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Canada needs a principled approach to tax policy

CPA Canada is pushing for a principled approach to taxation in its pre-budget submission. Canada's current approach has resulted in complexity, poor implementation and insufficient consultation

John Oakey, vice-president of taxation at CPA Canada, says the rollout of the increase to the capital gains inclusion rate will go down in history as a good example of an unprincipled approach to tax policy.  

“There was no consultation by the government regarding the proposed changes, only a ten-week implementation period provided with no legislation until the eight-week mark, and a marketing campaign that resulted in confusion and misinformation,” he says.   

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Oakey also cites the bare trust reporting requirement that ended up being cancelled for the 2023 taxation year at almost the last minute. “The government is rightfully trying to find ways to create more transparency in Canada to deal with money laundering and terrorist financing. [But] the utilization of our federal tax system with the broad reporting concept of bare trusts to flush out these bad actors seems questionable,” he adds. 

“Sheer volume of tax policies being introduced is resulting in poorly drafted legislation lacking sufficient guidance to properly implement and administer,” Oakey warns.  

Oakey says the main purpose of Canada’s tax system is to generate revenue to pay for government-funded expenditures. “A secondary, or ancillary purpose, of our tax system is economic stimulus or wealth redistribution by incentivizing certain industries or activities and minimizing income inequality,” he adds. 

He says the Home Buyers’ Plan is a long-standing policy that works well, allowing individuals to take up to a specified amount out of their registered retirement savings plan (RRSP) tax-free and invest it in a qualifying first home and then repay that back to the RRSP over 15 years. 

But, he notes, when the housing crisis arose with demand surpassing supply, the government first chose to introduce the First Home Savings Account (FHSA), a brand new tax policy accompanied by new legislation and administration before eventually amending their already well-established Home Buyers’ Plan (HBP). “The introduction of the FHSA when a small tweak to the HBP would likely have accomplished the same objective is a good example of an unprincipled approach to tax policy,” says Oakey. 

Ryan Minor, director of tax for CPA Canada, says a tax system should ideally be fair, simple, transparent and predictable. It should also be neutral, avoiding distortion of economic decision-making unless there is a clear policy rationale for doing so.  

Minor notes there are some strong features of the Canadian tax system. It is, he says, grounded to a significant extent on the idea of integration, such that if a taxpayer is unincorporated, they should pay approximately the same tax as if they had run the same income through a corporation and distributed it.  

However, over time, income tax legislation has expanded in volume and complexity and has strayed away from the ideals of a principled tax system. Complexity is related to the number of rules that taxpayers and their advisors need to consider, the clarity of those rules and the frequency with which those rules are changed, says Minor.  

For example, individuals now have two capital gains inclusion rates. High-income individuals must consider not only the normal income tax rules but also an alternative minimum tax with its own set of rules. Shareholders of private corporations need to consider the ‘tax on split income’ (TOSI) rules to determine whether a dividend received is subject to tax normally or at the highest rate. Canadian-controlled private corporations (CCPCs) need to consider a suite of rules to calculate their small business deduction, he explains.  

As complexity rises, so do compliance costs for individuals and businesses. Compliance costs make it especially difficult for low-income and vulnerable Canadians to access any benefits that rely on information from tax returns or are delivered through the tax system, says Minor. 

CPA Canada has long been advocating for a comprehensive tax system review in Canada, says Minor, who notes that comprehensive tax review offers the chance to examine the extent to which the tax system causes unproductive behaviour and to confront and reassess entrenched policies and exemptions that have long been considered untouchable.  

For example, the tax system has provided tax incentives for CCPCs for many years, including small business deductions and enhanced investment tax credits for conducting scientific research and experimental development. But do these tax incentives discourage firms from scaling up to become more productive larger firms? Another example is the lifetime capital gains exemption. Does the lifetime capital gains exemption encourage economically productive behaviour? asks Minor.  

A principled approach to tax policy can benefit from an ongoing dialogue with organizations like CPA Canada. 

“We are a part of the tax system. Finance makes the rules, CRA administers them, and we help taxpayers comply with the system,” explains Minor, adding that CPA Canada hosts numerous committees that study the impact of proposed legislation and how it is administered.  

Oakey notes that CPA Canada has good communication with the Canada Revenue Agency to help ensure legislation is being implemented properly with the best possible guidance provided. He points out that this has been an increasing challenge with the volume of legislation over the last several years.  

Although CPA Canada is well respected by Department of Finance officials, better communication is required at the political stage to help ensure a principled approach to tax policy, he adds.