Finance Committee on Nov. 17th, 2016

[The Chair, Liberal, Wayne Easter]

Thank you. We can come back if you've got more later, Jen.

Mr. Caron is next.

[Guy Caron, NDP, Rimouski-Neigette—Témiscouata—Les Basques, QC]

Thank you, Mr. Chair.

I would like to thank the witnesses for being here.

I'll continue with emissions. The sections of the Income Tax Act that dealt with emissions didn't apply only to carbon. I imagine that they were from the days when we used market mechanisms to limit sulfur dioxide. Has it been in place even longer? Do you know when these legal provisions went into force?

[Trevor McGowan]

Sir, are you asking about the coming into force for the provisions relating to emissions allowances?

[Guy Caron, NDP, Rimouski-Neigette—Témiscouata—Les Basques, QC]

Oh, when we're looking...

Currently, clause 10(1) of the bill would amend section 27 of the Income Tax Act by introducing specific rules on the tax treatment of emissions allowances. Was there tax treatment of emissions allowances in the past? At the time, there was a market mechanism for sulfur dioxide to fight acid rain. So there already were pollution rights mechanisms, ultimately. So there had to have been a tax system. Is that correct?

[Trevor McGowan]

There were the general rules in the Income Tax Act that various taxpayers had to apply to their particular situations. None of those rules dealt specifically with emissions allowances, so prior to the introduction of the rules contained in Bill C-29, taxpayers applied the general tax principles as they thought most appropriate, because there was a real element of uncertainty.

One of the things we're hearing is that taxpayers want certainty in how these things are taxed. Of course, they were taxed. Some taxpayers took the position they were inventory; some took the position they were eligible capital property. There were issues with each. It is true that the general tax rules would apply prior to this, and this doesn't override that unless a taxpayer elects to do so.

You also mentioned carbon and the definition of emissions allowance applying to carbon. That's what I would call the paradigm example of something to which they would apply, but the definition itself, which is introduced in subsection 248(1), is broader than that. Emissions allowances can be used to satisfy—and I'm going from memory—an obligation with respect to emission of a controlled substance. Carbon, of course, is the classic example, but it's not limited to that.

[Guy Caron, NDP, Rimouski-Neigette—Témiscouata—Les Basques, QC]

Sir, what did you say was a classic example?

[Trevor McGowan]

It was of carbon emissions qualifying—

[Guy Caron, NDP, Rimouski-Neigette—Témiscouata—Les Basques, QC]

Yes.

[Trevor McGowan]

—but it doesn't just apply to carbon emissions. It could be other emissions.

[Guy Caron, NDP, Rimouski-Neigette—Témiscouata—Les Basques, QC]

My question might be directed more to an historian, but back in the eighties the question I was really referring to was.... If you are proposing this, I'll assume that you're not reinventing the wheel, but I also think that there was a mechanism back in the eighties to fight acid rain, a cap and trade system on sulphur dioxide, which basically was addressed through emissions or polluting rights, basically, for sulphur dioxide. These rights had a certain value, which you could compare with the value we're giving to carbon emissions at this point.

If we had that back in the eighties, how different is the current system with carbon that it necessitates those changes, and why weren't they initially used with sulphur dioxide emissions?

[James Greene]

If I may, Mr. Chair, I think the issue is essentially the same.

What the Income Tax Act is trying to do in these cases is recognize that in a regulated system that involves creating allowances to emit or control a substance and then requiring firms to provide the permits in order to make the emissions, those permits have value that fluctuates up and down, so there's a potential for profit and loss in those situations.

Basically, the Income Tax Act is just trying to establish the rules by which we will recognize those profits and losses. The situation with SO_x trading is akin to the issue that we have today with carbon trading.

The systems in the 1980s applied to a very small number of taxpayers, but there was and has always been a certain amount of uncertainty, as my colleague has been saying, about how those transactions should best be treated for tax purposes. The purpose of the provisions in this bill is essentially to codify the treatment and to remove some of these questions around the proper way to account for these in tax terms.

You could argue that in the 1980s there might have been a case for providing more clarity, but a strong case was not made.

[Guy Caron, NDP, Rimouski-Neigette—Témiscouata—Les Basques, QC]

Basically what you're saying is that we're modernizing what we had back in the eighties.

[James Greene]

Yes, I think it's fair to say that we're codifying a set of specific rules, as distinct from relying upon very general rules.

[Guy Caron, NDP, Rimouski-Neigette—Témiscouata—Les Basques, QC]

I will ask one last question and come back to the subject afterwards.

[The Chair, Liberal, Wayne Easter]

If you're going to a different subject we can come back to you, or if you're okay to continue, there's no problem, Guy.

[Guy Caron, NDP, Rimouski-Neigette—Témiscouata—Les Basques, QC]

I'll continue with one more question on a different topic; it's probably the only one I will have.

July 1, 2020, was chosen as the date for indexing the Canada Child Benefit.

Was the decision based on mathematic calculations aimed at optimization and at determining whether the timing was ideal?

In other words, was it a political decision by the government?

I'm not necessarily asking you to comment on the merits of the decision.

[Pierre LeBlanc, Director, Personal Income Tax Division, Tax Policy Branch, Department of Finance]

Thank you for the question.

The Canada Child Benefit established by the government is much more generous than the previous program. The government wanted to stick to the July 2016 deadline for implementing this new benefit, despite the economic conditions and other budget pressures, and announced its intention to implement indexing by 2020. That is what was indicated in this provision of the bill.

[Guy Caron, NDP, Rimouski-Neigette—Témiscouata—Les Basques, QC]

My question was about the choice of the date.

Why 2020 and not 2019, 2021 or another date?

[Pierre LeBlanc]

Nine out of ten families benefit from this program. It also involves keeping a balance between these benefits and the expenses. I think that's why the government chose July 2020.

[The Chair, Liberal, Wayne Easter]

Mr. Ouellette is next.

[Robert-Falcon Ouellette, Liberal, Winnipeg Centre, MB]

Thank you very much, Mr. Chair. I appreciate it.

I was interested in the amendments with respect to the exception in the anti-avoidance rules in the Income Tax Act for cross-border surplus-stripping transactions.

Could you in layman's terms explain that a little bit more? Then I have a couple of other supplementary questions to ask.

[Trevor McGowan]

I would be happy to.

Cross-border surplus-stripping is unfortunately a bit of technical jargon. “Surplus” in this case refers to the retained earnings in a corporation. Normally when they are paid out, they are paid out as dividends. Dividends, when they cross a border, are generally subject to a 25% withholding tax, which can be reduced under tax treaties. In a parent-sub situation, it's usually reduced to 5%, but of course 5% is still more than 0%.

These cross-border—Canada to another country—surplus-stripping techniques, which is the extraction of these retained earnings from a Canadian entity up to its foreign parent, free of Canadian withholding tax, are of course contrary to tax policy. They typically rely upon an exemption under Canada's tax treaties whereby dividends might be subject to a 5% withholding tax rate, but a sale of shares of a Canadian entity can be tax-exempt under the terms of the treaty.

In very general terms, a dividend involves moving a certain amount of cash from Canada up to the parent, but when you sell shares, that also involves moving cash from the purchaser to the seller. If you contrived a situation that could be as simple as one Canadian subsidiary buying shares of its Canadian sister company from the parent, you can have money going from a Canadian company up to its foreign parent, but as proceeds from the disposition of another Canadian company's shares. That could be exempt from tax, absent these anti-surplus-stripping rules.

[Robert-Falcon Ouellette, Liberal, Winnipeg Centre, MB]

That's a pretty good explanation. You're essentially closing a loophole about transferring money and making sure it is taxed at a proper rate and that people aren't hiding money and getting away with it.

What might be the impact of closing this loophole on sales of these shares? Would it have some impact on the ability of non-resident corporations to buy resident Canadian corporations?

[Trevor McGowan]

The big loophole would be surplus-stripping. Then there's an important exception to that rule when you have—I'll provide a bit more background—a Canadian entity buying a foreign company that happens to own another Canadian entity. You could say that the foreign target in that purchase is sandwiched between the two Canadians.

For a number of reasons, you want to unwind that sandwich and move the bottom Canadian company up. That might ordinarily be caught within the surplus-stripping rules, so there's an exception saying that if you have a Canadian company that buys a foreign target with a Canadian sub, you are allowed to unwind it.

The specific amendment here deals with foreign parent companies reorganizing to work their way into that exception in cases in which it really isn't a Canadian entity buying a foreign target, but a foreign parent establishing a Canadian entity that has another foreign entity; cases in which they are trying to get into this situation.

In terms of cross-border purchases and sales of shares, this basically clarifies an existing exception to an anti-avoidance rule that prevents people in inappropriate circumstances from essentially either stripping Canadian—

[Robert-Falcon Ouellette, Liberal, Winnipeg Centre, MB]

Would there be other methods for people to find a way to transfer those without paying taxes? I will say this is almost esoteric in some ways.