Human Resources Committee on May 14th, 2015

[The Chair, Conservative, Phil McColeman]

Good afternoon, ladies and gentlemen. This is meeting number 55 of the Standing Committee on Human Resources, Skills and Social Development and the Status of Persons with Disabilities. We're here to continue with our current study to explore the potential of social finance in Canada.

Members of the committee expressed an interest in bringing back government officials for further questioning after hearing from witnesses across Canada.

We're pleased today to have with us from the Department of Employment and Social Development, Ms. Siobhan Harty, director general, social policy directorate, strategic policy and research branch, along with Mr. Blair McMurren, director, social innovation, strategic policy and research branch. Welcome back to the committee.

From the Department of Finance we have Miodrag Jovanovic, director, personal income tax, tax policy branch.

Finally, from the Canada Revenue Agency, we have Ms. Cathy Hawara, director general, charities directorate, legislative policy and regulatory affairs branch, and Mr. Bryan McLean, director, policy, planning and legislation division, charities directorate, legislative policy and regulatory affairs branch.

Members, we have just the one panel today, so we'll start with seven-minute rounds during the first round. I'm at your behest in terms of how long you want the meeting to go on. If you exhaust the questioning, at a certain point we'll end the meeting, because I think there's a feeling there may be some redundancy. I'm just pointing that out. I've talked to a few members of the committee who feel that might be the case. We may end early, but I'm at your behest in terms of how many questions you wish to ask or your timing of them.

Let's begin with our first round of questioning with Madam Groguhé. Are you going first?

[Sadia Groguhé, NDP, Saint-Lambert, QC]

Yes, I can go first, but we have to—

[The Chair, Conservative, Phil McColeman]

Oh, I'm sorry. I told you earlier before the meeting started that I was getting punchy, because I'm looking forward to getting home.

Sorry, to the witnesses. You have my sincerest apology.

The witnesses who are presenting will have up to 10 minutes, and I'll try to give you a signal at nine minutes if you're approaching the 10-minute mark.

Shall we begin with Ms. Harty.

[Siobhan Harty, Director General, Social Policy Directorate, Strategic Policy and Research Branch, Department of Employment and Social Development]

Thank you very much.

I want to thank the committee for giving me the opportunity to return to speak today. I am pleased to be here with my colleagues from the Department of Finance and the Canada Revenue Agency to address any final questions you may have, or indeed to provide you with clarification on particular points.

I would first like to take a moment to thank the committee for the valuable work you have undertaken with this study.

I also acknowledge all the stakeholder groups who took the time to contribute to your study.

Since I last spoke to you, the Government of Canada has announced new measures in Budget 2015 to grow the social finance marketplace in Canada.

First, Budget 2015 proposes that registered charities be permitted to invest in limited partnerships with some conditions. My colleague from the Department of Finance will speak about that in his remarks.

Second, the budget announced the forthcoming launch of a social finance accelerator initiative to be led by ESDC. This announcement follows up on a commitment made by the government in the 2013 report of the National Call for Concepts for Social Finance, called “Harnessing the Power of Social Finance”, to bring together innovative, not-for-profit, and private sector organizations in order to sharpen their social finance ideas into investment-ready proposals.

Greater detail on this initiative will be made available in the coming weeks. lt's expected to involve advisory services, mentorship, brokering, and investor introductions to help fast-track promising social finance ventures to a greater stage of investment readiness.

Finally, I want to advise the committee of an upcoming event. The last regular meeting of the international Social Impact Investment Taskforce will take place in Toronto next month. The task force was created during the United Kingdom's G-8 presidency in 2013, with the aim of catalyzing the development of a global market for social finance.

The former minister of employment and social development, the Honourable Jason Kenney, had nominated me and Tim Jackson of the MaRS Centre for Impact Investing to sit on the task force.

This task force meeting will be hosted by the MaRS Centre for Impact lnvesting, and it offers a unique opportunity to profile Canadian approaches to social impact investment and benefit from the perspectives of task force members, who might have advice on how to advance the development of the Canadian market. Every task force member country that has hosted a meeting has used the opportunity to organize panels profiling aspects of their market that distinguish them from other countries.

These panels have created important cross-national learning opportunities. For the Canadian Task force meeting, there is a proposed panel on Aboriginal models that will likely elicit strong interest. A proposed panel on using social finance to advance international development will also be of great interest, given the government's record on innovation.

Thank you again for this opportunity to appear as a witness.

[The Chair, Conservative, Phil McColeman]

Thank you very much.

Now we can move to Mr. Jovanovic.

[Miodrag Jovanovic, Director, Personal Income Tax, Tax Policy Branch, Department of Finance]

Thank you, Mr. Chair.

My name is Miodrag Jovanovic. I am director of the personal income tax division with the Department of Finance.

Thank you very much for your invitation to appear here today before the committee regarding your study of the potential for social finance in Canada.

First, I would like to speak briefly in broad terms about the Canadian taxation and regulatory framework for registered charities in the Income Tax Act as it relates to social finance and social enterprise. I understand that my colleagues from the Canada Revenue Agency will speak in more detail about how they administer the provisions in the Income Tax Act.

Second, I would also like to draw your attention to a measure in the recent budget that responds to recommendations made to this committee.

The rules that relate to charities' involvement in social finance take into account a number of different principles, policy objectives and practical considerations. These considerations include the following:

In Canada, charities are exempt from taxes and are permitted to issue tax receipts for charitable donations for which individuals may claim a tax credit and corporations may claim a tax deduction. This results in forgone revenue and a tax expenditure of about $3 billion annually. This tax expenditure recognizes the charitable sector's important social and economic contributions. The lncome Tax Act provides a set of rules to ensure that tax assisted charitable resources are used to advance the purposes for which a charity has been established. In other words, charitable resources must be used for charitable purposes.

ln this context, the lncome Tax Act aims to strike a balance between allowing charities to engage in business activities, including social enterprise, as a source of revenue while ensuring that charities ultimately remain focused on their charitable purposes and activities.

Most charities can raise revenues directly to support their charitable activities as long as their business activities are directly related to, and subordinate to, the purposes for which they have been created. Where the business activity is closely related to the charitable purpose, it can make sense to integrate the business activities into the charity.

With the exception of private foundations, charities that wish to engage in unrelated business activities can do so by establishing a separate entity, typically a corporation, to carry out these activities. This can be an attractive option for charities since there are few, if any, restrictions on how a corporation's capital is raised and how its assets and revenues are used. Having a separate entity allows the charity to maintain its focus on charitable activities and use its charitable assets towards these activities.

The rules also attempt to provide a level playing field between businesses run by charities which are tax-exempt and businesses that pay tax. Taxpaying businesses, including small and medium-sized businesses could be placed at a competitive disadvantage if charities were able to conduct tax-exempt business activities without restriction.

To re-iterate, this suite of parameters is intended to allow charities to engage in business activities as a source of revenue while at the same time ensuring that charitable resources are not diverted from their charitable purposes.

As mentioned by my colleague from the Department of Employment and Social Development, I would like to discuss briefly a measure introduced in Budget 2015.

The Department of Finance discusses policy issues concerning registered charities with the charitable sector on an ongoing basis. We have been in touch with the charitable sector on social finance for several years. A number of stakeholders have told us that, if charities were permitted to invest in limited partnerships, they would be able to make more impact investments, that is, investments that generate both a social and financial return.

Up to now, charities have not been permitted to hold interests in limited partnerships in most cases because a charity that held an interest in a partnership was considered to be carrying on a business. Charitable organizations and public foundations can only engage in related businesses, with the result that few are in a position to hold interests in a partnership. Private foundations cannot engage in any business activities that prohibited them in all instances from holding interests in a partnership.

Charities have also told us that allowing them to invest in limited partnerships would permit them access to a wider range of investment opportunities to diversify their investment portfolios.

ln light of these recommendations, budget 2015 proposed that registered charities be permitted to invest in limited partnerships subject to certain conditions. This measure is expected to have two benefits. First, in allowing charities to diversify their investments, it will provide them with the opportunity to access a wider range of private market investments, such as infrastructure investments, and by so doing enable them to obtain better returns on their investments. This will in turn increase the resources they have available to fund charitable programs. Second, since there are many social impact investments that are structured as limited partnerships, allowing charities to invest in limited partnerships will enable them to better align their investment portfolios with their charitable purposes, and will potentially make available additional funds for social enterprise projects in Canada.

I would be pleased to respond to any questions the committee might have.

Thank you.

[The Chair, Conservative, Phil McColeman]

Thank you very much.

Now we move on to Madam Hawara.

[Cathy Hawara, Director General, Charities Directorate, Legislative Policy and Regulatory Affairs Branch, Canada Revenue Agency]

Thank you very much, Mr. Chair.

My name is Cathy Hawara and I am the Director General of the Charities Directorate within the Canada Revenue Agency.

As my finance colleague explained, it is their role to write the rules that support the government’s tax policy agenda. It is the CRA’s responsibility to administer those rules.

Let me start by saying that while the term “non-profit” is sometimes used to refer to both registered charities and non-profit organizations, there are some important differences. First, only charities are registered by the CRA. While both are tax-exempt, only registered charities can issue official donation receipts to donors. In exchange for the privilege of issuing receipts for donations, registered charities are also required to file a publicly accessible annual information return. Finally, while registered charities can carry on related business activities with the intention of making a profit, NPOs cannot have a profit purpose.

As the charities directorate of the CRA is responsible for the regulation of registered charities, that's where I will focus my remarks.

There are approximately 86,000 registered charities in Canada and these entities enjoy significant tax privileges. In 2014, the Department of Finance estimated that the fiscal cost for the federal government of tax incentives for charitable donations by individuals was more than $2.5 billion. As my colleague mentioned, when we take business deductions into account the fiscal cost is closer to $3 billion. These tax privileges come with the obligation to follow the rules set out in the Income Tax Act.

Under the basic statutory framework, there are three types of registered charities: charitable organizations; public foundations; and private foundations. Regardless of the designation, the Income Tax Act requires that all registered charities operate in one of two ways: they can carry on their own charitable activities; or they can make gifts to other “qualified donees”. In this context, the term “qualified donee” usually refers to other registered charities, but it also includes low-cost housing corporations for the aged, municipalities, municipal or public bodies performing a function of Canadian government, prescribed universities, certain foreign charities, registered Canadian amateur athletic associations, the United Nations and its agencies, and Her Majesty in right of Canada or a province.

In order to finance their charitable programs, whether they be through direct activity or funding of other qualified donees, registered charities need to generate revenues and do so in a number of ways.

The first is through fundraising. Most registered charities rely on fundraising to generate revenues. In 2013, registered charities reported $14.79 billion in tax-receipted gifts according to the information reported in their annual information return, the T3010. The recent budget proposal to exempt capital gains tax on gifts involving real estate and private shares adds a new incentive with respect to fundraising efforts.

Second, most charities can conduct related business activities. Under the Income Tax Act, there are two basic types of acceptable business activities: businesses that are related to a charity’s purposes and subordinate to those purposes, and businesses that are run substantially by volunteers. An important caveat is that private foundations are prohibited from engaging in any business activity.

Third, registered charities can generate revenues by making prudent market investments, which may include investments in separate taxable corporations or trusts established by the charity.

A charity’s board of directors would need to ensure that the investment is a prudent use of the charity’s assets. It must also ensure that no benefit of a private nature is conferred on the corporation or the trust.

Charities can also make program-related investments, commonly referred to as PRIs. A PRI is not an investment in the conventional financial sense since it would not necessarily yield a market rate of return. If a PRI furthers the investor charity’s charitable purposes, it could be considered a charitable activity. Common examples of PRIs include loans, share purchases, and leases of land or buildings.

An additional point to note, as my colleague has already, is that the recent budget announcement relating to investments in partnerships increases the flexibility charities have in structuring their investments.

Finally, registered charities can generate revenues through their charitable activities. Registered charities can charge fees for the services they provide.

In closing, while the common law and the Income Tax Act place certain restrictions on the use of charitable assets, Canadian registered charities can and do play an active role in addressing pressing social problems, as service delivery agents, as funders, and as investors.

Registered charities can also work together with the business community to deliver programs that are designed to achieve social outcomes, for example, educational activities relating to employability training, career counselling, entrepreneurial training, or on-the-job training in vocational or work skills; running social businesses with individuals with disabilities; and preserving and maintaining high standards of practice within an industry.

The CRA is committed to helping registered charities understand the rules and for that reason, publishes a variety of guidance products on a wide array of topics. Our website contains information of interest to charities, donors, legal representatives, and researchers.

You can also find the annual information return for each of Canada’s 86,000 registered charities. The return contains a wealth of both program and financial information on charities.

As we add new information to our website and develop and refine our tools, we continue to be interested in receiving feedback from external stakeholders.

I would now be happy to take any questions.

[The Chair, Conservative, Phil McColeman]

Thank you very much to all our presenters today. Now we move on to questioning.

Madam Groguhé, for seven minutes.

[Sadia Groguhé, NDP, Saint-Lambert, QC]

Thank you, Mr. Chair.

I want to thank the witnesses for being here today.

My first question is for our witnesses from the Canada Revenue Agency and the Department of Finance.

You quickly went over the criteria, if I may put it that way, for the new rules for charities.

However, I would like to come back to the negative impact that a number of witnesses raised here, before this committee, with regard to the costs associated with adopting social finance. For example, when David Juppe, senior operating budget manager and tax expert from Maryland testified, he illustrated to us that using social finance, including SIBs, would cost the government more because of the use of a third party and the pay-for-success model. He even described SIBs as the government's credit card.

I would like your take on this warning. In your view, how can we effectively assess the recurring cost of social finance in general and SIBs in particular? When might such an assessment take place? Before, after, or during the launch? How can we truly know, in any meaningful way, what the government is getting itself into and what costs will be associated with this social finance?

[The Chair, Conservative, Phil McColeman]

Before we move on to your answers to these questions, just for all committee members, obviously, we have professional people of the government service before us. Opinions are generally not asked of government officials at this level. Witnesses are welcome to answer in any way they would like, but I am just saying to committee members to be aware that in many cases, asking our government officials for opinions is not appropriate. Instead, the question should be geared toward things, other than opinion.

I will let that continue. If anyone chooses to answer that, you are welcome to. Otherwise, we'll move on.

[Sadia Groguhé, NDP, Saint-Lambert, QC]

I could reword my question.

[Miodrag Jovanovic]

If I may, I would like to clarify something. I am here as an expert in tax legislation. I can speak to how social finance fits in that framework. However, I am unfortunately unable to answer broader questions on social finance and on the cost of using it as an instrument, if the questions go beyond the legislative and regulatory framework of taxes.

[Sadia Groguhé, NDP, Saint-Lambert, QC]

Okay.

Ms. Harty, you mentioned at a prior committee meeting that you studied the issue. Can you tell us a bit more about it?

[Siobhan Harty]

I think that there are probably different costs. Again, I am not speaking from experience. I am speaking from a comparative perspective, knowing how other countries have managed this. The first cost is a transaction cost, just from the legal dimensions of having to make contractual arrangements related to social finance or a social impact bond. What we hear from other countries is that the more you do, the lower the transaction costs become. The transaction costs are high for the first transaction because there is a learning dimension to it, but the more you do, the lower the cost. The British case is a good example here. They have multiple social impact bonds, so they have been able to capture lessons learned from the first social impact bonds and apply them to subsequent ones, thereby reducing the transaction costs.

In terms of evaluating things as you proceed, I am not sure here if you mean the costs of implementing a social finance initiative like a social impact bond, or if you mean evaluating any kinds of savings. As with any kind of project or expenditure, costs are monitored. With any project management approach, you would monitor costs along the way, and then you would do an assessment at the end.

In terms of being able to assess whether there are any savings, that could only come at the end, unless you establish some milestones of payments along the way, which is done, for example, in standard pay-for-performance contracts in many countries, including our own, as well as in some of the social impact bond projects that have been put together in various jurisdictions.

[Sadia Groguhé, NDP, Saint-Lambert, QC]

Okay.

Ms. Hawara, you said that charities would be allowed to work on social issues involving education, job integration, and other things. The rules serve to promote the implementation you described.

On the other hand, is the method for determining the social impact of these initiatives applied ahead of time? I suppose they are, or at least I hope so.

[Cathy Hawara]

Charities have to abide by a rather specific framework. Before accepting them and registering them as charities in Canada, we are required by law to ensure that they pursue activities for charitable purposes that are recognized by the courts. As you said, we are talking here about advancing education and alleviating poverty.

As far as the impact is concerned, our role as a regulatory agency is not to determine the effectiveness of charities or the results obtained within the framework of their program. That exceeds our mandate and our jurisdiction. Our role is to ensure that the organizations are obeying the rules established under the law, and to help them understand those rules, and give them the tools they need to implement them.

[Sadia Groguhé, NDP, Saint-Lambert, QC]

Okay.

[The Chair, Conservative, Phil McColeman]

Thank you.

Mr. Mayes.

[Colin Mayes, Conservative, Okanagan—Shuswap, BC]

Thank you, Mr. Chair, and thank you to the witnesses for being here today.

It's interesting that today I had a delegation representing national charities in my office talking about our government's initiatives and policies as far as charities are concerned and trying to encourage them and make their job easier to raise funds, and to do their good work, and they did commend the Department of Finance and CRA for the great work you've done together with the group. So thank you for that.

The chair was quite right that politicians are going to look at the value of social finance. You are here to tell us how the framework will work in order to make it happen, and also to be able to regulate it to a certain extent. One of the things that the framework has to do is to talk a little bit about best practices, and the tax framework, and financial policy.

I would like to direct my first question to Mr. Jovanovic.

In business you have two types of income. You have active and passive income, and you're taxed at a different rate for those. Is there any possibility of having something like that for a social initiative even in a small business or a large business where you could look at the social impact and have a different level of taxation so that you wouldn't have, like you say, charities competing against businesses? A business could take advantage of it too if they wanted to hire disabled people and there was a certain way that we could evaluate that social value and it could be reflected on their income and how it's taxed.

I just throw that out there, because for me I'm having some challenge in looking at the value of social finance with regard to maybe replacing some of the services provided by government, and then there's the private sector. I'd like to see an opportunity for the private sector to take advantage of what I call social finance in what they do. This could be as partners. Could you share a little bit on whether or not that would be something that could even entertained?

[Miodrag Jovanovic]

As you can understand, it's a bit difficult for me to discuss the pros and cons of a policy that is not in place. What I can maybe explain to you is how it works, and how it could work now for a charity that wished to also develop some social enterprise and generate some commercial activities and income.

As I said in my remarks, a charity can invest directly in related businesses, in which case then it's simply not taxable. Any income generated would be tax-exempt. If the charity wants to undertake unrelated businesses, as long as it's not a private foundation, it is possible right now for that charity to do so. They simply have to set up a separate entity. It can be a corporation. Once that is set up, and as long as there is a separation between the charity and the charitable activities and the commercial activities that are undertaken by the corporation, as long as there's clear separation, the income generated in the corporation, yes, will be taxed as it is in any corporation. However, there's up to 75% of the income generated there that can be sold back to the charity to support charitable activities. Within that system there's already this flexibility for these charities to be creative and develop their own business activities.

[Colin Mayes, Conservative, Okanagan—Shuswap, BC]

I'll move away from charities. I'll give you an example.

We had a witness here when we first started this study who mentioned that there was a family foundation in Quebec that gives capital out to new businesses that want to start and they discount the interest, their ROI, if there's a percentage of the people who they hire with disabilities. I think that is a great initiative for a small business, or even a large business, that they are going to benefit by having a social conscience and hiring people with disabilities.

Is there any way we could even incorporate that in our finance or the things that we do? That's where I'm going, to that type of thing, because as I say, I just think that in Canada we don't do enough to encourage trying to help people with disabilities and work them into the workforce. I think there could be policy forwarded by the government that would assist businesses and encourage them. I had that experience myself. We had a program. We had a person with Down's syndrome work for us stocking shelves in our grocery store. It made a big difference in how our customers and our employees, as they saw that person working in our store, looked at me as the owner. The program was only for a certain length of time and then it was gone. The manager discontinued it, and everybody was disappointed, including myself. The thing is if there was some sort of initiative so that you go into that program and then you can carry on, I think it would be great and it would be an opportunity for what I call social finance. It's a government acting in a way of social finance to help a business incorporate that.

Maybe you could comment on any of those. Is there any possibility maybe in finance that you could discuss the opportunity that would present?

[The Chair, Conservative, Phil McColeman]

We've really exhausted the time on this round through your comments, Mr. Mayes.

If you want to comment on that perhaps in another round of questioning, you can look at providing some input.

Mr. Cuzner.

[Rodger Cuzner, Liberal, Cape Breton—Canso, NS]

Thanks very much, Mr. Chair.

Thank you to the witnesses for being here today. My question is not going to be for an opinion, but it will be “opinion-ish” I think. Let's go with that one.

[Brad Butt, Conservative, Mississauga—Streetsville, ON]

That has to be a Cape Breton thing.