Can fed’s tax expenditure review yield much-needed tax simplification?

"If the federal government decides that some of these tax credits just aren’t working and they remove them, it will make the tax system easier to use,” says Bruce Ball, FCPA, FCA, national tax partner with BDO Canada LLP in Toronto.

"Presumably these credits had a purpose in terms of trying to entice people to do certain things. But if a credit isn’t working, is eliminated and there are savings, those savings could be used instead for general tax cuts,” adds Ball, a member of CPA Canada’s Small and Medium Practitioner (SMP) Tax Committee.

Experts want all tax credit expenditures, including their annual administration costs, studied carefully to determine whether they add unnecessary complexity to the tax system.

Even high-cost, high-profile expenditures are not sacrosanct.

Denis St-Pierre, FCPA, FCGA, tax partner with EPR Bathurst in New Brunswick, says the federal government needs to consider eliminating the small business deduction on the first $500,000 of earnings by a Canadian-controlled private corporation. To what extent are these companies using the tax savings to reinvest in the economy by creating more jobs, he asks.

Moreover, a clawback in the $500,000 deduction for a business with taxable capital of $10 million to $15 million adds complexity, says St-Pierre, also a member of the SMP Tax Committee.

"The question that often gets asked of the small business deduction is ‘Are we rewarding staying small?’” says Hugh Neilson, FCPA, FCA, director of taxation services for KRP Group in Edmonton and another member of the SMP Tax Committee.

He adds that alternative models of encouraging entrepreneurship should be explored, noting that commentators have suggested ideas that include a tax break linked to maintaining or increasing employment, accelerated tax deductions for capital investments in business expansion and removal of the large-corporation–based erosion of access to the deduction.

The 50 per cent capital gains inclusion rate has also become problematic now that dividends are taxed higher than capital gains. In many Canadian jurisdictions, taxation of capital gains versus dividends used to be fairly close. But today, following the addition of a new 33 per cent top tax bracket, the numbers look very different, says Neilson.

As a result, “if you look at federal taxes, you’re now paying at the top personal rate on income over $200,000, 24.81 per cent on an eligible dividend, and 75 per cent of the top rate of 33 per cent would be 24.75 per cent. So there’s no question about how much more tax-efficient it is to get a capital gain instead of a dividend,” he elaborates.

The Scientific Research and Experimental Development (SR&ED) credit’s role in encouraging innovation is also contentious.

St-Pierre notes that the SR&ED credit, while not perfect, yields good results. “Our clients do get refunds from SR&ED. They do continue to research,” he says.

But Neilson criticizes the SR&ED credit because the research must be done, and the cost expended, before a recovery of funds can be applied for, he notes. One possible alternative that has been suggested by some tax experts is a grant model, under which the project is reviewed first, then funds are advanced and the work is performed.

Income-tested credits such as the GST/HST credit and provincial credits can be problematic because of clawbacks. “If somebody is in a specific range, their effective tax rate could be pretty high when you factor in actual taxes paid, plus losing some of these benefits at the same time. That could be a disincentive to earn more,” says Ball.

Key to a more efficient and fairer, broad-based tax system is having an ongoing review to ensure the purpose of a tax credit is valid.

"I think the federal government should seriously be looking at some kind of rotational model,” says Neilson, who suggests a five-year review cycle.

CPA Canada is a prominent contributor to the tax expenditure review process. CPA Canada’s recent submission to the Deputy Minister of Finance sets out views and recommendations in relation to the current review, as well as suggestions for the government’s consideration toward a broader, longer-term tax reform initiative. Individual CPAs also have much to offer.

Note: This article reflects various members' views on specific tax issues. It does not necessarily represent the formal policy positions of CPA Canada.