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Hon. Douglas D. Peters' Submission in Response to Finance Canada's Tax and Other Issues Related to Publicly Listed Flow-Through Entities (Income Trusts and Limited Partnerships) consultation:
Comments on Department of Finance Consultation Paper
Tax and Other Issues Related to Publicly Listed Flow-Through Entities
The September 2005 Consultation Paper raises serious public policy questions and allows public written submissions to be sent to the Department of Finance by December 31, 2005. The following is my submission related to that paper.
In this brief there are three important issues to be addressed. These are:
1. Whether the corporate and personal income tax systems should be fully integrated and whether or not the flow-through entities are the best method or even an adequate method of doing so.
2. How best to tax the income that non-residents receive on their investments that earn income in Canada.
3. If flow-through entities are to be allowed, then the loss of tax revenues to Canada and the provinces must be made up from other sources, such as the personal income tax or excise taxes, such as the GST. It is incumbent on anyone favouring the continuance of the tax exemption of flow-through entities to indicate from where the revenue loss is to be recovered.
The question of integrating the corporate and personal income tax schemes was addressed in full by the Carter Royal Commission on Taxation. Although full integration was recommended by the Royal Commission for Canadians, the business community and particularly the accounting profession lobbied strongly against it. In the end, Finance Minister Benson put forth a system of partial integration, which we still have today.
If a system of full integration of corporate and personal income tax systems were wanted then two factors need to be recognized. The first is that integration (by which I mean, like the Royal Commission, that corporate income should be taxed only in the hands of the shareholder and not additionally taxed in the corporate entity) should not be set up through a system that recognizes only some corporations, such as a system using flow-through entities. Integration should be done only for Canadian tax payers. Flow-through entities are not a efficient system to set up full integration as they favour mature corporate income. As your paper points out growing companies would find the corporate structure more favourable than a flow-through entity structure.
Even financial institutions, such as the large banks have taken steps and talked about setting themselves up as such flow-through entities. Report on Business columnist, Eric Reguly has quite rightly argued that such flow-through entities are not appropriate for the chartered banks as they would reduce the bank's retention of earnings, thus making the banking system less safe. But if such flow-through entities are to be allowed, how can certain corporations be precluded from using them to increase the return to their shareholders? The whole question needs a careful examination.
The second question flows from this first. The corporate tax in Canada has always, as its partial justification, been to enable Canada and the provinces to tax the income earned by foreigners on investments in Canada. This is both necessary and desirable because the level of foreign investment in Canada is very large and Canada's withholding tax is quite small. It is also noted from your paper that the holdings of flow-through entities by foreigners is very large. This means that foreign owners of flow-through entities pay very little if any Canadian tax even though their income comes from Canadian investments.
The third question is clearly one that would have to be addressed by anyone advocating the continuing use of tax-exempt flow-through entities. The use of flow-through entities has clear implications for the distribution of the tax burden. The flow-through entity gives a major tax cut to high-income individuals. It is the upper-income individuals that both own shares outright as well as own them through RRSP's and defined-contribution pension plans. In addition the use of flow-through entities by defined-benefit pension plans reduces the contribution to such plans by their sponsoring companies. That increases profits which benefit shareholders, mainly the wealthy. Thus, for almost all reasons the flow-through entities benefit the wealthy tax payer. And therefore the use of flow-through entities shifts the tax burden from the wealthy to all tax payers.
Considering all the above questions it would be my recommendation that the fairest way for the Government to proceed would be to apply the corporate income tax regime to all flow-through entities. This would ensure that foreigners would pay some tax on their earnings in Canada. If a system of full integration, as recommended by the Carter Royal Commission, were to be implemented then it should be done only for Canadian tax payers and done for all corporate income subject to the corporate income tax regime. As this brief recommends that income from flow-through entities be taxed as corporate income then the question of replacing the loss of tax revenue does not need to be addressed. But it should be stressed that anyone recommending that flow-through entities be not taxed then they must also address the question of from where the additional tax revenues will come.
Hon. Douglas D. Peters PhD