I call this meeting to order. Pursuant to Standing Order 108(2), today's meeting is on the subject matter of Bill , a second act to implement certain provisions of the budget tabled in Parliament on March 22, 2017, and other measures.
We have quite a number of sections to go through. Hopefully, we'll get through them today. We'll have witnesses from various departments and areas within Finance Canada to explain the measures that are in parts 1, 2, 3, 4, and 5, and the divisions in the bill.
We'll start with part 1, amendments to the Income Tax Act and to related legislation. We have with us Trevor McGowan, who's the senior legislative chief, tax legislation division, tax policy branch. Also from the tax policy branch, we have the director of personal income tax division, Mr. Leblanc and the senior tax policy officer, Mr. Freda.
The floor is yours. You'll have an opening statement and then we'll go to questions.
I'm going to provide a brief overview of the items in part 1 of the bill, each of which relates to proposed income tax amendments.
Part 1 includes a number of amendments that were announced as part of the 2017 federal budget. These include removing the classification as Canadian exploration expenses of costs incurred in respect of a drilling well. They would instead, unless they're proven to be unsuccessful, be classified as Canadian development expenses. If unsuccessful, they would continue to be Canadian exploration expenses.
They would eliminate, for qualifying small oil and gas companies, the ability to re-characterize up to $1 million of expenses, which would otherwise qualify as Canadian development expenses, as Canadian exploration expenses. The difference being that Canadian development expenses are deductible at a rate of 30% per year, whereas Canadian exploration expenses are fully deductible in the year incurred.
They would revise the anti-avoidance rules for registered education savings plans and registered disability savings plans, aligning them with the current rules that apply in respect of registered retirement savings plans, registered retirement income funds, and tax-free savings accounts.
They would eliminate the ability of designated professionals to use the billed-basis accounting system. They would instead be required to use the general rules applicable to other taxpayers in the Income Tax Act for their tax accounting purposes.
They provide enhanced tax treatment in respect of eligible geothermal energy equipment. The enhanced treatment consists of accelerated capital cost allowance rates at 50% in class 43.2, as well as the ability to classify certain expenses in respect of qualifying geothermal projects as Canadian renewable conservation expenses, which can be deducted in the year incurred, or transferred to investors in flow-through shares.
It would extend the currently existing base for erosion rules that apply to foreign affiliates of Canadian taxpayers, and prevent them from inappropriately shifting income in respect of the insurance of Canadian risks offshore to a foreign affiliate. It would extend those rules to foreign branches of Canadian life insurers, which, for many purposes of the tax system, are treated in a manner similar to foreign affiliates of a Canadian corporation, including their, in very general terms, exemption from Canadian tax on their active business income.
It would clarify who has factual or de facto control of a corporation for Canadian tax purposes. This is intended to return the state of the law to what it was before a recent court decision, and requires that all relevant factors are to be taken into consideration in determining whether a person has factual control of the corporation.
It introduces an election that would allow taxpayers who hold eligible derivatives as income properties to be able to treat them as market-to-market properties, which would allow changes in the value of the derivatives to be realized for tax purposes on an annual basis. Otherwise, the default rule would be taxation on the realization basis.
It would introduce a specific anti-avoidance rule in respect of so-called straddle transactions. These are transactions that use somewhat complex derivative instruments, offsetting derivative instruments to achieve an inappropriate deferral of taxation from one year to the next.
It would allow mutual fund corporations, that are organized as switch corporations, but would now be more appropriately called multi-class mutual fund corporations, where each class of share of a corporation is a separate investment fund. It would allow them to effectively, on a tax-deferred basis, merge or split up into a number of mutual fund trusts. Each of those mutual fund trusts would constitute its own investment fund.
It would also improve the tax treatment of segregated funds. These are insurance products that in many ways, including through their tax treatment, are intended to be similar to ordinary investment funds. There are some minor differences. This bill would extend the ability for segregated funds to merge on a tax-deferred basis and as such achieve economies of scale. It also would allow the carry-forward of non-capital losses from one year to the next. Both of those can currently be achieved by an ordinary mutual fund operating through a trust. That would be extended to segregated funds of insurance companies.
On the measures announced in the budget, finally, there are enhancements to the protections afforded to gifts of ecologically sensitive land. It also implements a number of other income tax measures in part 1 by closing loopholes surrounding capital gains exemptions on the sale of a principal residence. These were released for public consultation in October 2016, and were mentioned as previously announced measures in the budget text in “Tax Measures: Supplementary Information”.
It extends a measure, announced as part of budget 2017, to provide additional authority for nurse practitioners—for many Canadians, they are the primary point of contact in the medical system—so that nurse practitioners can certify things for a number of purposes beyond the disability tax credit, which was announced in budget 2016.
It would also, following on a measure from budget 2016, provide that sales by farmers and fishers of their farming products and fishing catches to qualifying co-operatives would be exempted from the measures announced as part of budget 2016 that would prohibit the multiplication of the small business deduction, allowing each such farmer or fisher to have full access to the small business deduction.
It would also introduce a number of proposed technical amendments that were released for public consultation in September of 2016 and were also mentioned in “Tax Measures: Supplementary Information”, which accompanied the budget. These include measures that would extend the types of reverse takeover transactions to which the corporate acquisition of control rules apply and make a number of tweaks and improvements to the scientific research and experimental development rules. It would provide rules for the allocation of income for federal credit unions between provinces and territories that completely mirror the rules that currently apply to banks. It would make a number of changes to improve the operation of Canada's international tax rules.
Finally, it contains a number of measures that are technical in nature to improve the accuracy and consistency of the income tax legislation and regulations. These are technical amendments that are announced for consultation and included in bills from time to time to ensure the proper ongoing operation of the income tax system.
That's a summary of the measures in part 1 of the bill.
As I said in the introduction, the elimination of the election to use billed-basis accounting would essentially align the tax treatment of the designated professionals—these are, as you mentioned, lawyers but also accountants, dentists, medical doctors, veterinarians, and chiropractors—to the rules that are generally followed by most businesses and taxpayers.
I would categorize those two separately. For pro bono work that's not intended to be billed....
I guess I should explain the general rules. You can value inventory at the end of the year either at its fair market value or on an item-of-inventory by item-of-inventory basis at the lower of cost or fair market value. That's the choice that's available to taxpayers generally, and that's the default set of rules that is considered to provide the truest picture of a taxpayer's income. Pro bono work that is not intended to be billed would have a fair market value of essentially nil because there is no intention to bill for it and there is not going to be a recovery on that time, so it would be valued at nil for tax purposes.
For contingency fees, the taxation is a little bit more complicated. There is case law and Canada Revenue Agency administrative guidance to the effect that, even in the absence of section 34, which provides the election for billed-basis accounting, certain contingency fees where your return on your time is not guaranteed.... A classic example might be that whether or not you're going to get paid at the end of the day is determined by whether or not you win a court case or by how much of an award is given for it, and there's real uncertainty as to whether or not that will be received. There is case law to the effect in those situations.
There is no ascertainable fair market value to the work in progress, so it would not be taken into account for tax purposes. Otherwise, you have for contingency fees the requirement to come up with a reasonable estimate of what the fair market value is. You can tell what you think the value is. Again, if there is a complete contingency fee and you just have no idea, perhaps it's not taxable because it's too uncertain. If it is sufficiently certain, then you can arrive at a reasonable fair market value, and that can take into account anticipated writedowns, end fees, and time that you don't think you're going to bill and so on. If after the end of the year you decide that you were wrong, you can do a writedown of that value for tax purposes.
Lastly—you didn't ask this—the next step is if you have bad or doubtful debts. There are reserves for those as well, so you're not immediately taxed on them.
Yes, of course. I would be happy to. I think it would be a good idea to provide a brief overview of the 2016 proposals.
We have a small business deduction that allows qualifying small businesses, on up to $500,000 of their active business income, to get a small business deduction, but it's commonly thought of as just a low rate of tax. It's currently at 10.5% and, as recently announced, is to be reduced down to 9%. In October, that was announced.
The general policy for the small business deduction is that you get one small business limit of $500,000 per business. The tax planning that had arisen for a partnership in a classic case would have one business where each of the partners—let's say there are 10 partners—would normally have to share that business limit, so instead, each of the partners would incorporate a side company that would provide that partner's services to the partnership, thus multiplying access to the small business deduction by the number of partners. With the 10 in my example, that brings it up from $500,000 to essentially $5 million.
The budget 2016 measure constrained that to provide that when there's one business, there's only going to be one business limit. That didn't just apply to partnerships. It also applied to central corporation structures, which could, in the corporate context, achieve the same multiplication results as you could have gotten in a partnership.
As part of our continuing consultation with stakeholders, we heard from a number of farmers and fishers who had dealings with co-operative organizations, and really, for co-operatives, they have membership interests in a co-operative that are for many purposes, including for the purposes of the small business deduction in the tax system. They're treated like shares, but they're not fundamentally the same as shares. They're different enough to be outside of the policy against the multiplication of the small business deduction.
For example, they often have one vote per member regardless of the number of shares, whereas if you're a shareholder and you're voting, that can allow you to elect members of the board of directors, for example, proportionate to the number of shares you have. Likewise, with a normal company, with the shareholdings representing more of an economic investment, you're looking to participate in the profits of the corporation, and your participation in the profits is going to be determined by your shareholdings.
With membership interests in a co-operative, it's a different system. In these cases where you have farmers or fishers selling their farm products or fishing catches to a co-operative, that would be called I think “specified co-operative income” and excluded from the rules that prevent multiplication of the small business deduction.
Okay. I'm going to take forward that, if they had formed a co-operative instead of a shared practice, then, in the same vein, they should receive equal treatment, because I hear that we're all about tax fairness in Canada, right?
We had a whole bunch of people last year who were hit on average, I think, $40,000. There were some, obviously, hit much harder than others and many of them faced a tax bill. To me, this seems to be completely contrary to what we heard last year.
Anyway, I'd like to go back to the elimination of the use of billed-basis accounting by designated professionals.
First of all, I have a quick question. In the summary of the bill, you list it in paragraph (d), yet it's the first provision in the bill. That doesn't seem to coincide. Maybe next year that might be a thing to consider to make it easy for members of Parliament to walk through the summary.
Now, in the proposed act here, it's called “work in progress” versus being called “billed-basis accounting” in the summary. Are they the same thing?
Okay. But you see how, when you say one thing in the summary and then another thing in the actual act, it can be a little bit confusing to the average person. Consistency is key, just so we're all on the same page.
When it comes to low-income individuals, say they end up in a car accident, and ICBC in my province says, “We're not going to pay you for things”. It happens all the time. Someone goes to a lawyer, and the lawyer says, “I'll represent you. It's not going to be free, but if we have a winning case, I'll get a percentage, a contingency”.
How does that work in that case? Would they be paying tax, about 20% per year, on something that may never result in money coming in the door?
In the abstract, you can elect to choose a fair market value or the lower of cost or market method for valuing inventory.
Where you have a lawyer who's incurred expenses, costs in order to earn their revenue, the lawyer can measure that file under work in progress, in respect to that file, at the lower of its cost and fair market value. I believe in your example it was $10,000 of work in progress at the end of the year. Let's say they have $10,000 of work in progress at the end of the year, and they have incurred $6,000 of costs, for example, to pay an associate on the file or whatever is properly allocable to it. They would value, for tax purposes, at the lower of their costs and fair market value, so the costs, which would be generally deductible, would offset the income from the work in progress. But that's just in an abstract case.
I recognize you'll have more than one file in a practice, which brings us to the second point, which is that it essentially represents a deferral. Think of it in the simplest case, where you perform services in one year and then bill in the next. Let's say, to make the example simple, you have just that one item worth $10,000. Under the billed-basis system, where you get it included in your inventory when you send out the bill, you could add the costs in the first year but then you'd have an income inclusion in the second year, where the first year's income was deferred to. You will pick that up in the second year.
In that year, if you take on another file with a contingent amount to be paid after the end of the year, so you bill at the end of the year. Let's say that's of comparable size of $10,000, then you wouldn't bill for that in the current year, your second year, you would bill it in the third year. If you look at the tax results in the second year, you have $10,000 that has been deferred from the previous year, and then $10,000 deferred into the next year. You can see that you end up in roughly the same place as if you had, at least in respect of that year, been taxed on an accrual basis.
If you're deferring income from year to year every year, and certainly taken across the industry, it's primarily a deferral benefit where one inclusion from a previous year would ordinarily tend to offset, to varying degrees, income deferred to a following year. You have that averaging out as well that mitigates the impact of the change.
To summarize and answer your question, first, if you have a real contingency, perhaps it's not included under the case law and general rules. Second, if it is going to be subject on an accrual basis, there's the option to use the lower of cost or market method. Third, if you have a number of files, where some are billed and some aren't, over time you would expect the other deferrals to even out.
Again, there are so many circumstances. For example, you take someone's case and it's an elderly person who has been struck by a car and can't afford to pay you. You go to try to get them some money. In a year or two down the line when their court case finally comes up, they die. It may be natural causes or maybe it's because of ill health. What does the lawyer do in those kinds of cases? Where they have paid taxes, do they get to apply for it back?
It's lost time, which, by the way, to a professional is very expensive.
What I think may end up happening is that many lawyers might say, particularly in more rural areas, they just don't take cases anymore on contingency, because they don't have the client base to subsidize them, to subsidize these extra taxes.
I'm very concerned, Mr. Chair, that this is going to have serious impacts.
I'm not making this up. First of all, I did work in a law office for about a year and a half. I got to know clients, and I got to know how things don't work out the way that we try to arrange life. Life is very messy. The second thing, though, is that I've actually been contacted by people in B.C., members of the bar, who say exactly that. The big firms in the big cities will subsidize these cases because they know that every one out of 10 may win big, but for the smaller firms in the rural areas, people will not be able to access justice.
I really am disappointed with this provision.
I have other things I'd like to talk about, but we'll go to someone else.
Thank you to the witnesses for being with us today and providing us with these explanations.
I always say that, in Canada, ignorance of the law is no excuse. All Canadians are expected to understand the Income Tax Act so that they can respect it. For that reason, I think that, with each opportunity, we should strive to simplify it, rather than make it more complicated.
That said, I am mainly interested in clause 16. I'm referring essentially to the department's explanatory notes. The provision deals with pension income splitting and makes changes to the retirement income security benefit payable under the Canadian Forces Members and Veterans Re-establishment and Compensation Act.
Could you explain the changes in greater detail? If I understand correctly, the provisions limit the ability to split income. Is that correct?
Then in regard to these changes as well, I guess there have been concerns or suggestions that, for example, when a charity is established for a sole purpose.... I know, at least in my area, that there are a few in terms of conservation groups that become stewards of various lands. Sometimes in doing so, there are costs associated with, let's say, the survey of the land or some of the acquisitions from it that the charity would pay. It's not coming from the estate, but then there are treatments of that funding, and it's not included in part of the gift.
Is there anything that deals with some of the costs associated with that transfer, that gift of the asset, or is this not part...?
Mr. McGowan, I want to go back to the discussion you were having about billed-basis accounting.
I share some of the concern about how you're going to track what was in a previous year, and not necessarily with respect to pro bono, as Mr. Sorbara talked about, but more about those cases where the deal, so to speak, with the lawyers, is how it gets paid out afterwards. I'm not as concerned about the expenses, because I think that everybody, by default, is going to expense the costs as they're incurred in that year.
How do you know that you can accurately capture that after the fact? You don't know how much time you're going to put into a particular case. It might go on for several years. Are you suggesting that the individual amount of time billed should be captured in each year and then reconciled later on?
I'm just trying to wrap my head around that. I was trying to listen to the kind of weird explanation, and I didn't quite get it.
I think that if you know that there won't be a premium billing and your recovery rate's at 100%, then that's probably what you would do to determine the fair market value of it, although there are other considerations.
However, that's not the situation you were talking about. You were talking about when you bill 100 hours, and maybe your recovery is higher than your normal billing rate—or lower, depending on the outcome of a case—or perhaps it's contingent, in the sense that you know that you'll bill x dollars per hour for the case, but there's some uncertainty about whether you'll be able to collect at the end of the day or will just take a writeoff. That's where you have to make a determination at the end of the year, based upon the facts, of the worth or the fair market value of the work you've done to that point.
It's difficult to put exact numbers on it, but let's say you have $10,000 of work in progress. You make a reasonable determination that you'll probably collect 80% of it, so then it would be worth $8,000. That's where the ability to come up with a fair value comes in. As I said earlier, if it is truly uncertain, if you just don't know whether or not you're going to win it or whether or not you're going to get paid, there is case law supporting the notion that you don't have to include anything.
Third, there is the ability to pick the lower of cost or fair market value, a method for inventory where you have that kind of file. Let's say you know that your costs are $6,000. You think your costs might be $10,000, or they might be up to $14,000, or they might be as low as zero. If you reasonably think that it probably will be $10,000, you can pick the lower of cost or fair market value to take the $6,000 of cost. So you're insulated from that, to some degree.
I understand the symmetry one might want as a tax official, but again, the reality and the practicality is maybe something less than that.
Finally, I share the general concern expressed by Mr. Gerretsen and Mr. Albas concerning the billed-basis accounting. Having practised law for 22 years, I would look at this as just a major headache, an absolute delight for my accountant, and a conflict for my partners, because one partner would probably do the work-in-progress stuff, and the rest of us would be doing cash or something very similar, where the bill and the activity were closely linked.
What I don't get, since this is one great deferral that started out as a two-year deferral, and now a five-year deferral—a deferral isn't quite right, a phase-in. I don't see the public policy gain in this activity. Initially, when you started, you essentially moved a whole bunch of work in progress into income, and you whacked the tax. Now you've pushed that out over five years. I don't see the revenue gains to the government now that you've effectively moved from two years to five.
To clarify, there are two measures. When you said “exploration” in a general sense, I then went with the idea that you were talking about the discovery well measure.
There is another measure with regard to reclassification of Canadian development expenses for flow-through share investors. That's a different measure altogether, the one that's for smaller companies. In the normal context, that measure is for a development expense; therefore, it would normally be deductible at only 30% for that company, on a declining-balance basis. That company, on those particular measures, can essentially reclassify that. We would know it's a development expense, normally deductible at only 30%, but we would let them reclassify it as an exploration expense—which, in any other context, would not be considered an exploration expense—and allow it to be deducted at 100%, but it's not actually the company, in that case, that's deducting it at 100%.
Thank you to the witnesses for being here today.
My question is about clause 30. This won't be the first time you'll hear me bring this up: retroactive measures. In this case, the retroactive period goes back to October 24, 2001. It always worries me when retroactive amendments are made to the Income Tax Act.
Would you explain the change being proposed in clause 30, in relation to trusts and foreign affiliates? I'm trying to understand the reason, or rationale, for the amendment coming into effect retroactively on October 24, 2001, in other words, 16 years ago.
One of the fundamental aspects of the general tax rules and tax systems—this comes from Supreme Court decisions in IKEA and Canderel—is that tax rules ought to provide taxation on the truest picture of your income. To that end, the basic scheme of the act, currently, for a large majority of taxpayers, requires accrual accounting, which means that in any year, you pay tax on the amount that you earn in that year.
Back in the 1980s, as I said, there was a general shift in the tax rules, away from what we call billed-basis accounting, whereby you include something in income when you send out the bill, to this more comprehensive, truer picture of income, the accrual system. Exclusions were made back then for certain designated professionals. Of course, lawyers are on the list, but there were also doctors, chiropractors, I think maybe veterinarians, and others.
However, the reasons for excluding them from the general rule that provides the truest picture of income no longer exist right now. Therefore, as part of the tax expenditure review, it was determined to be inappropriate to provide for continued access to this tax deferral, rather than applying the general rules that apply to other taxpayers. This could include other professionals, such as engineering firms and the like, It's instead of having two sets of rules, with a favoured category and then the general one.
Thank you, gentlemen, for spending an hour and 20 minutes with us, or longer than that. It was an hour and 50 minutes.
We'll call up the witnesses on part 2 and see if we can at least get the summary done. Maybe we can get it all done.
Thank you, Mr. McGowan and Mr. Freda. It was quality time.
Now we are looking at part 2 in terms of amendments to the Excise Tax Act and to related legislation, the GST and HST measures.
With us are Mr. Mercille, who is the senior legislative chief, sales tax division, Finance Canada, and Mr. Achadinha—I might not have pronounced that correctly—who is the legislative chief, sales tax division, tax policy branch.
Welcome. The floor is yours. Thank you for your endurance.
Part 2 of the bill makes changes to the GST and HST. The amendments appear in clauses 106 to 164.
I'm going to describe the measures in the order they appear in the summary, with only one exception, given that two of the measures are more closely linked.
I want first to say that all the amendments in part 2 of the bill are technical in nature and generally correct small deficiencies to ensure that the rule applies as intended. All of the measures in part 2 of the bill, except the PSB rebate measure, were released for consultation for the first time in the summer of 2016. These measures have also been confirmed in budget 2017, and they were re-released for consultation in the summer of 2017 with a small number of improvements. No request for amendment was received from stakeholders during the second consultation.
The first measure makes technical amendments to the GST/HST pension plan rules. Existing GST/HST rules ensure that pension plans receive the same GST/HST treatment whether pension expenses are incurred by an employer participating in a pension plan or directly by a pension trust or a pension entity of the pension plan.
These rules also generally provide a 33% GST rebate to pension trusts and pension corporations in respect of their expenses and their expenses that are deemed to have been incurred. These rules are fairly sophisticated and came into force relatively recently, in 2009. Certain small deficiencies and mistakes had been identified over the years by stakeholders and internally by the government. The proposed measure makes technical amendments to these GST/HST rules to clarify certain points, correct technical deficiencies or errors, and simplify compliance.
The second measure I'm going to talk about deals with GST/HST treatment of master trusts and master corporations. What master trusts and master corporations do is hold and invest funds of individual pension plans, and planned pension plan corporations too. They do that in order to diversify the risk and reduce the costs. These amendments ensure that the same GST/HST treatments apply to pension plans and related expenses whether the funds of the pension plan are invested directly in a trust or a corporation of a single pension plan, or whether the money is being invested in a master corporation or a master trust.
The third measure that I'm going to talk about, and it's part of the first item in the summary, is a measure to make technical amendments to the GST/HST rule for financial institutions.
Financial institutions are subject to special GST/HST rules, and this is due to the complexity of the financial service industry. Because financial services are exempt under the GST/HST, financial institutions are generally not allowed to recover, through input tax credit, the tax they pay on expenses they incur to provide those financial services. This is contrary to general commercial activity businesses, where they charge tax on their output but they claim an input tax credit on their inputs.
These rules are fairly sophisticated in certain cases, and technical anomalies are identified from time to time. The measure here makes technical amendments to these rules to clarify certain points and reflect amendments to the Income Tax Act. Concepts of the Income Tax Act are referred to in the Excise Tax Act, and sometimes there's a modification in the Income Tax Act and the Excise Tax Act has to catch up. Also, there are rules to simplify compliance.
The fourth measure, which is the third item on the summary, makes a technical amendment to the GST/HST drop shipment rules. The drop shipment rules help Canadian businesses that sell to non-residents by ensuring that non-resident businesses do not incur unrecoverable GST/HST when they acquire goods in Canada.
The amendments that are made to those rules provide a new tax relief mechanism, and this is in a situation where an existing tax relief mechanism was not functioning for technical reasons. The amendments also extend the application of the drop shipment rules in respect of certain leased goods and generally make technical improvements to those rules.
The next measure relates to municipal transit. Municipal transit services are exempt under the GST/HST. This measure clarifies that the GST/HST exemption for municipal transit service also applies to supply of tickets, passes, and other similar rights entitling individuals to receive municipal transit services. The amendment is proposed to reflect the modern way in which transit services are supplied and paid for, which can often be better characterized as supplies of rights as opposed to supply of service.
In practice, these amendments do not change anything, because they simply codify the ways the CRA has been interpreting relief over the years.
The next amendment would improve the manner in which public service bodies can claim public service body rebates. For the purpose of the GST/HST, public service bodies are entities such as municipalities, schools, public colleges, public hospitals, charities, and substantially government-funded non-profit organizations.
The amendment would provide these public service bodies with an improved flexibility in claiming their rebate of the GST/HST. It would generally allow public service bodies to claim, in a subsequent claim period, a rebate of GST/HST that has been paid in a previous claim period, for a period of up to two years. This is a simplification measure, because it's less burdensome to claim in a subsequent period a rebate that you may have forgotten in a previous period than it is to use the current process, which is to make an amended rebate claim.
The last measure in part 2 is a housekeeping amendment to make the legislative provisions governing GST and HST more precise and consistent. The measure does not amend the application of the GST or HST. Essentially, it is meant to make the English and French versions of the act consistent, update references to certain tax-related terms, make changes related to bijuralism, and correct errors, references and other items of that nature.
That concludes my explanation of the measures in part 2 of the bill.