Mr. Speaker, I am pleased to take part in the debate on Bill C-265.
I would like to first congratulate my colleague from Essex and his wife on the birth of their son. I had the chance to meet them early in our respective careers as parliamentarians at an orientation session, and I wish them both the very best.
Bill C-265 proposes to extend the exemption from tax granted to U.S. social security benefits from 15% to 50%. The government does not support this bill. The 15% exemption that already exists is a concession negotiated in a treaty that already represents some departure from basic tax policy principles. Extending the exemption to 50% would exacerbate the situation.
I believe that it would be helpful for members of the House to have the benefit of some history regarding the taxation of social security benefits as set out in the Canada-U.S. tax treaty and why it is that we have agreed to the 15% exemption.
The history has been complex and the current state of affairs represents the delicate balance between competing interests, a balance which the Conservative member's bill ignores. The Canada-U.S. tax treaty included rules for the taxation of social security benefits paid by one country to residents of the other since 1984. The evolution of these rules has progressed in three distinct phases.
Between 1984 and 1996, the treaty contained a residence-based taxation rule. Only the country of residence was allowed to tax social security benefits. During this time a resident of Canada receiving U.S. social security benefits would only pay tax to Canada. There was however a 50% deduction in computing taxable income in respect of those benefits because at that time the U.S. only taxed a maximum of 50% of U.S. social security payments. This represented a tax advantage over Canadian benefits, which were fully subject to tax.
In addition, U.S. residents receiving Canadian benefits were not subject to Canadian tax and so benefited from the 50% maximum inclusion rate in the United States. One consequence of this was that high income U.S. taxpayers did not pay the tax on old age security benefits, which applies to incomes above a certain level.
This residence-based rule was seen to be unfair. There were calls to change the rules so that all recipients of Canadian benefits were taxed in the same way regardless of residence, and so the rules were changed.
In 1995 Canada and the United States agreed to replace the residence-based rule with a source-based rule. In other words, the new rule would allow only the country from which the payment arose to tax that benefit. The result was that a Canadian resident receiving U.S. social security benefits was taxed only by the United States.
In addition, the maximum inclusion rate under U.S. law had risen over time from 50% to 85%, so a U.S. citizen in receipt of U.S. benefits would be subject to ordinary U.S. rates on a maximum of 85% of that income. If the recipients were Canadian residents, they would either pay U.S. rates or, if they were U.S. citizens, they would be subject to a final withholding tax. This rate was computed as 85% of the standard U.S. withholding rate of 30%. This was a final tax and was non-refundable.
For high income Canadians this tax was usually acceptable since, if they had to pay tax in Canada on this income, their marginal rate of taxation would likely have been higher than 25.5%. However, for low income taxpayers who otherwise rely on the progressive nature of the Canadian tax system to fairly distribute the tax burden, the 25.5% withholding tax constituted excessive taxation and caused, in many cases, severe hardship.
These taxpayers, had they been subject to tax in Canada on this income, would have paid little or no tax. Because they were subject to U.S. taxation, a quarter of their income was lost.
Conversely, U.S. residents receiving Canadian benefits under this rule could choose between the 25% withholding tax or, if they filed a tax return in Canada, graduated income tax at ordinary rates. For low income U.S. taxpayers, this meant they paid little or no tax.
At that time there was a great discrepancy in the taxation of these benefits to the detriment of many low income Canadian seniors. Canada and the U.S. recognized this unfair treatment and we came together again to change the rules.
To relieve hardship on low income Canadians, we agreed to restore residents only taxation. The current rule provides that social security payments are taxed as if they were payments from the home country's benefit plan. A Canadian recipient of U.S. social security is treated as if the payment were from CPP, QPP or OAS.
United States recipients of QPP, CPP or OAS are treated as if they were receiving U.S. social security benefits. This meant that Canadians receiving U.S. benefits could avail themselves of the graduated rates of our tax system and were no longer subject to a flat 25.5% withholding tax. As mentioned, the maximum inclusion rate in the United States had changed from 50% to 85%.
As a concession to the United States, we agreed to the 15% exemption for these benefits to match the maximum inclusion rate in the U.S. However, any rationale for returning to a 50% exemption based on an analogy to the U.S. rules disappeared once these rules were changed. That is the history of the taxation of social security benefits between Canada and the United States. That is pretty exciting too.
As the history reveals, it is a complicated issue. It also shows that any rule will advantage some over others. What is important is to find a rule that makes sense, that is fair, and that avoids imposing hardships on taxpayers who are least able to adapt to such hardships.
We have such a rule. While some higher income taxpayers may complain that they were better off under the previous regime with a U.S. withholding tax, the concerns regarding low income taxpayers were more urgent. Many of these taxpayers were simply not in a position to absorb a high withholding tax.
While a 15% exemption is a departure from the basic principle that individuals in similar circumstances should pay a similar amount of tax, it represents an agreement stemming from a process of careful negotiation. Extending this exemption to 50% would be completely out of line with tax policy and would fail to take into account the history of how the current exemption was reached. I therefore ask hon. members to join me in not supporting this bill.