thank you for inviting us to speak with you today.
MNP believes that we need comprehensive tax reform. Without it, we will have an increasingly complex and costly tax system. We need simplification and modernization of the current system.
At MNP, we represent over 150,000 private businesses in Canada, including 16,000 farms. We are the country's tax experts on small business. No one in Canada works with more small businesses day in and day out than MNP.
First, I would like to commend the government for listening to the concerns raised by the community relating to the private company tax proposals. The draft legislation released on December 13 relating to the tax on split income—or, as we call it, TOSI—and the passive income proposals in the budget of 2018 have addressed many of the concerns that we had last summer and fall. However, we believe that there still needs to be further clarity.
Given the amount of time we have today, I would like to focus on TOSI.
First, it unfairly targets service businesses. They account for 78% of Canadian small businesses, and they are being specifically excluded from some of the rules.
There is a new 20-hour test, which would exclude people from having TOSI apply to them. Most family-run businesses have never kept time sheets. They have never really kept track of the hours that are being put in by the owners of the business. We question how CRA will ever be able to have the evidence they need for these audits. It will all be personal testimony. This legislation could be retroactive in nature, because Canadians will be penalized for not keeping records that they did not have to keep at the time the work was being performed.
Next is the test of reasonability. These TOSI rules introduce several new factors to the reasonability tests. Labour is one of the factors that we see elsewhere in the Income Tax Act with a reasonability concept, but this new reasonability test blurs the line between investment, the return on investment, and the labour. This is new ground. We are asking for a balanced approach whereby the Department of Finance and the CRA provide a comprehensive framework to help determine what is reasonable and what is not. This will allow Canadians and the CRA to apply the framework consistently.
I would like to introduce you to a sample client.
Bob and Karen have a company: BK Transport. This is a very typical client that you would see across Canada. Over the last 30 years, they have grown from a small trucking business to one with significant capital. They have over 250 employees and operate in three different provinces. Karen is ill. She has reduced her regular duties in the business and is rarely able to come into work. Like many entrepreneurs, Bob and Karen declared dividends instead of paying themselves wages throughout the last 30 years. No one needed time sheets; no one prepared time sheets. Now, due to the TOSI changes, when we are paying out dividends, we will need to determine the relative value of Bob's work in the business to Karen's work in the business.
The first thing we need to look at is whether TOSI even applies. Because they are both involved in the business and both are shareholders in the business, TOSI will apply unless we meet one of the specific exclusions. For Bob, he'll have to start tracking his hours. He's going to need to meet that test of 20 hours a week on average. He'll have to start tracking it and keeping time sheets. Karen won't meet this test, and the other thing is that Karen has never had time sheets in the past.
Next, BK Transport is a service business. It is in trucking, which is a service. This will not meet the specific carve-outs. When we explain this to Bob and Karen, they can't understand why their trucking business is impacted, but a business that is in retail or in construction, with the same number of employees and the same amount of capital, is fine. Their service business is not.
Under this draft legislation, the final way out is that of meeting the reasonability test. This is very subjective. Do we think her dividends would be reasonable? We would think so. Do we have certainty that the CRA would agree? There is no certainty here.
What they would benefit from would be more administrative guidance on what would be considered reasonable as well as clarity on the intended businesses to be caught. We believe catching businesses like BK Transport is an unintended consequence in the drafting of the legislation.
As far as passive income is concerned, the draft legislation is greatly improved from what was in the July paper. We recognize the government's commitment to finding an acceptable balance on this issue. In our written submission, we have three comments on these proposals for your consideration.
In closing, Bill C-74 is a considerable improvement over what we saw in July. That said, we still need more simplification of TOSI so that it's something that business owners can understand and actually comply with.
Please consider our three recommendations. First, we believe strongly in comprehensive tax reform. This should be for all taxes, not just income taxes. Second, because the new TOSI rules unfairly target service businesses, we think we should look at this again and see whether service businesses should be excluded. Last, we are very encouraged by the continued collaboration with all stakeholders and also the experts.
As we move forward to ensure that we have a fair tax system for all Canadians, we will have to keep doing this. I look forward to the committee's questions on the tax on split income, on the passive income proposals, and on the new RDTOH regime.
Thank you.