Finance Committee on March 11th, 2021

[Shawn Porter]

I have just a handful of observations. I know the committee has heard from a number of witnesses and is pretty familiar with the content, the purpose and the policy underlying Bill C-208, but to level-set, it's obviously intended to facilitate intergenerational transfers of a business that are otherwise caught by a surplus-stripping rule under the existing tax system.

What is surplus stripping? That is an important context-setting question.

Surplus stripping occurs when an individual shareholder reaches into a corporation to access its surplus in a manner that produces a capital gain at the personal level rather than a dividend. The normative expectation is that a corporation would earn income that forms part of surplus and be distributed to the individual shareholder as a dividend. When steps are taken to achieve that kind of result not in the context of a sale of those shares to an arm's-length person, then this section 84.1 rule, which you're all becoming quite familiar with, steps in to characterize that capital gain as a dividend.

That's the starting contextual point, the foundational principle.

Building on that just a little, the rule applies to corporate surplus that is accessed by a parent through a corporation owned by a child. The reason that's the result is that the parent and the child are related for purposes of the tax rules and, for purposes of this surplus-stripping rule, are essentially treated as the same economic unit. There has been no disposition of shares to an arm's-length person in that context. Corporate surplus has merely been accessed by the individual shareholders. The tax system doesn't care who they are if they're related or not dealing at arm's-length.

That's important context as well, the parent and the child, because this is the point we're taken to where surplus stripping bumps up against an intergenerational transfer, which is the point underlying Bill C-208. We know and accept that, in some cases, it could be more attractive to sell the shares of a business corporation to an arm's-length person than to a child, in the expectation that the sale of those shares to an arm's-length person would produce a capital gain whereas there are circumstances in which the sale to a child would produce a dividend.

Trevor will get into the differentials in a little more detail, but again, the context is that those dividends are likely going to be taxed in the mid to high 40% range, and a capital gain in the mid to high 20% range. There is delta of around 20 percentage points as it relates to realizing corporate surplus in the form of a capital gain in the hands of an individual rather than a dividend. That's a fairly significant benefit, and needless to say, one that is sought after in the context of ordinary-course tax planning.

The key point we want to bring to the committee's attention as it relates to your deliberations around Bill C-208 is that, if there is a decision to except from the surplus-stripping rule a genuine intergenerational transfer, say, on neutrality grounds—neutrality in terms of producing the same result as the sale to an arm's-length person—I'm not going to comment on that policy point at the moment, but if that decision were taken, one needs to be mindful of the boundaries that are established between what constitutes surplus stripping and what constitutes a real intergenerational transfer of a business.

In other words, we wouldn't want to make an amendment to the act that would open the system up to vulnerability in the form of a parent being able to access corporate surplus through a corporation owned by a child if that was not in the context of a real or genuine intergenerational transfer of a business. In the hallmarks for assessing whether there has been a real, genuine intergenerational transfer of a business, one would look to the terms and conditions that would be reached between arm's-length parties in the context of the sale of a business and to what extent those terms and conditions exist as between any transaction that might be undertaken between a parent and a corporation owned by a child.

The legislative challenge is in how to delineate in legislative language those boundaries so that the real intergenerational transfer situation could be protected, but at the same time, the system isn't opened up such that it becomes vulnerable to relatively more aggressive or abusive forms of tax planning.

The final point that I would make, before I turn it over to Trevor, is just to remind the committee that this issue only arises when the shares of a small business corporation or a business corporation generally are sold by a parent to a corporation owned by a child. There are no impediments under the tax system to an intergenerational transfer of a business carried on in unincorporated form, whether a sole proprietorship or a partnership. Indeed, there are no impediments under the tax rules to the sale of shares of a business corporation to a child in circumstances where the child does not seek to use the corporate surplus of the acquired company to finance the acquisition itself. That's where the rub occurs.

It's the accessing of the corporate surplus to finance the acquisition by the child that arises at this awkward intersection point between surplus stripping and a transaction that looks like a genuine intergenerational transfer of a business.

With that, I know we'll have ample opportunity for questions.

I would turn it over to you now, Trevor, for a slightly more detailed walk-through with some illustrations and some examples to help highlight that critical point around establishing the boundary.

[The Chair, Liberal, Wayne Easter]

Mr. McGowan, please go ahead.

[Trevor McGowan]

Thank you.

I'd like to build upon what my colleague Shawn has already said about the context of the anti-surplus-stripping rules in section 84.1 and the intended purpose of the proposed amendment in Bill C-208, and then discuss how it would apply, looking at the specific legislative proposal.

I'll skip ahead to clause 2. I will mention clause 1 a little bit later, but clause 2 is the one that really deals with intergenerational transfers. It applies where a parent transfers shares of a corporation to a corporation controlled by their child or grandchild. There's a fairly simple trigger for that relief to be provided when it applies. That is the deeming of the purchaser corporation to not be dealing at arm's-length, which effectively turns off the anti-avoidance rule in section 84.1.

The difficulty or some of the challenge with the measure in the bill is how precisely targeted it is to get at what you'd think of as a real intergenerational transfer of a business. Of course, it deals, as I said, with the transfer of shares of a corporation owned by a parent to a corporation controlled by the child. It does not intrinsically deal with the real transfer of the business that is being carried on.

That level of abstraction from the actual business—where a parent wants to hand it over to their child or to their grandchild, so they can carry it on, keep it going, continue building it and continue running the business—is not directly provided in the bill due to this abstraction, just looking at transfers of shares going from one to another. It's that lack of precise targeting that I think we want to highlight as being a concern with the measure.

I could provide a few more details on that. In particular, the rule doesn't require the child, after the transfer, to be involved in the business in any way. It doesn't require the parent to cease to be involved in the business after the transfer of the shares. In fact, the parent could simply wind up the business right after the transfer.

There is a requirement that the purchaser corporation that gets the transfer shares be legally controlled by the child at the time of transfer. “Legally controlled” is generally defined for tax purposes to mean that the child could elect a majority of the board of directors. However, it does not prevent the purchaser corporation from being factually controlled by the parent. Likewise, it doesn't provide that the child will necessarily have any economic exposure to the shares being transferred. In fact, it does not require the child to retain ownership of the purchaser corporation after the transfer.

The requirement that shares be transferred to a purchaser corporation controlled, at the time of transfer, by the parent, is somewhat abstract, but I think it's worth noting the points of departure between that and what you'd normally consider to be a real transfer of a business to a child.

Why do these matter? They matter because while it is generally described as facilitating an intergenerational transfer in certain cases that Shawn set out—basically a transfer of shares to a corporation owned or controlled by the child—it would also open the door to facilitate tax planning, generally for high-net-worth individuals.

Shawn was mentioning the tax rate differential between capital gains and dividends in this anti-surplus-stripping rule. That's at the heart of it. In particular, as Shawn said, for a top-marginal-rate individual in Ontario, that might be the difference between around a 47% tax rate on dividends going down to a tax rate of 26% or so on capital gains.

Likewise, if the parent is able to access the lifetime capital gains exemption, as they would with some fairly simple planning, it could drive their tax rate down to zero. They would effectively be able to extract retained earnings from the corporation they control and continue controlling the corporation, continue running the business. The child need not necessarily have any involvement in the business after the transfer. To the extent their lifetime capital gains exemption is available, their tax would go from, again, for a top-rate Ontario resident—just to use as an example—47% down to nil.

Even in circumstances where a lifetime capital gains exemption is not available, say either because it's already been used up or because the corporation that carries on the business has more than $15 million in taxable capital—as I understand, a component of the rules would provide a grind to prevent a lifetime capital gains exemption from being accessed for larger companies—you would still have a rate delta, as Shawn said, of around 20 percentage points.

That is obviously going to be the most valuable for high-net-worth individuals who are subject to the top marginal tax rates and for individuals who want to extract a sizable amount of money from their corporation, such that the tax savings would be enough to more than offset the transaction fees of putting these kinds of complex arrangements into place.

I'd be happy to walk the committee through exactly how these transactions can be structured. The gist of it is that the parent has shares of a corporation, transfers them to a child or a company owned by the child in exchange for a promissory note. The parent's company pays the child's company an intercorporate dividend, which of course is tax free, and that dividend is then used to repay the promissory note that was used to purchase the shares. In that way, the money gets out of the corporation; you have a capital gain if the anti-avoidance rules of section 84.1 don't apply; and the individual is able to, instead of paying dividend rates, pay the much lower capital gains rates or nil if the lifetime capital gains exemption is applied.

That, hopefully, gives a bit of a flavour about the slight disconnect in the rules. When we look at the legal form of a transfer of shares by a parent to a company owned by their child, there's that bit of a factual disconnect between that and the real bricks-and-mortar transfer of an actual business to their child that the child continues to carry on.

I had mentioned earlier that I wanted to touch on clause 1, as it is different from clause 2. Clause 2 relates to intergenerational transfers and provides an exception for the anti-surplus-stripping rule in section 84.1. Clause 1 doesn't really relate to intergenerational transfers of a business. Rather, it relates to a different anti-avoidance rule, but it relates to siblings.

Just like for an individual moving from a dividend rate down to a capital gains rate means a tax savings, for corporations, transfers between corporations, if they can essentially transmogrify or change a capital gain into a dividend, intercorporate dividends are generally not subject to tax and so they're able to avoid tax in that way. That's what's called capital gains stripping generally. Section 55 is an anti-avoidance rule intended to prevent that.

There are a couple of important exceptions. One of them is that if you have a corporate reorganization between related parties, then you can move amounts around among your corporations. As long as it's all in the same group, there won't be any negative tax consequences.

This measure would allow siblings to escape the application of the anti-avoidance rule in section 55. As a result, one sibling would essentially be allowed to transfer their stake in the business to the other sibling without triggering this anti-avoidance rule that could result in capital gains treatment. It would provide a tax deferral on that sort of transfer between siblings. Again, it's not intergenerational and is dramatically different, which is why I did it in that order. I hope that provides a bit more of a flavour of what clause 1 does.

That, I think, provides a bit of an overview of the bill and some of the observations that we at the department have made about its technical operation. Shawn and I would be happy to answer any questions you might have.

[The Chair, Liberal, Wayne Easter]

Okay. We'll go to questions.

I'm not sure who's up first on the Conservative side. Who wants to go first there, Pat?

Just let me ask you this question, Mr. McGowan, first. I know the committee wants to move with this bill today. I think that's pretty likely. It's the third time that this bill has come forward in Parliament from three different members over the years, starting with the Liberals, the NDP and now the Conservatives. It's basically the same bill.

How difficult is it to fix? Can it be fixed? What kinds of amendments are required in order to cover off what you folks believe is a concern? If it were carried here today, the only amendments that can happen in the House, as I understand it, at report stage, are things that require a royal recommendation or a ways and means motion by a minister.

Could it be fixed at that stage if the committee were to carry it as is today?

[Trevor McGowan]

Thank you for that question, Mr. Chair.

I, of course, can't speak to the government's intentions about what fixes it might wish to do or anything like that. I can point to the fact that addressing this sort of intergenerational transfer is in the Minister of Finance's mandate letter. It is something that we, as department officials, are looking at.

In terms of whatever fixes would be needed, I would just go back to my earlier comments and say that the fundamental issue we have identified is this disconnect that I was trying to describe from a real transfer of a business as people would ordinarily understand it, where a parent carries on a business and for one reason or another they want to transfer it to their children or their grandchildren, and the next generation starts to carry on that business.

It's that fundamental disconnect between that factual situation on the one hand and, on the other hand, the approach of this measure looking solely to a transfer of shares from one individual to a corporation owned by their child, without really connecting the legal form with the real underlying story behind it. It is certainly something that we believe can be addressed.

In terms of the bill, hopefully, I've gone through and provided enough of an overview of the fundamental issues with it. I don't know if Shawn had anything to add to that. I think that's about as much as I could think to share.

[The Chair, Liberal, Wayne Easter]

Shawn, did you have anything you wanted to add?

Then I'll go to Mr. Kelly, Mr. Fragiskatos, Mr. Ste-Marie and Mr. Julian. There will be one question each.

[Shawn Porter]

It's just a quick point, Mr. Chair, to emphasize the complexities that Trevor and I have been speaking to around the boundary, and to answer your question around the extent of amendments.

Surplus stripping is a challenge for governments generally. There's a lot of case law on the point. It's a very difficult delineation to make at the best of times. I would only observe that one would want to be careful in making amendments to a surplus-stripping regime that would provide a road map for taxpayers to shoehorn their way into that exception and out of the regime. It's really just a further sounding of caution around how important it is to get that boundary right.

[The Chair, Liberal, Wayne Easter]

I didn't see your hand up there, Mr. Fast. Did you have something?

Okay. We'll go to Mr. Kelly, then, for a question.

[Pat Kelly, Conservative, Calgary Rocky Ridge, AB]

It's only a brief comment, and I'll give the time to Mr. Fragiskatos, if he has questions.

I only want to say that the points that were raised are important ones. They are ones that were anticipated and on which we had pretty good testimony from other experts on Tuesday to indicate that these are issues that can be dealt with within the bill as it is. I urge members to support it.

[The Chair, Liberal, Wayne Easter]

Mr. Fragiskatos.

[Peter Fragiskatos, Liberal, London North Centre, ON]

Thank you, Chair.

This is to whichever of the officials wants to take it.

The other day, as you may know, we had witnesses speak to this very issue. A number included tax experts. One was Kevin Wark from CALU, the Canadian association of life underwriters.

I asked Mr. Wark about what seems to be a gap in the bill. I think Mr. McGowan just spoke to this matter briefly a few minutes ago. It is the lack of requirement in the bill for the parent to cease to be involved after the transfer.

This is what Mr. Wark put back to me when I asked him his thoughts on that issue. I quote here from the meeting the other day, Mr. Chair.

We engaged an outside consultant who was involved in consulting primarily on arm's-length transactions of private businesses. He indicated that in the majority of those situations, the selling owner was obligated to continue in the business because of the transfer of information and relationships. To differentiate that from a family transfer doesn't seem to make sense. It would make more sense for the business owner to have some role to play longer term to ensure the business continues to be successful.

Our argument is that they should not necessarily control the business after the transfer, but they should continue to be able to play a significant role.

Maybe this is to Mr. McGowan. I'm not sure, but are there any thoughts on that perspective? Is this a reasonable rebuttal that was offered in response to this concern about the lack of requirement that I'm talking about?

[Trevor McGowan]

Thank you for that question. It's a good one. It's a good illustration of a point that Shawn was making earlier, that these are hard lines to draw and have to be done with careful thought, being mindful of real business transactions and what really happens when a business is transferred. It's finding the right balance.

As Mr. Wark said in his comments, it would be a somewhat extreme rule that said that when you have a transfer, you have to shutter the doors and the parent is not allowed in the building anymore, as of the date of transfer. That, of course, goes pretty far.

At the same time, you have at the other end of the extreme some provisions, such as the ones we've been discussing today, that have no requirement that the parent cease or restrict in any way their involvement in the business and, in fact, have no requirement that the child have any involvement in the business or that there be any sort of transfer between the two.

Part of the hard work that we're thinking about, consistent with the Minister of Finance's mandate letter, is the balancing of these kinds of practical considerations, so that you can have a real intergenerational transfer that reflects what actually goes on.

It is a fair point that in many cases it's not a hard break, such that at the date of transfer the keys are given, as when you buy a house, and the parent is no longer involved at all and the child completely takes over. It makes sense for there to be some overlap, and that is something that I think a set of rules would need to think about.

On the other extreme, however, it seems that when you have an intergenerational transfer of a business, some diminution in the role of the parent, coupled with the child's actually taking over the business, is an integral part of it. That really is a lot of the difficulty in coming up with a nuanced and complete set of rules to deal with it.

[Peter Fragiskatos, Liberal, London North Centre, ON]

Thank you very much.

If—

[The Chair, Liberal, Wayne Easter]

I'll have to go to Mr. Ste-Marie and then Mr. Julian.

Mr. Ste-Marie.

[Gabriel Ste-Marie, Bloc, Joliette, QC]

Thank you, Mr. Chair.

The bill before us is very important. Since being elected, I have met quite a few owners of family businesses, farming and non-farming, who were having a horrible time of things. It's a serious matter and they were in deep trouble. We've heard from a group of witnesses, and they all told us that we needed to forge ahead and that the situation made no sense. I know that it's a complex matter from the legislative and other standpoints. We certainly need to take the points that you've made into consideration. I wouldn't want to just hear that it's all very complicated and then find that nothing is being done. It's an urgent problem and the bill should be adopted.

From my point of view, as it's written, Bill C-208 would deal with the situation. After that we could examine the Hansard transcriptions, the debates in the House and the committee evidence to understand the intent of the bill. It's been said many times that we wouldn't want this bill to provide an opportunity for people who are cheating to avoid paying taxes. Its purpose is to facilitate intergenerational business transfers. Government regulations could spell out the details, and if there are problems, we could deal with those afterwards. But it's really essential to forge ahead.

The Quebec finance minister, Mr. Eric Girard, came to the Grand Joliette chamber of commerce before the pandemic, and said he couldn't understand why it hadn't been dealt with in Ottawa yet, when it had in Quebec.

Gentlemen, you've been working on that and you've been able to look at the model used in Quebec, which has guidelines.

What's the problem with what Quebec is doing? Why are you so afraid that we're going to go ahead and adopt a similar bill?

[The Chair, Liberal, Wayne Easter]

Mr. McGowan.

[Trevor McGowan]

Thank you for the question.

I think certainly the intergenerational transfer rules in Quebec as well as precedence in the United States and elsewhere have informed our thinking on the matter. It is, as I said, an important topic, sufficiently important, of course, to have made it into the Minister of Finance's mandate letter.

You'd asked about the specific concerns and had raised tax planning, and whether or not it could be dealt with later. I would simply note that the amendment, as provided in the bill, would facilitate more often high-net-worth individuals to extract or to pay out retained earnings from the corporation, possibly using the lifetime capital gains exemption to avoid or reduce taxes. Those could go from, to choose the Ontario rates we talked about earlier, 47% down to 26%, roughly, or down to zero where the lifetime capital gains exemption applies.

This kind of surplus stripping is very widespread, I would say, within the tax planning community. It's fairly common to try to convert dividends into lower taxed capital gains. It would seem reasonable to expect that to not only continue but to be accelerated and emboldened with the kind of planning that could be utilized through some of the measures in this bill.

You'd asked about what kinds of concerns there were on the tax avoidance side of things, and I think that's about it. I don't want to get into too many technical details. I alluded to them earlier. By using some tweaks on existing techniques, it is very possible, through a few transactions, to eventually....

Say, you're going to extract $100,000 from your business. You wanted that money out. You'd normally pay around $47,000 or $48,000 of tax on it. To have your child set up a corporation, transfer through—

[Pat Kelly, Conservative, Calgary Rocky Ridge, AB]

On a point of order, I'm really sorry, Mr. Chair and officials, but time marches on. We are a little bit over what we agreed to on the time for officials. I'm just asking you to be aware of the time and to keep this going.

[The Chair, Liberal, Wayne Easter]

I know we're a little over, but I'd like to give Mr. Julian the chance for a question. At least that's one from each party, if he wants to take it.

Mr. Julian, did you want a question, if you could be fairly quick?

[Peter Julian, NDP, New Westminster—Burnaby, BC]

Yes. Thanks, Mr. Chair.

My question to the witnesses is this: What kind of modelling have you done? The Department of Finance has obviously come up against this bill a number of times. I'm a little dismayed that we don't have amendments that could be offered.

That's fair enough, but there is some speculation that it may open up some broader aspects that allow some wealthier individuals to take advantage of it. What is the modelling internal to the Department of Finance? What kind of fact-based evaluation of this bill have you made? What difference do you see in terms of people claiming the amounts?

I'm looking for modelling. I'm looking for actual figures, anything that you bring to this discussion.

[Shawn Porter]

I'm going to let Trevor deal with that one.

While I defer that to him, the one thing, Mr. Julian, that I would point out around modelling—because we have been looking at it, as you say, for a while, for the reasons that Trevor has given—is that this delineation question is at the heart of it. There's a significant risk of revenue erosion if this exception to the surplus-stripping rule is too wide. We've had some conversations about it.

You've heard from Mr. Wark. He's just touching on the design features, the notion of how long a parent could remain involved in a business transferred to a child. There's that element. There's the element of whether they can own shares and the nature of those shares, and the extent to which the children need to be involved in the business.

Delineating what looks like a real intergenerational transfer is very difficult. If that isn't done properly, then, yes, we are saying that there is a significant risk of revenue erosion, which runs to your question about modelling.

Trevor, I don't know if you want to add anything to that.

[Trevor McGowan]

No, that's great, Shawn.

I apologize if I ran long a bit earlier.

Mindful of time, I would only point out that with regard to these planning techniques, we work with the Canada Revenue Agency. We understand the prevalence of surplus-stripping transactions. We've looked at that. Also, we have done our internal analysis as to what planning techniques that currently exist out there could be modified in order to facilitate tax avoidance through these proposals.

We've done the due diligence that way, in addition to Shawn's comments about thoughts on how to appropriately balance the different interests involved.

[The Chair, Liberal, Wayne Easter]

With that, we will go to clause-by-clause.

Thank you very much to the witnesses for providing the information.

If this doesn't carry, we'll deal with that. If it does carry, I would suggest that someone needs to look at it to make sure that there are amendments made that protect genuine transfers and don't open up tax planning in a way that creates some problems. There's always that opportunity, as was suggested earlier, either by a ways-and-means motion from a minister or a royal recommendation when we report it to the House. There are always options.

(Clauses 1 and 2 agreed to on division)

Shall the title carry?

[Some hon. members]

Agreed.

[An hon. member]

On division.