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Accounting
Tax

Repairing tax law on the fly is never a good idea

The government essentially beta-tested some new tax rules. Here’s why that’s a bad idea

In the gaming industry, it's a well-established strategy: software developers release early versions of their games so eager users can beta-test them, i.e., search for bugs and glitches, and then feed their discoveries back to the developers to fix the glitches before putting their products into circulation. This approach to crowdsourcing the identification of problems also saves the developers huge sums they'd otherwise have to spend on internal quality controls. 

We can probably all agree that what works in the software industry isn't necessarily the most effective approach to developing public policy and regulation. Beta testing tax legislation isn’t as much fun as a video game. 

Yet, it seems in recent years, this is precisely how the federal government has managed some new federal tax rules, such as the Underused Housing Tax (UHT) and updates to reporting requirements for bare trusts: release new tax legislation to taxpayers and their advisors as beta testers, then scramble to repair the damage on the fly.  

In the case of the UHT, a tax meant to target foreign owners ended up affecting countless Canadian individuals who indirectly owned their residential properties through a specified Canadian trust, partnership, or corporation. These Canadian tax filers and their CPAs had to invest a significant amount of time in understanding the rules and completing the UHT filings, even though most Canadian taxpayers were ultimately exempt from the tax. It was a non-sensical process that added cost and stress for everyone involved, yielded no additional tax revenue, and failed to improve the housing market. After receiving plenty of negative feedback from stakeholders, including CPA Canada, the Department of Finance, this past November, tabled amendments to the UHT to "help facilitate compliance."  

A more recent example: the new rules for reporting bare trusts. These changes to the Income Tax Act emerged from a Department of Finance that seems to be struggling to keep up with the torrent of tax-oriented legislative activity coming from the federal government. The application of the final version of these rules turned out to be so broad that it would have imposed reporting obligations on all sorts of situations involving bare trusts that were never intended to fall within their scope. After months of sounding the alarm that there were serious flaws in the system, and just days before the filing deadline for countless bare trusts across Canada, the decision was made, albeit at the last minute, to exempt bare trusts for the 2023 tax year.  Canada Revenue Agency indicated in its announcement that it will “work with the Department of Finance to further clarify its guidance on this filing requirement”.  

This is a problem, and we need to get in front of it.  

In both cases, it seems as if the federal government has opted to beta-test its new tax rules rather than take the appropriate time to properly consult, listen to expert external advice and then work out the bugs and glitches before the rules go into effect. In the meantime, taxpayers and accountants are forced to spend an enormous amount of time and resources trying to comply, only to find out that there were bugs in the system. 

Not all of the government's recent tax legislation has followed this trajectory. Take, for example, recent changes in the tax treatment of inter-generational transfers of shares in a corporation. For years, section 84.1 of the Income Tax Act made it more advantageous from a tax planning perspective for those shares to be transferred to a third party than to a child or grandchild. The Department of Finance eventually drafted changes that wouldn't penalize family members with a deemed dividend, thus enabling genuine inter-generational transfers of businesses to benefit from capital gain treatment and even a lifetime capital gains exemption. In this case, though the changes have evolved since the introduction of Bill C-208, the government did consult with stakeholders including the Joint Committee on Taxation of the CBA and CPA Canada, and the Department of Finance made some important modifications based on those recommendations. Yet, in this fast-paced legislative environment, it seems that such outcomes are becoming the exception and not the rule. 

Clearly, we have an opportunity to learn from debacles such as the implementation of the UHT and trust reporting rules. The federal government should take a more cautious and collaborative approach to tax reform. Tax legislation is intricate and highly technical, and everyone benefits when the Department of Finance takes its time and leverages the resources in the Canadian tax community that are necessary to draft effective legislation that balances policy objectives and the compliance burden imposed upon taxpayers.  

While beta-testing may be great for catching the bugs in a video game, it's not the right approach to implementing tax legislation. I prefer the wisdom of another profession: measure twice, as the old carpenter's adage goes, and cut once. It's a pragmatic philosophy that surely applies to tax policy as well.