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A better way of designing new tax legislation

As the government gradually transitions towards a more forward-looking agenda, now is a good time to examine tax legislative processes and consider better practices for managing tax change.

The pandemic demanded swift action by the federal government to speed up regular processes for making laws so it could deliver the financial supports that Canadians and businesses urgently needed.

As these immediate needs subside, the government will set its sights on its wider objectives. This includes implementing the host of measures related to tax set out in the Deputy Prime Minister and Minister of Finance’s mandate letter.

At this point, we think the government should do more than return to legislation-as-usual. Rather, we believe that the government should consider adopting better practices for managing legislative change when it comes to tax. Taking a look at the approach now in place in the United Kingdom would be a good place to start.

In this blog, we discuss:

  • the U.K.’s Tax Consultation Framework
  • how to get tax change right from the start
  • getting stakeholder feedback from start to finish
  • post-implementation reviews
  • GST/HST on digital supplies: Lessons learned

Of course, designing and adopting a new approach to tax policy development would bring some costs and potential disruption, and possibly impede the government’s progress in the short term. But in the long run, Canada’s tax system stands to benefit from a more consultative, systematic framework for developing and implementing new tax legislation.

The U.K.’s Tax Consultation Framework

The U.K.’s Tax Consultation Framework, introduced in 2011, identifies five stages to be followed when developing and implementing tax policy:

  • Stage 1: Set objectives and identify options
  • Stage 2: Determine the best option and develop a framework for implementation, including detailed policy design
  • Stage 3: Draft legislation to effect the proposed change
  • Stage 4: Implement and monitor the change
  • Stage 5: Review and evaluate the change

Broad consultation is central to this process. The framework says: “The best public engagement allows the Government to explore, develop and test new ideas to improve the tax system, and to ensure that change is well targeted and its likely impacts are understood. Better scrutiny of tax legislation, through early exposure of drafts, will help ensure that legislation is fit for purpose.”

As we discuss below, the key is to identify when consultation will be helpful and how feedback should be obtained. However, we believe three questions should be carefully considered with each potential change:

  1. Is the tax change in fact needed, and if so, is the change designed to meet the objective as simply, clearly and efficiently as possible?
  2. Has sufficient consultation occurred with the right stakeholders to identify potential issues?
  3. Have implementation issues been considered to ensure the outcomes expected in theory would be effectively achieved?

How to get the tax change right from the start

Before any tax policy initiative goes forward, it should be subject to a systematic review to ensure it is the best alternative for achieving its policy objective at an acceptable cost. The volume of tax changes that now or soon will be on the drawing board is tremendous, and we have concerns about whether they will undergo adequate analysis to determine if they will be clear, efficient and effective in meeting key goals while not overly complicating the tax system.

As we explain in our recent tax brief, the federal government bears the same public accountability for government funds spent through the tax system as it does for money it spends directly. As the Auditor General of Canada has recommended, tax expenditures should be subject to the same systematic evaluations that are required for direct program spending.

We believe governments are more likely to get tax change right from the start by ensuring a number of verification and design issues are addressed. Some of these issues are discussed below.

Define the goal and explore the alternatives

A first step in getting tax change right is to clearly define the policy goal to be met. For example, perhaps the aim is to increase the use of cleaner processes and equipment that will reduce pollution and other adverse impacts on the environment.

With this goal in mind, the next step is to ask whether a tax initiative or incentive is the best way to achieve the desired result. Historically, policy makers in Canada seem to have had a bias toward using the tax system rather than other means, such as direct spending, grants or subsidies.

Analyze the design options, including practical issues

If a tax change is determined to be the best route, all of the available design options should be comprehensively analyzed — from both conceptual and practical standpoints — to identify the option that holds the best chance of success. No matter how theoretically sound an idea may be, it has a scant chance of success if it would be hard to implement in practice.

Balance effectiveness and complexity

Part of the analysis should ensure the change is made in a way that balances effectiveness and complexity. Sometimes, a new tax rule may be designed to discourage certain behaviours in general or to stop taxpayers from taking undue advantage of a broader, beneficial tax change. These cases often involve a trade-off – if everything under the sun is done to bullet-proof a rule’s integrity, then the rule may become so complex that taxpayers would find it hard to understand and apply. This could discourage them from complying with the rule or cause them to apply it incorrectly, making the rule ineffective.

Watch for collateral damage

When rules are too broadly worded, they may catch some taxpayers or factual situations unintentionally. Tax policy makers should be especially alert to this sort of collateral damage, for example, when setting rules that prevent certain outcomes or increase reporting requirements.

Tax administrations can also bear unexpected impacts from the scope of tax rules. For example, with every bit of complexity that a new rule adds to the tax system, the goal of streamlining and automating tax return filing for vulnerable Canadians gets further out of reach.

Guard against windfalls and ineffectual measures

When designing tax incentives to encourage certain types of behaviours or investments, the government needs to guard against taxpayer windfalls — that is, taxpayers should not gain tax savings for doing things that they would have done anyway.

Similarly, tax incentives should only be introduced when it can be shown they would in fact promote the desired taxpayer actions.

Balancing complexity against revenues

A further consideration is whether the amount of complexity that a tax change would add for taxpayers and the tax administration makes sense in view of the amount of projected revenues it would raise. For example, ignoring non-technical considerations, the government’s proposed luxury tax and tax on underused property will add complexity to the tax system . However, the amount of revenue they would bring is nominal compared to other federal taxes levied by the federal government. This draws their introduction into question.

Getting stakeholder feedback from start to finish

As we noted earlier, the U.K. Tax Policy Framework highlights the benefits of consultation at various stages of tax policy development, with attention to the timing of the rounds of consultation and the form of input requested.

In Canada, proposed tax legislation is usually released for a set period of consultation. This approach has benefits, and combining this with earlier consultation, such as at the conceptual stage, would be even better. Once the path has been picked and the draft legislation written and published, it may be too late to discuss the other options at hand for achieving the same ends.

For example, the February 4, 2022 draft legislation on trust reporting extends the requirements to bare trust arrangements. Under this proposal, a T3 return will have to be filed where one party holds legal title for another beneficial owner who treats the property as their own for tax purposes. This seems like an inefficient way for the government to get more information on beneficial ownership, and we believe there are better ways to obtain it. Had stakeholders been consulted earlier, other options to achieve the government’s objectives could have been raised for consideration.

In our experience, broader tax changes become more difficult to reshape after the legislation has been released because of the amount of work that has already been done. That’s why consultation at the concept stage is important. If nothing else, the government can point to the feedback to show that people outside the government were consulted with and understood the path that was chosen.

After the concept stage, further consultation to gain feedback on proposed legislation can help identify drafting inconsistencies and the practical impacts. At this stage, it’s important to allow enough time. Although some practical issues may be obvious from the legislation, more subtle issues may take longer to detect.

Taxpayers and their advisors often research the implications of a proposed change by applying the draft rules to real sets of facts. In the past, we’ve seen these scenario analyses help identify and resolve key inconsistencies and issues in tax measures before they became law. Consultation periods should allow ample time for this important work.

Consultation is also valuable at the implementation stage. Governments can hear from taxpayers what guides, forms or other tools might ease their compliance with new rules, and also how much lead time taxpayers and their advisers need to get ready before it takes effect. As legislation is drafted, ensuring that the implementation date of legislation allows time for such consultation is important.

For example, proposed changes that would allow the Canada Revenue Agency (CRA) to send electronic notices of assessment without the taxpayer’s authorization were originally slated to apply as early as this coming tax season for 2021 T1 personal tax returns. After we and others raised practical concerns over the proposals and the tight timing for their coming into force, draft legislation released on February 4, 2022 indicates that the effective date for these measures is now January 1, 2023. See our recent Tax Blog for details.

Setting a reasonable implementation date based on stakeholder feedback is especially important for transactional taxes, given their high volumes, reporting frequency and reliance of properly configured processing systems. Moving too quickly to impose changes to the GST, for example, could cause serious issues that would be much more difficult and costly to fix after the rule change is in place.

Consultation can also help the government define the information that taxpayers would need to report to comply with a rule change. For changes where new information is now required to comply, there is a good chance that taxpayers would need time to change their system to gather this information. Again, this is especially important for transactional taxes, where compliance data is required more closely after the related business activity than it is for income taxes.

Post-implementation reviews

The U.K. Tax Policy Framework document identifies post-implementation follow-up as another important step. Tax measures should be periodically reviewed to ensure they are meeting their objectives effectively, efficiently and at an acceptable cost.

We believe Canada’s tax system could benefit from more post-implementation evaluations. For example, the private company changes introduced in 2017 were highly complex, but we are not aware of any study done by the government since then to determine whether they could be improved or simplified. Similarly, the rules for reporting foreign property should be reviewed to see if they could be simplified while ensuring the government still has access to the tax information it needs.

GST/HST on digital supplies: Lessons learned

The way the government introduced last year’s change to apply the GST/HST to certain digital supplies provided to Canadians by non-resident businesses offers some important lessons for future tax policy development.

The change was intended to level the playing field for businesses resident in Canada that provided — and were obliged to collect GST/HST on — the same types of digital supplies.

While the proposal may have seemed straightforward at first glance, we made a submission pointing out a number of complicated issues, for example, involving online platforms, that needed to be addressed with more thought and information (see our February 2021 Tax Blog for details). We stressed that businesses needed more time, beyond the July 1, 2021 effective date, to prepare. The CRA was also racing to create online systems and guidance by that date, some of which are still in progress.

Acknowledging the tight deadline, the government stated that it would work with affected taxpayers during a 12-month transitional period after the rules take effect to meet their obligations.

We’re sure this was well intended, but the announcement created confusion, especially when it was not clear that taxpayers were expected to come forward and request this help. We believe this has put Canadian taxpayers in an unfair position, and that it would have been more helpful to simply delay the effective date of the legislation to give them more time to get ready and register. Allowing taxpayers and the CRA another six months to prepare seems reasonable, especially since the problem that the rule was designed to fix was recognized many years ago.

What’s next?

Our discussions with the CRA give us comfort that it will apply this concession fairly. We have also encouraged CRA officials to provide more information so affected taxpayers can ask for help with better knowledge of what help is available and how it would be delivered.

Nevertheless, these rules could have been implemented far more smoothly if taxpayers had been given a reasonable time before the change took effect, as well as the processes, guidance and tools they need to comply.

More broadly, we and many like-minded stakeholders are ready and willing to help the federal government get the legislative process back on track and establish an improved process for thoughtful tax policy development and implementation.

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The views and opinions expressed in this article are those of the author and do not necessarily reflect that of CPA Canada.