Finance Committee on June 20th, 2019

[Pierre Poilievre, Conservative, Carleton, ON]

All right. Recently you released a report that showed a net advantage resulting from CPPIB's decision to go to active management. Andrew Coyne wrote an interesting piece wherein he said that your report did not take into consideration the savings in management and transaction costs that come from passive management.

I'll just read to you from his article:

The return that matters, as any mutual fund investor knows, is not the gross return but the return net of costs: one of the reasons actively managed funds tend to underperform passively managed is because their costs are so much higher. Bizarrely, while the PBO study deducts transaction costs and management fees—which are now, respectively, 17 times and 44 times what they were under passive management—from the CPPIB’s returns, “operating expenses were assumed to be the same under either approach.”

I don't know if that's the assumption you made, but that is what he reports and I do know that passively managed instruments are infinitely cheaper. You can buy a Barclays or a Vanguard ETF and pay a 0.01% fee for management, whereas if you hire a mutual fund it can be up to 2%, hundreds of times higher.

First, is Mr. Coyne is right that you did use that methodology, and second, if he is, why did you do so?

[The Chair, Liberal, Wayne Easter]

We didn't bring you here for this subject, but are you fine with this subject, Mr. Giroux?

[Yves Giroux]

Yes, I'm fine.

We looked at operating expenses. Deciding to reduce the operating expenses under a passive strategy would have required us to make assumptions as to by how much the operating expenses would need to go down.

They would not be brought down to zero because of the magnitude of funds that are managed. There would certainly need to be continuous oversight of dozens of billions of dollars, and that's why we assumed there would still be a need for operating expenses.

That said, for sure one would hope that the operating expenses, under a passive strategy, would be significantly lower, but because it was not possible to determine what quantum would be appropriate, we decided to assume that operating expenses would remain roughly the same. That said, it doesn't significantly change the outcome or conclusions of the report, because the operating expenses are still a small fraction of the overall assets and of the returns.

[Pierre Poilievre, Conservative, Carleton, ON]

It depends on how you define small. Over the lifetime of an investor, if you have a one-percentage-point increase in management costs for your investments, that does subtract significantly from the final asset that emerges from your investment at the end of life. If Mr. Coyne is correct that the CPPIB's transaction costs and management fees are up 17 times and 44 times, respectively, those are absolutely astronomical increases.

In fairness, the CPPIB will justify that, given the very high returns they've achieved, so I'm not making a judgment that it wasn't necessarily worth the increased management cost, but if you are going to compare the two options, there's no question that you are right to include the virtues of active investing in that they're able to get a higher return, but ought you not also include the vices of active management in achieving that return, namely, that it is much more expensive to do so?

It seems to me that you did not consider the last part, because you assumed that passive management would have been just as expensive as active management, which I think we agree is not the case.

[Yves Giroux]

You're right that passive management would be cheaper. The conundrum we faced was that for the funds that manage, in the case of the CPPIB, hundreds of billions of dollars, how much cheaper would it be?

Even if they were to go to a purely passive investment strategy, I don't think there are currently instruments that would fit the CPPIB's volume. There would be a need for some operational expenses—

[Pierre Poilievre, Conservative, Carleton, ON]

Right.

[Yves Giroux]

—for the CPPIB to mimic what you were referring to, such as ETFs, for example. I don't think there are ETFs on the market that would be big enough to absorb such a high volume.

[Pierre Poilievre, Conservative, Carleton, ON]

Right.

[Yves Giroux]

There would still be a need for people to actively be involved and to make transactions on an almost daily basis to ensure that they do properly track the indexes they would decide to follow under a passive strategy. There would be reductions in management fees, for sure, but to what extent? That remains unclear.

[Pierre Poilievre, Conservative, Carleton, ON]

Could I ask just one last question?

[The Chair, Liberal, Wayne Easter]

Okay. We're quite over time. We must—

[Pierre Poilievre, Conservative, Carleton, ON]

Could I just have a parting request, then?

[The Chair, Liberal, Wayne Easter]

What's your parting request?

[Pierre Poilievre, Conservative, Carleton, ON]

Just that the next time, you look at this—

[The Chair, Liberal, Wayne Easter]

From virtues and vices to parting requests....

[Voices]

Oh, oh!

[Pierre Poilievre, Conservative, Carleton, ON]

Yes, that's right. My greatest vice today is that I'm too loquacious.

It's just that the next time you look at this, could PBO try to find a methodology to at least credit a passive approach for its lower management costs? For all of the complications you've just stated—and they are legitimate—notwithstanding, there must be some way, if we're going to compare the two, to give passive management credit for its lower cost of administration—both transactions and management—that it brings.

My request as a parliamentarian is that the next time you do this calculation, you take that into account.

[The Chair, Liberal, Wayne Easter]

All right. That's up for consideration by the PBO.

[Pierre Poilievre, Conservative, Carleton, ON]

Thank you, Chair.

[The Chair, Liberal, Wayne Easter]

Now we have Mr. Sorbara, and then we are coming back to Mr. Julian.

Mr. Sorbara.

[Francesco Sorbara, Liberal, Vaughan—Woodbridge, ON]

Thank you, Mr. Chair.

I do want to start very quickly by acknowledging the passing of MP Mark Warawa. Mark and I were on the same floor in the Valour Building, and I had the chance to get to know him quite well from a number of conversations. I do wish to pass on my sincerest condolences to his family. I know that the Lord has inherited quite the angel in the last 24 hours. My condolences on Mark's passing.

Going to the topic at hand, the CRA has published a set of reports. The fifth one came out this week: “Tax Gap and Compliance Results for the Federal Corporate Income Tax System”.

If I could just read out the preamble in the executive summary, I think it speaks to the measures our government undertook to ensure the integrity of our tax system. It states:

In April 2016, the Government of Canada committed to estimating the federal tax gap to encourage an open and transparent discussion on tax non-compliance. Understanding how and why taxpayers are non-compliant is critical to help preserve the integrity of the tax system and to protect Canada's revenue base, which supports programs and benefits delivered to Canadians.

I think that little preamble, that first sentence of this last report, is very important to folks back home in my riding and across Canada to assure them that the federal government is providing CRA with all the resources it needs to do its job for integrity.

I have a quick question. We heard some numbers: the before tax gap numbers, the broad ones, but then the audited ones. In your view, how important were the resources we invested in the CRA to pursue those proper audits and reduce that tax gap to be as minimal as possible?

[Yves Giroux]

I won't comment on the level or the appropriateness.... I'll let the CRA officials determine whether they have sufficient resources to pursue all the audits they should be pursuing.

It's certainly the case that audits are a very important way of addressing the tax gap and narrowing it to the extent possible, because audits, first of all, uncover tax evasion. Also, and I think equally important, they provide a disincentive to engage in the behaviour in the first place. If there's a relatively high likelihood of getting caught, it's a disincentive to engaging in the behaviour in the first place.

[Francesco Sorbara, Liberal, Vaughan—Woodbridge, ON]

Exactly, and if I can interject, page 9 of the CRA report shows a tax gap before audit of $9.4 to $11.4 billion for SMEs and large corporations. The “Impact of Audit” brought it down by literally three-quarters. You're still at $3.3 billion to $5.3 billion, but it gives you an indication of the magnitude when audits are performed correctly.

I'm going to pivot, because there is something in the PBO report at the end, on page 20, where you say:

CRA efforts to increase audits on the information reported on T106 forms could reduce the magnitude of aggressive tax planning. However, it may be time for a “fundamental rethink” on international corporate taxation to ensure income is taxed where the economic activity is taking place.

Now, we do know that we've entered into a base erosion and profit shifting agreement, another multilateral instrument. Our government, in the last three years, invested a billion dollars plus into CRA, with more audit teams, in responses to KPMG and other activities that have been taking place.

Could you comment on this last paragraph on page 20, before the appendix? This is your concluding statement.

[Mark Mahabir]

Basically what we're saying here is that the T106 forms are not a reliable source of information for data analysis. A lot of the forms are incomplete, and we had to get the CRA to clean the data for us before our analysis.

As well, there are certain outliers on the forms. There are certain corporations with a lot of transactions reported on the forms in comparison to other corporations.

The last sentence basically says that the level of transactions is not commensurate to the level of economic activity in Canada and in those jurisdictions where those transactions occur.

[The Chair, Liberal, Wayne Easter]

You have time for a quick question.