Finance Committee on May 22nd, 2018

[The Chair, Liberal, Wayne Easter]

We'll call the meeting to order. As I think all members certainly know, we're dealing with clause-by-clause consideration of Bill C-74.

Before I start into the bill, would anyone have any problems if we stood part 4 and part 5 and started with them at 3:30 tomorrow? Are we okay with that? We'll deal today with parts 1, 2, and 3, and then part 6, divisions 1, 2, and 3, and so on. We'll hold part 4 and part 5 until 3:30 tomorrow. There are no officials on part 4 for today because they have to come from Charlottetown.

Are we okay with that? Okay. Then we'll start.

First of all, pursuant to Standing Order 75(1), consideration of clause 1, the short title, is postponed.

There are no amendments on clauses 2 to 12. Do you want to group those, with clauses 2 to 12 carried on division?

(Clauses 2 to 12 inclusive agreed to on division)

(On clause 13)

The first amendment up is CPC-1, by Mr. Kmiec.

The floor is yours, Tom.

[Tom Kmiec, Conservative, Calgary Shepard, AB]

Mr. Chair, this is based on some conversations I had and some things I've read about a marriage penalty. I'm going to refer to the submission of the Joint Committee on Taxation of The Canadian Bar Association and Chartered Professional Accountants of Canada. In their appendix, they say that the “relationship breakdown exclusion is too narrow”, according to them, and they go into the details. I'm not a tax lawyer, and I'm not a tax accountant, but this is a friendly amendment to make this work better.

I'm just trying to get at the situation where there would be a breakdown in a couple's relationship, whether it's a marriage or a common-law relationship. I'm going to read a portion of this appendix. They say:

In many cases where a couple involved in a family business separates, one of the spouses or common-law partners will receive assets in his or her holding corporation through a paragraph 55(3)(a) spin-off transaction. In such arrangements, because the transfer of assets occurs between the operating corporation and the holding corporation, the spouse or common-law partner will not have received property personally in a manner described in subsection 160(4). As a result, that spouse or common-law partner will be unable to take advantage of paragraph (b) of the definition of “excluded amount”, even though the economic substance of the arrangement is similar to a property transfer to the spouse or—

[The Chair, Liberal, Wayne Easter]

Would you slow down a bit as the booth is going to wonder where you're at.

[Tom Kmiec, Conservative, Calgary Shepard, AB]

Pardon me. My apologies to the interpreters.

There is a description that continues on in terms of what the problem is. They also go into situations where the “inherited property exclusion” in the subparagraph won't apply, limiting parent-child, and say as well that “[a]rm's length borrowings with no personal guarantee should be arm's length capital”. It goes on.

I thought that this amendment as structured would avoid some of the issues and would be closer to what the joint committee of these two large organizations, the Bar Association and the CPAs, have said would be a means of making it fairer in situations where there is a spousal breakdown, and ensuring that the agreement they reach, and that the judge agrees to, would then be the way that they would be taxed.

Again, if there's a clean, friendly amendment to make this more effective, I just think this gets at a fairness provision in making sure that an outcome is fair in situation where.... Right now, as the rules are, they won't apply, and some people might get into a situation where they're taxed too much or taxed in a way that would be inappropriate. This would just be an easier way to plan the property settlement agreement through the court system. That's the overview.

[The Chair, Liberal, Wayne Easter]

I wonder if the officials might have something to add. I neglected to invite the officials to the table. I believe Mr. McGowan, Ms. Lavoie, and Mr. Leblanc are here to participate in clauses 2 to 46.

My apologies, folks.

I'm not sure, Mr. McGowan, if you or the others heard Mr. Kmiec's points. If you have anything you want to add here, or if there are any questions around the table, go ahead. The floor is open.

Mr. McGowan.

[Trevor McGowan, Director General, Tax Legislation Division, Tax Policy Branch, Department of Finance]

Thank you, Mr. Chair.

The proposals in clause 13 of the bill operate within the general scheme of the act relating to property transfers on the dissolution of a marriage, the breakdown of a marriage.

In particular, there is already a provision in the “excluded amount” definition that relates to property transferred as a result of the dissolution of a marriage. It refers simply to subsection 160(4) of the act, which is a general rule that applies in respect to property transferred on the dissolution of a marriage. It has within it certain restrictions, and those are consistent with the rules in the general scheme of the act relating to transfers of property on a marriage breakdown.

This amendment would seem to apply where property is acquired directly or indirectly by an individual. Also, it seems to remove the requirement that they be living separate and apart at the end of the taxation year, which is in subsection 160(4).

The general rules in the act are designed to provide flexibility in the appropriate tax consequences on the dissolution of a marriage. There's a scheme, a coherent set of rules, that operates under very similar conditions so that things work well and appropriately together. The proposals in the excluded amount definition are designed to fit within that framework. That's why they specifically reference the general rule in subsection 160(4) on transfers as a result of the dissolution of a marriage, or of a common-law partnership—it's not just marriage.

In addition, another rule was added in response to comments by the joint committee and others relating to the dissolution of a marriage or common-law partnership. Where at the end of the year the two partners are living separate and apart, they would not be considered to be related for the purposes of the tax on split income. That was added after the December 2017 release and before the inclusion of the proposals in this bill. That's another circumstance to ensure that couples who have split are treated appropriately under the split-income rule. If you're not related to somebody, you won't be in a position to split income with them, and then you're appropriately cut under the rules.

There are rules currently in the proposals dealing with the dissolution of a marriage or common-law partnership. They exist within and, in the case of the deemed not-related status, go a bit beyond the current regime and the current set of rules that apply. They were considered to be appropriate to fit within how these events are taxed generally for income tax purposes.

[The Chair, Liberal, Wayne Easter]

Dan.

[Dan Albas, Conservative, Central Okanagan—Similkameen—Nicola, BC]

Thank you, Mr. Chair.

In regard to the other provisions that you said relate to tenancy, if they are considered as still living together, they are then considered part of that same relationship that still exists. Is that correct?

[Trevor McGowan]

I'm sorry. Under this proposed amendment—

[Dan Albas, Conservative, Central Okanagan—Similkameen—Nicola, BC]

No. I'm talking about the other part of the act and where you said that it refers to the dissolution of a common-law...or marriage and that it has to do with tenancy: that they are living together under occupancy, I believe.

[Trevor McGowan]

I believe that one of the conditions for the application of subsection 160(4), which is the provision referenced in the proposal in the excluded amount definition, has the requirement that the couple be living separate and apart at the end of the year in order to qualify.

[Dan Albas, Conservative, Central Okanagan—Similkameen—Nicola, BC]

I'll just state to my colleagues who are here that I'm sure many of you have come across your own cases of this. I know of individuals who are living separately but within the same household and have structured their affairs differently. I would simply say that if the marriage was dissolved by a court order but they were still living in the same house, so to speak, whether they would be separated by a renovation or whatnot, to me, if a court was able to say that they are not living common-law or whatnot, I think this would give that. They would have to convince a court of law for that.

The second part is that we also know from my interventions both here and in the chamber that there are single parents who will have a spouse or ex-spouse who will continue to file their taxes as their last place of residence, and then...usually, it's a single mother who can't get her child benefit. I think what Mr. Kmiec is suggesting is that if someone has a court order that says they are living...that says they've dissolved that relationship, I think that would be at least worthy of inclusion in this new arrangement.

[The Chair, Liberal, Wayne Easter]

Tom, did you want to add more to that? I have Jennifer next.

[Tom Kmiec, Conservative, Calgary Shepard, AB]

I'll just close with this. There are a lot of situations where separation is inevitable, and it will happen, but there might be one, two, or three tax years before it's resolved. I think this is just a way to ensure that the financial assets that the couple had are broken down in a way that will ensure that they are at least financially whole. If a judge agrees to it by decree, or a “competent tribunal” does, as said in the amendment, it would be a means of ensuring at least financially speaking that they would be made whole.

The definition in subsection 160(4) is too narrow, according to that joint committee. In an equalization arrangement, a spouse would receive a significant dividend, potentially, on the share the spouse already owns. That dividend will also now be protected by paragraph (b.1).

It's too narrow in scope. If you broaden it a bit and allow the court to say yea or nay on this, it would allow that space for individual situations that may vary. If you run a bakery and have a holding company or an operating company—I understand what the rule changes are—and there's a marriage breakdown, on that particular one you're not talking about a lot of money. You're maybe talking about the business itself, or maybe a mortgage. It's just allowing a judge to have that latitude to determine what will be taxed and what wouldn't be and under what conditions. I think it's a way to ensure some fairness. That's the point of this.

[The Chair, Liberal, Wayne Easter]

Ms. O'Connell.

[Jennifer O'Connell, Liberal, Pickering—Uxbridge, ON]

Mr. Chair, while I appreciate the intention of amendment, I think the issue is that you're actually creating another stream of exemption or an exclusion to spouses and common-law partners who live apart. In the scenarios that were just presented, you will eventually get there through court proceedings, but what you would do with this amendment is create exemptions for spouses or common-law partners who continue to live together, and I think it would raise tax integrity issues in the larger system. As Mr. McGowan pointed out, relating to marriage breakdown, this is a general principle that is used throughout the Income Tax Act.

Again, while I understand and appreciate the intention, I think you're actually creating bigger issues by exempting spouses and common-law partners who still live together, and you're not keeping it consistent with the act. I won't be supporting this amendment.

[The Chair, Liberal, Wayne Easter]

Mr. Albas.

[Dan Albas, Conservative, Central Okanagan—Similkameen—Nicola, BC]

Mr. Chair, I would just say that a court of law or a tribunal would hear the evidence. There are reasons that people will stay together in the same home, particularly if they renovate it. Many people cannot afford, thanks to a stress test or because of high rates for house prices, to simply separate. In some families, it's done to provide stability for the children over the long term while a separation happens.

Again, having a court of law differentiate who should be able to receive which asset I think is actually quite helpful, because it removes the arbitrariness of CRA or the uncertainty that a tax planner or an accountant would have to give to their clients. I would hope that other members would support it.

[The Chair, Liberal, Wayne Easter]

Okay, we'll vote on CPC-1.

(Amendment negatived [See Minutes of Proceedings])

Next we have CPC-2, with Mr. Kmiec.

[Tom Kmiec, Conservative, Calgary Shepard, AB]

Mr. Chair, this amendment was the more difficult one to draft, I found, so I want to thank the legislative counsel people. They were very understanding. I'll explain the scenario I'm trying to avoid.

If these new TOSI rules apply, the specified individual will pay the top marginal personal rate applicable to that income with no personal tax credits available. For example, let's assume it's a husband and wife who own shares in an operating company. Let's further assume that any dividends paid to the husband would attract TOSI. Both husband and wife are not in the top marginal rates of income, even if such dividends were received by the wife. If the husband receives dividends from this operating company, he will pay the top marginal personal tax rate on those dividends as a result of the application of the TOSI rules, even though, had the wife received those dividends on top of her actual dividends—in this scenario the same person is receiving all of it, with the husband not getting anything—she would still not have to pay the top marginal rates. I think that's unfair.

The scenario I have in my head is that maybe they have a successful micro-business. It's a family business. Maybe they earn $100,000 a year. Just to make the math simple, let's say they have $20,000 of operating costs they set aside. This is a year when they want to pay themselves out and pay themselves some money. The wife pays herself $60,000. The husband attracts the TOSI rules. She wants to pay him $20,000. In that scenario, he's paying the highest marginal rate on the $20,000, but if she took the $80,000, the whole amount to herself, she'd have a lower rate. The combined taxes are actually higher in this scenario. It just winds up in an unusual way.

I talked to Kenneth Keung and Kim Moody at Moodys Gartner about exactly how this would work. This amendment would at least get at that fairness concept, where both spouses may be working in the business but one spouse is not active enough to avoid the new TOSI rules. You would have a situation where you could overtax a spouse who is critical to the business because they're supporting the other one. The business is not successful enough to make a huge amount of money—the real target, I guess, of these TOSI rules would be the top 1%—and these people are just getting by. As I said, $100,000 a year in revenue is a pretty reasonable example, but paying out one of the spouses at a smaller rate would then attract this new marginal effective tax rate, the highest bracket they'd be paying on those dividends.

I'm trying to avoid the unfairness that I see here. Again, there may be a friendly amendment that would make this work better. This was a very difficult one to draft. I was told that if I had drafted it in the original format, it would have been very long and almost an entire rewrite of that portion of the Income Tax Act. I'm just looking for a way to avoid those types of scenarios where we unfairly overtax one person in a spousal relationship who is contributing to the business but not sufficiently to avoid the TOSI rules in a scenario where you're overtaxing them. I want to avoid that type of situation.

[The Chair, Liberal, Wayne Easter]

Mr. McGowan, do you want in here?

[Trevor McGowan]

Mr. Chair, I'd be happy to go through the proposed amendment from a technical perspective.

The charging provision for the tax on split income is in subsection 120.4(2). As was noted, it currently applies the tax on split income at the highest marginal rate. That's defined in subsection 248(1) of the act as just the highest personal income tax, or the “highest percentage” in subsection 117(2), which is where you have the different marginal tax rates. It would make the tax on split income apply at the lower of the highest individual percentage and what's called the “appropriate percentage”. The appropriate percentage is defined in subsection 248(1). As well, looking back to the different marginal tax rates, it's defined as the “lowest percentage” that's listed in subsection 117(2), so the lowest of all personal income tax rates. The highest is 33% and the lowest is currently 15%. Of course, the lesser of 33% and 15% will always be 15%.

This would have the effect of applying the tax on split income at the lowest personal income tax rate, which would create an incentive to split income insofar as it would ensure that any income you're able to divert would be taxed at the lowest marginal rate, regardless of the tax rate of the actual income earner.

[The Chair, Liberal, Wayne Easter]

Would this get to what Mr. Kmiec called a “fairness concept”?

[Trevor McGowan]

Setting aside a subjective and normative evaluation of what's fair, what it would do is ensure that to the extent you're able to split income, you'll be taxed at the lowest personal income tax rate. To give you a different example, let's say two married lawyers were each earning $800,000 a year but working at different firms. If they engaged in planning to cross-pay dividends to each other so that they'd be considered split income, they'd cap their federal tax rate at 15% instead of the normal marginal rates that you'd expect to apply.

The fairness concern that was raised was something that we had considered in developing the amendments. I think the concept would be to apply it at the top marginal rate, but that's not, unfortunately, what this amendment would do. In the example—I forget the exact numbers, but I think the higher income earner had $60,000—instead of looking at the rate applicable to their marginal income, it would simply apply the tax on split income at the lowest 15% rate.

[The Chair, Liberal, Wayne Easter]

I believe Mr. Fergus was next.