BRIEF TO THE STANDING SENATE COMMITTEE ON NATIONAL FINANCE Relating - - PDF document

BRIEF TO THE STANDING SENATE COMMITTEE ON NATIONAL FINANCE

Relating To Bill C-43, Second Act to Implement Certain Provisions of the Budget Tabled in Parliament

• n February 11, 2014 and Other Measures

Good afternoon, My name is Katie Walmsley. I am the President of the Portfolio Management Association of Canada (PMAC). Joining me today is Lindsay Rogan, Managing Director of Rogan Investment Management, an investment firms that specializes in managing assets for private clients, Michael Friedman a tax partner McMillan and Joe Micallef a Partner at Ernst & Young. PMAC represents almost 200 investment management firms across Canada that manage total assets in excess of $1.3 trillion. PMAC members manage investment portfolios for private individuals, foundations and pension plans. Our comments today will focus on two issues relating to trusts referenced in Bill C-43: (i) the trust loss restriction rules as they apply to investment funds, including pooled funds; and (ii) the elimination of graduated rates of taxation for testamentary trusts and other trusts. i. Trust Loss Restriction Rules By way of background, on March 21, 2013, under Bill C-40, section 251.2 came into force. This new trust loss restriction provision was enacted to prevent arm’s length loss trading transactions that have been developed and that purport to enable one taxpayer to access the unused losses of another. Investment funds, including mutual funds and pooled funds, which are formed as trusts, were inadvertently captured under this provision. How were funds captured? In simple terms, Bill C-40 included changes to trust loss restriction event rules, specifically the rules are triggered whenever a person becomes a majority-interest beneficiary or when there is more than a 50% change in the beneficial ownership of a trust. The loss restriction event rules can have significant consequences to funds that are structured as trusts. These include:

• A deemed taxation year-end or multiple year ends, that may require additional distributions and

tax filings.

• Unused capital losses and certain non-capital losses are extinguished.
• Unrealized losses on non-depreciable capital properties are deemed to be realized.
• A potential negative impact on an investor’s returns

Various industry stakeholders made submissions to the Department of Finance on the key negative impact of these rules on investment funds. I’m pleased to report that many of the concerns faced by

• ur members and Canadian investors invested in these funds were addressed by way of amendments in

Bill C-43. We applaud the Government for expediting these amendments. While the amendments in Bill C-43 are positive and a step in the right direction, they do not go far enough in exempting. In particular, the relief does not capture pooled funds that are managed to comply with investment restrictions under the Pension Benefits Standards Act (“PBSA”) or similar restrictions under provincial law. First, some background on pooled funds. Pooled funds are very similar to mutual funds, but with a few key differences. Mutual funds are sold to the public via a prospectus whereas pooled funds are sold via private placement, with simpler disclosure provided in an offering memorandum. A recent estimation indicates that there are over $120 billion in pooled fund assets in Canada. Many PMAC Members manage pooled funds designed for small to mid-sized defined benefit and defined contribution pension plans, group RRSP plans as well as foundations and endowment clients. Pooled funds represent an important investment option for Canadians that allow for the management of volatility, and they comprise a necessary component of investment strategies, particularly for institutional investors. They also have the advantage of fees that are typically 50% lower than retail mutual funds. As mentioned, Bill C-43 contains amendments which provide relief from the loss restriction event rules for certain investment funds, but the relief does not capture pooled funds that contain pension plan assets, under the PBSA. Here’s a simple example of the potential impact on one investor. Mrs. Smith has all of her retirement savings invested in a pooled fund managed by a portfolio manager. Individual investors as well as pension assets are invested in the fund. As a result, the pooled fund manages the assets of the fund in accordance with certain rules in pension legislation. This means that the trust loss relief would not apply to Mrs. Smith’s investment because the relief relies on a slightly different set of rules. If Mrs.

Smith has her retirement savings invested in a mutual fund, the trust loss relief would apply to her and could impact her savings. In more technical terms, pension rules apply a “book value” test in determining permitted investment concentration rather than fair “market value” test as contemplated by the trust loss restriction relief. Consequently, this would mean that a significant portion of the $120 billion in pooled fund assets would not be able to rely on the relief and investors and pensions invested in these funds would be punitively impacted by the trust loss restriction rules. For an individual investor, like Mrs. Smith, her investment returns could potentially be lower simply due to the fact that she is invested in a fund, with pension assets. That said, the investment restrictions under the PBSA are under review and are expected to be changed to a fair market value test in the future. Thus, we recommend that transitional relief be provided for those funds that are managed to comply with the investment restrictions under the PBSA until such restrictions are amended by the Department of Finance. We do not see a justified policy reason to exclude these types of pooled funds from the trust loss restriction relief. As the Standing committee is well aware, this relief could easily be addressed by way of a comfort letter, or possibly through clarifying explanatory notes to Bill C-43. The second issue we’d like to comment on relating to changes in trusts is ii) The elimination of graduated rates of taxation for testamentary trusts and other trusts. I’ll turn it over to Lindsay Rogan to discuss this issue. Lindsay is managing director of Rogan Investment Management, a firm that focuses on managing portfolios for private clients Thanks Katie. Good afternoon. We understand the Government is concerned with the use of testamentary trusts and tax-motivated delays in completing the administration of estates. However, we believe there are ways to address these concerns other than penalizing the beneficiaries of testamentary trusts that have been established or maintained for a variety of reasons totally unrelated to tax. Some of the reasons include:

• Management of inheritances for minor beneficiaries before reaching the age of majority or

completing their education,

• Management of estates for elderly spouses, who because of age or lack of capacity, are

vulnerable to financial abuse

• Protection of capital from the claims of potential creditors
• Staged distribution to spendthrift beneficiaries
• Preservation of family inheritance for one’s children
• Professional investment management of the assets
• Inability to fully administer an estate for non-tax reasons

After Jan. 1, 2016, all income retained in a testamentary trust will be taxed at the highest tax rate applicable to individuals in the province of residence of the trust. This is particularly problematic for Trustees without the power to distribute certain types of trust income. This significant change in tax policy in Canada does contain some limited exceptions – especially important is the treatment of disabled beneficiaries. I’d like to focus my comments around three key recommendations: 1. Reconsider the 36 month period after death For the first 36 months after the date of death, graduated tax rates will apply to an estate. If the estate remains in existence for more than 36 months, it will then become subject to the highest marginal tax rate applicable to individuals for all income retained in the trust. We think that a 36 month period is arbitrary, is not responsive to the non-tax related circumstances of many estates and is, therefore unreasonable.

• First, an estate is merely a holding vehicle for a person’s property created automatically on their
• death. Graduated tax rates should apply to the income of the estate as long as there are

legitimate non-tax reasons for the estate to exist. We believe that 36 months is an arbitrary administration period that, in many cases, may not be a reasonable period of time for the winding up of an estate. In particular, in cases involving illiquid assets, beneficiaries who are hard to locate, or where litigation is involved.

• Second, the 36-month administration period should be reconceptualised as a “safe harbour”

period and the Department of Finance should consider a specific anti-avoidance purpose test to tax those estates whose continued existence after 36 months is primarily tax motivated.

• Third, we note that the 36-month period is also inconsistent with provincial legislation1.

2. Allow for ministerial discretion to obtain relief in certain cases and include grandfathering options Like any new policy change, there will be unanticipated consequences when administering the new

• rules. These concerns could be addressed if there is an ability for the Minister to provide relief and

1 For example, under Ontario’s Estate Administration Tax Act, the Minister of Revenue may assess or reassess an estate for tax

payable within four years after the day that such tax became payable. Similarly, Alberta’s Wills and Succession Act does not provide a time limit for an estate administrator to make an application for probate.

extend the period during which an estate is subject to tax on the basis of graduated rates on a case by case basis; the Income Tax Act should permit this flexibility. For instance, many Canadians may have provided for the establishment of testamentary trusts in their wills and no longer have capacity to change their wills. We also believe that consideration should be given to grandfathering options such as extending the period during which graduated rates apply to testamentary trusts with minor beneficiaries (until they reach the age of majority). 3. Delay the implementation date to 2017 Given the aging population of Canadian investors, we believe that there will be a significant portion of Canadians who will not be aware of this change. Many wills establish testamentary trusts structured on the expectation that they would be taxed at graduated tax rates as a way to mitigate the differences between income for tax purposes and income for trust purposes. The loss of access to those rates will negatively impact many Canadians who thought they had planned prudently many years ago. This will cause many clients and their advisors to rethink existing estate planning and this will take time and

• effort. One thing is clear – estate and tax planning and administration in Canada will change as a result
• f Budget 2014. The bigger questions are: will Canadians be aware of the significance of these changes
• n their life savings and will they have enough time to plan accordingly?

We recommend a longer transition to 2017 in order to allow more time for awareness and proper planning. PMAC thanks the Standing Senate Committee for the opportunity to make these submissions. PORTFOLIO MANAGEMENT ASSOCIATION OF CANADA Per: Katie Walmsley and Lindsay Rogan