Finance Committee on Nov. 17th, 2016

[The Chair, Liberal, Wayne Easter]

Committee, come to order, please.

Today we're dealing with the Budget Implementation Act 2016, Bill C-29, A second Act to implement certain provisions of the budget tabled in Parliament on March 22, 2016 and other measures.

There are a couple of items before we get to departmental officials. First, we need a budget to hear from witnesses. That schedule is all laid out according to a previous motion of this committee, but a cost has been calculated for us to do the hearings on Bill C-29, which will all be in Ottawa. We need to request $10,100.

Does somebody want to move that? It is moved by Mr. Liepert.

Is there a seconder? It is seconded by Mr. Sorbara.

All those in favour?

We don't need a seconder. Sorry; I'm used to Robert's Rules of Order.

All those in favour?

(Motion agreed to)

You had a point you wanted to raise, Dan, before I go to witnesses.

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

Yes, thank you, Mr. Chair.

Earlier today, I believe through the clerk, we received a request from the Canadian Medical Association in regard to the contents of the bill that we're going to be discussing today. They have some concerns, and as Parliamentarians, we obviously want to do all of our due diligence, so I would just make a suggestion that if we can accommodate them, it would be very helpful. They're the largest organization representing doctors.

[The Chair, Liberal, Wayne Easter]

Okay. In fact, we've received that email, and we are looking at trying to schedule them into our list of witnesses.

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

You're amazing, Mr. Chair.

[The Chair, Liberal, Wayne Easter]

I tell you.

In fact, I think they raised some good questions in their brief. There may be an opportunity to discuss some of those questions with departmental witnesses today. I expect you'll be on your toes and do that.

This is the way we will proceed, just to get a kind of a feel of where we're at here so maybe we can finish in the two hours.

We will deal with the bill in its parts: part 1, part 2, part 3, and part 4. On part 4, there are seven different divisions. We will deal with them division by division in case people have questions on those sections.

If any committee member has a particular area where they think they are going to have a lot of questions, if it's down the list on part 3, part 4, or divisions, you could indicate that to me, and we'll maybe try to get there a little faster.

In any event, we will start with part 1. Officials will give a brief overview of what that section means in terms of the legislation. For part 1, Amendments to the Income Tax Act and to Related Legislation, we have with us Mr. McGowan, Mr. Greene, and Mr. LeBlanc.

Mr. McGowan, I believe you're to lead off. The floor is yours.

Thank you.

[Trevor McGowan, Acting Chief, Tax Legislation Division, Tax Policy Branch, Department of Finance]

Thank you.

I'll provide a brief overview of the bill so that we can get to the questions section. I'll proceed measure by measure, aligning with when they first appear in the bill.

The bill replaces the existing eligible capital property regime in the Income Tax Act with a new class of depreciable property, which is intended to replicate, to the extent possible, the old eligible capital property regime, but in a simpler way, as for any other class of depreciable property. These amendments include simplification measures to, for example, allow taxpayers to eliminate small balances in their eligible capital property pools within the first 10 years after the transition.

It extends what are known as the back-to-back rules of the Income Tax Act in three important ways. These are rules designed to apply wherever certain tax consequences apply when a transaction occurs between two entities that typically are related. It prevents the avoidance of tax consequences when those entities interpose a third party between the two of them. The classic example is using a company in a low-tax treaty jurisdiction to make a loan through that treaty jurisdiction to a Canadian entity and thus obtain a lower rate of withholding tax on interest.

These rules are extended, as I said, in three important ways. The first is to apply to rents, royalties, and similar payments. The second is to prevent their avoidance through the use of character substitution transactions or the introduction of multiple intermediaries, meaning that rather than back-to-back, there might be back-to-back-to-back arrangements. Third, it prevents the avoidance of the shareholder loan rules through the use of the back-to-back techniques I described.

Next, it provides rules for the valuation of derivatives, ensuring that if they're held as inventory, they cannot use the “lower of cost or market” method.

Next, it applies to the sale of linked notes to ensure that the tax consequences arising on a sale before maturity of a linked note align with the tax consequences on maturity.

It introduces tax rules to clarify the tax treatment of emissions allowances under emissions trading regimes.

It prevents the use of so-called “debt parking” techniques to avoid a realization of an accrued foreign exchange gain on the repayment of a debt denominated under a foreign currency.

It closes loopholes relating to the use of life insurance policies to extract income, free of tax, from a corporation.

It provides for the appropriate use of an exception to our existing anti-surplus-stripping regimes, which prevent the use of somewhat artificial structures by foreign multinationals to make use of an exception that is intended only for Canadian companies.

It indexes the Canada child benefit, beginning in the 2020-21 benefit year.

It includes measures that are intended to prevent the multiplication of the small business deduction.

It prevents the tax deferral on switches between classes of shares in what's called a “switch fund” mutual fund corporation.

It would introduce the country-by-country reporting standard for transfer pricing for multinationals.

It contains rules relating to estates donations to provide more flexibility for giving by certain graduated-rate estates.

It refines and improves the trust loss restriction event rules, in particular to ensure that they apply appropriately in the case of investment funds.

It again amends rules relating to spousal and similar trusts to provide more flexibility and to ensure appropriate tax consequences on the death of the primary beneficiary under such a trust.

It allows for alternative arguments to be presented in support of an assessment after the expiry of the normal limitation period, provided the total amount on assessment does not increase.

Last, it introduces the OECD common reporting standard. That's a tax information sharing standard designed to prevent fiscal evasion, and it provides for the sharing of account information between tax authorities.

Those are each of the provisions in part 1 of the bill, with a fairly short bit of detail.

[The Chair, Liberal, Wayne Easter]

We will go to questions in no particular order. Whoever wants to start has the floor.

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

Thank you, Mr. Chair.

Thank you for the work you do. I'm glad you could be here to talk about this today.

I'm going to start with the common reporting standard and work my way backward.

The common reporting standard has come under a fair bit of scrutiny by various groups, particularly the credit unions, in that it imposes a one-size-fits-all regime. We all obviously want to keep the integrity of our tax system and align with other jurisdictions, but unlike the FATCA regulations that were brought into place a few years ago, where there was a risk-based assessment of 2%, these common reporting standards are actually slightly different. They require a slightly different bit of information to be sent on, and there is no risk-based assessment. All credit unions, regardless of size, have to comply.

I have the Summerland Credit Union in my riding, with a staff of about 10, and this actually seems to be quite an onerous process.

Could you please address why the law was written in such a way so as not to allow the same treatment as under FATCA?

[Trevor McGowan]

My colleague Jim Greene can speak to that.

[The Chair, Liberal, Wayne Easter]

Mr. Greene, go ahead.

[James Greene, Director, Business Income Tax Division, Tax Policy Branch, Department of Finance]

Thank you, Mr. Chairman.

The agreement with the United States with respect to FATCA, of course, was a bilateral agreement. The common reporting standard is a similar system in the sense that it involves a requirement on financial institutions to identify accounts that are held by non-residents and to share that information with the CRA, which will then provide it to the tax authority of the person's residence.

It's essentially an extension to the kind of reporting on financial accounts that we've been used to for many years, the idea that if you open.... If you're a Canadian resident and you have a bank account in Canada, the income you earn on that bank or investment account will be reported to the CRA through a T5 slip or a T3 slip. However, when accounts are held by a non-resident, that person's home country has no way of knowing that information unless the person reports it.

The common reporting standard is an international arrangement by which countries have agreed to collect this information from their financial institutions and to exchange it among their financial criteria. The international community, when it was looking at this approach, considered the fact that the U.S. FATCA agreements have a carve-out for certain small institutions. There were discussions around that, but there was no agreement that small institutions should be exempted.

There was a concern, essentially, that if a group of institutions was carved out, they could then become a pathway for non-reporting. If people know that if they place money in a certain kind of institution, they'll be safe and it won't be reported, this could create an incentive to use those institutions.

More than a hundred countries have now agreed to this standard. I'm not aware that any country has departed from the standard in that way.

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

On this point, you do recognize, though, that in provinces like British Columbia—obviously, credit unions are provincially regulated—you cannot be a credit union member unless you've resided in the province for six months. You have to be a resident of British Columbia to open an account.

While I can understand that there may be some issues, right from the beginning they're not allowed to offer services of any type unless someone has been there for some time.

[James Greene]

Certainly it's understood, in that case, that the requirement with respect to existing accounts in place on July 1, 2017, when it's proposed the system will come into place, is that institutions can rely on the address they have on file for a person. The requirement is essentially that they identify any non-residents they have on file. If there are very few, one might expect that it will not be such an onerous exercise. They're not required to contact people. They're entitled to rely on their paper records, or I guess, in cases today, on electronic records.

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

Was the agreement written in such a way that it was overly prescriptive in requiring this, or did we just generally agree to a set of principles and then institute it by a very top-heavy, Ottawa-centric system?

Credit unions, I understand, are all provincially regulated, and perhaps that fact isn't known widely enough here. I would like to know if we agreed, knowing specifically that these kinds of rules would have this impact on small credit unions.

[James Greene]

The standard is extremely detailed. It's not a set of broad principles; it's a set of quite detailed rules, which are reflected in the provisions of the bill.

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

Okay.

This is my last intervention, Mr. Chair, and then I'll let someone else go ahead.

FATCA was implemented by the Americans; we really had no say in the matter. However, the OECD requirements are something that Canada voluntarily signed up to. Is that correct?

[James Greene]

That's correct. The view of the Canadian government has been that the common reporting standard is an important tool to ensure reporting of assets and income that individuals have abroad; it's considered to be an important tool in the fight against international tax evasion.

[The Chair, Liberal, Wayne Easter]

Okay.

Jim, just before we go on, because the credit unions were on the table—and I too hear the complaint that Dan has talked about—whether it's a case of reporting to FINTRAC or of the paper burden that will be required under these measures, one difficulty for the credit unions is that the big banks have an administrative structure that looks after all that. In the case of the credit unions and individual credit unions—Malpeque Bay in my riding, which is not very big—the administrative burden on the operation to do that paperwork for this area and for FINTRAC is proportionally much higher. It really is. It's a real burden, because they're a small operation.

Do you see any way of addressing that? In my view, it's a legitimate complaint by credit unions. I don't know how we can deal with it. We have to do these things because we're a global player and we have international agreements, but I think we have to recognize as well that the burden on a small credit union that may have 10 employees to do all this administrative work, plus satisfy FINTRAC, is a huge proportional cost to them versus what it may be for the Royal Bank of Canada.

I think we're on the same wavelength. Do you see any way of reducing that burden on those credit unions?

[James Greene]

Mr. Chairman, I think the government recognizes that for smaller institutions, regulatory requirements of all kinds have, relative to their size, become more significant, and I think that is a real issue, as you indicate.

As I say, the intent with this standard has been to try to have it operate in as streamlined a way as possible and, with respect to accounts that are less than $1 million, to allow institutions to do a relatively straightforward paper-based search through their records. They're entitled to rely on the address on file, in which case, as long as it isn't a non-resident address, they're not required to make further inquiries.

On a go-forward basis, it simply means that when somebody opens a new account, the institution has to ask the person to indicate their jurisdiction of tax residency and to record that accordingly.

The government and the international community, in devising this standard, have certainly tried to devise it in such a way that the burden is minimized, but it's not zero.

[The Chair, Liberal, Wayne Easter]

Okay, you are aware of the issue for sure. It's something we had to keep uppermost in our minds.

Now we'll turn to Ms. O'Connell, and then Mr. Caron

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

Thank you, Mr. Chair.

Thank you all for coming.

I want to ask a couple of questions on the emissions allowances. I've had to read it a few times just to make sure I fully understand it and I would just like some clarification.

Essentially, if I'm reading it correctly—and I'm actually going off the Library of Parliament brief right now—the emissions allowances are treated as inventory. However, they're only included as income for tax purposes if the accumulated emissions exceed the taxpayer's emissions allowance. Is that correct?

[The Chair, Liberal, Wayne Easter]

I can hear the wheels turning up here.

[Trevor McGowan]

You can see the hamster.

Probably the best way—and I'm trying to think of the clearest way to answer that question—is to go through how the rules work and also, somewhat, how they address the current issues, because they were intended to be put in to clarify and provide rules for the taxation of emissions allowances.

Right now all we have are somewhat general tax principles. There are no specific rules in the Income Tax Act saying how to treat them nor, as I understand, are there any accounting principles. Beyond the obvious uncertainty problem, there is a real issue of double taxation that can arise. If you, for example, receive a free emissions allowance from the government, that could be taxable, and then you could be taxed again when it's used to satisfy an emissions obligation.

What the rules essentially do, through kind of a rolling balance mechanism, is they treat emissions allowances as inventory, as you said. That means that the purchase and sale of them is an income account. They're held as inventory, although they're not able to use the lower of cost or market rule, as some other types of inventory property could.

When they're received, they're held at their cost, and to the extent they can be used to satisfy emissions allowances, you can get a deduction. If they're not used in that year, then in the following year you get an inclusion and then another deduction for when they are used. This cycle of inclusions and deductions ensures that you can accrue the deduction not just in the year you get it but until it's used.

Last, I'll talk about the disposition, when you give up one of these emissions allowances to satisfy your obligations under an emissions regime. It's not when you sell it to a third party if you're a trader or what not, but it's when you give it up to satisfy your obligations under one of these regimes. Then there's no gain or loss on the satisfaction of it. It allows you to deduct, in essence, your cost accrued year to year until ultimately it's used to satisfy an obligation.

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

Okay.

I can see this being an issue in the sense that it is essentially putting a completely new tax regime on emissions, obviously, and there will be trading and what that means. You mentioned accounting standards and things like this, and you mentioned double taxation.

However, I look at it as not being competitive in the sense that if there are no international standards either, how do we understand its financial value, and then how do we keep that in line with others? Are there mechanisms in place?

This is such a new thing that's happening in a lot of economies. With these emission-pricing regimes, how flexible can the process be to allow these changes to come into place relatively quickly so that other markets are not completely different from what Canada is doing, for example?

[Trevor McGowan]

These rules, of course, govern the tax treatment, which is often aligned with accounting treatments, but that's not necessarily the case. If in the future accounting standards are developed that are inconsistent, these rules will still be what they are and govern the tax consequences, which we consider to be appropriate in the circumstances.

I said that there were no existing clear rules on how to tax these emission allowances that are purchased, sold, and used to satisfy obligations under these regimes, but it wasn't completely the Wild West. There were different interpretations of how, under the general principles in our tax system, they ought to be taxed. One of those theories, and a basis upon which I understand some taxpayers filed or people thought was the correct answer, was actually to treat them as inventory, which is what we have here.

I understand they could also have arguably been treated as eligible capital property. That is the class of property akin to depreciable property, soon to become a new class of depreciable capital property, but that's probably not the appropriate treatment, for a number of reasons. It's intended to apply to property with enduring value, whereas the emissions allowance is for one-use property. Often you'd imagine capital property declining in value, where that's not necessarily going to be the case for emissions allowances.

There were different theories of how it should be taxed, and this provides certainty by legislating that the inventory approach, which we consider to be the best approach, is the one to be used.

Also, you can see in the coming-into-force rule that there's an election that would allow taxpayers who either have been filing on the basis that it is inventory or who could be subject to double taxation to elect to have the rules apply retroactively to them. In the case that they determine that this is a benefit and this is how we've been considering them, it helps us out in avoiding double taxation. People can actually elect to have it apply back a number of years, so it's not a whole new system that's kind of made up ad hoc. Rather, it's legislating what we consider to be the appropriate approach to taxation.