October 2, Minister of Finance House of Commons Ottawa, ON K1A 0A6. Dear Mr. Morneau: Re: Tax Planning Using Private Corporations INTRODUCTION

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1 October 2, 2017 The Honourable Bill Morneau Minister of Finance House of Commons Ottawa, ON K1A 0A6 Via Dear Mr. Morneau: Re: Tax Planning Using Private Corporations INTRODUCTION The Canadian Pharmacists Association (CPhA) provides this submission in response to the Department of Finance s consultation titled Tax Planning Using Private Corporations (The Consultation), released on July 18, CPhA is the national voice for Canada s pharmacists. On behalf of its approximately 40,000 members, CPhA s mission is to advance the health and well-being of Canadians through excellence in pharmacist care. Part of this mission is listening to the concerns of our members and advocating on their behalf. Every year, pharmacists fill over 600 million prescriptions, and are responsible for providing the highest possible level of care to their patients. Ensuring medication and patient safety requires constant innovation and investments in pharmacy equipment, software and staff. Owning and managing a pharmacy involves considerable risks and expense and pharmacist owners have to adapt to ongoing regulatory changes that often requires further investments. This letter aims to outline several concerns with the proposed changes to the taxation of private corporations in Canada (the Proposals) as it relates to pharmacies. CPhA and its members are concerned that the Proposals will have far-reaching implications, some of which are unintended, that will cause significant harm to small businesses, in particular, to family pharmacies in Canada. These changes amount to a fundamental restructuring of the taxation of private corporations and their shareholders. The 75-day consultation period is too short given the far-reaching implications of these changes. We would strongly urge the Government to set aside the current proposals and hold a more meaningful consultation, involving all stakeholders that will be impacted by the Proposals.

2 INCOME SPRINKLING The proposals aim to implement a Reasonableness Test with respect to the payment of dividends to, or the realization of capital gains by family members who own shares in family pharmacy, often structured as a private corporation. The Proposals look to evaluate the value of labour and capital contributions made by family members when determining whether an amount paid to a family shareholder as a dividend is reasonable. We see a number of problems with the proposed approach: Subjectivity of Reasonableness Test & Valuation of Contributions Family members often take on non-traditional roles when working in a family business. This is especially true for pharmacies, many of which are open late, on weekends, and during holidays and where family members regularly cover shifts to allow paid employees to take time off. Rarely do family members have one specific job, where they work a fixed number of hours each day in a way that is easily measurable. Instead, they have varying contributions, often including: Assisting with strategic decisions with respect to the future of the pharmacy; Assisting with human resources decisions; Negotiating agreements such as leases or bank loans; Answering phones and s at all hours of the day; Processing payroll, bookkeeping and other administrative tasks; Allowing family assets to be used as security on business debts; The variety of work performed by family members is such that an arm s length person would never have the same responsibilities, or assume the same risks. This makes it impossible to determine what a reasonable amount of compensation would be if the work was performed by an arm s length individual. Further, this policy makes the mistake of comparing inputs to outputs. Entrepreneurs go into business for themselves with the expectation that the outputs (income) will exceed the inputs (expenses), resulting in a profitable enterprise. Family members have a vested interest in the success of the family business. The proposals only evaluate their inputs, and measure them on the basis of an arm s length employee, without any consideration for the outputs that should be attributable to the work done by family members. Unfair Results Under the Proposals, if a dividend paid to a family member is deemed to be unreasonable, the dividend will be subject to tax at the highest marginal rate of tax, regardless of the tax rate of the connected individual in respect of the business. This introduces significant uncertainty and risk for small family owned pharmacies, when paying dividends to family shareholders. Where the connected individual makes significantly less than $200,000 per year, and therefore is not subject to the top marginal rate of tax, it is unfair that a dividend deemed to be unreasonable should be subject to the top rate of tax. Retroactive Application In many cases a family s retirement nest egg will have been invested in the pharmacy. Under the current regime, it is common that each spouse would own 50% of the shares, and would therefore expect to draw 50%

3 of the dividends needed to support the family in retirement. Many couples will have already retired based on an understanding of the after-tax cash that would be available to them under the existing rules. Under the Proposals, the spouse that was not active in the business would no longer be able to receive 50% of the dividends in retirement. This would have the effect of significantly reducing the family s after-tax income in retirement. In many cases, the taxpayers will not be able to return to work and will therefore be subject to a lower quality of life through no fault of their own. HOLDING PASSIVE INVESTMENTS INSIDE A PRIVATE CORPORATION Investing passively in a private corporation has been a legitimate long-standing practice for many years. Pharmacy owners and other business owners face significant uncertainty with respect to the future results of their business, and therefore must maintain a pool of capital to protect themselves against this uncertainty. This allows them to support themselves during economic downturns, replace broken equipment, and reinvest in their business when the opportunity arises. This pool of capital is often retained in a corporation, as low corporate tax rates provide for more capital that can be used to finance these uncertainties. As this is typically a large pool of capital, most business owners choose to invest in passive investments so that the money is working for them and continues to grow. As a result, these funds often take on a dual purpose finance future uncertainty for the business, and contribute towards a business owner s retirement savings. The proposals will significantly increase the tax burden associated with passive investment income earned on these pools of capital, and will introduce an unprecedented amount of complexity into the Income Tax Act. As such, pharmacy owners will be penalized for maintaining capital in their corporation that they require due to the uncertain nature of running and managing their pharmacy. If they choose not to invest these funds in order to avoid the punitive effects of these rules, they will not be able to accumulate the capital that they need to retire. And if they remove all funds from the corporation via salary or dividends, they will have significantly less capital available to reinvest in the corporation in the event that their operations requires an injection of capital. This will be devastating to many small, independently owned pharmacies. CONVERTING INCOME INTO CAPITAL GAINS While we understand the policy intent of the proposals to prevent the conversion of income into capital gains, the wording of the legislation is sufficiently broad that it will have many unintended consequences: Estate Planning When a taxpayer dies owning shares of a private corporation, they are subject to double taxation by default once as a capital gain on death, and once as a dividend when the corporation is wound-up. Planning is often implemented to prevent this double taxation, either resulting in the elimination of the tax on dividends, or elimination of the tax on capital gains. Under the Proposals, only elimination of the tax on the capital gain will be possible. In order to eliminate the tax resulting from the capital gain on death, the private corporation must be woundup within one year of the date of death. This is often not achievable, or not desirable. Where there are family disputes, estates often take years to administer, which may prevent the winding up of the corporation. Where the corporation continues to carry on an active business, winding up the corporation is not desirable. The

4 result in these situations is that double tax applies, with no relief available to the taxpayers. This is not a fair result. Further, these rules may have retroactive implications. Where a taxpayer died prior to July 18, 2016, it is possible that their executors intended to implement planning to eliminate the tax on dividends that would arise on the winding-up of the corporation. This is no longer an option, and they are beyond the one year limitation to eliminate the capital gain on death. The value of the private corporation is therefore taxed twice, with no relief available to the taxpayers. This is not a fair result. Intergenerational Transfers The sale of a business is often completed through the use of a corporation by the purchaser. Where the purchaser uses a corporation to acquire the shares of the target company, they are able to use profits generated by the company to finance the purchase price. This is beneficial as these profits are only subject to corporate rates of tax. Where a shareholder wishes to avail themselves of the lifetime capital gains exemption, this type of planning is not currently available if they are selling their shares to a family member. As a result, under the existing legislation, the vendor would often forgo their lifetime capital gains exemption, and pay tax on the resulting capital gain in order to facilitate this type of planning on the sale to a family member. To be clear, there is already a disincentive to sell shares to a family member as the vendor is required to give up their lifetime capital gains exemption about $200,000 of tax savings. The Proposals exacerbate this issue. The vendor can no longer forgo their lifetime capital gains exemption in order to allow their family member to acquire the shares using a corporation. Instead, the vendor would pay tax on the resulting capital gain, and the purchaser would pay tax on the deemed dividend that arises on the transfer of shares to their corporation, meaning double tax applies. This is not a fair result. IMPACT ON CANADA S PHARMACISTS While these proposals will have a significant impact on the business community at large, we wanted to take this opportunity to explain how they will specifically affect Canada s pharmacists. General Information Of the approximately 41,000 pharmacists in Canada, the Canadian Institute for Health Information estimates that approximately 11,500 (28%) are classified as owner/managers meaning they either own an independent pharmacy or are franchisees operating a pharmacy. It is also estimated that 78% of pharmacies in Canada are considered to be small businesses. The average independent pharmacy in Canada employs about 7-8 people, which includes 2 pharmacists (one may be an owner), 4 FTE pharmacy staff and 1.5 FTE in the front shop. However, many pharmacies employ well over 10 staff. Pharmacists face all of the same issues regularly faced by small businesses. They lease space, or purchase real estate, invest in capital expenditures, hire employees, and carry inventory. They also face fierce competition from large corporate pharmacies in the market.

5 Lastly, 63% of Canada s pharmacists are female. As a result, where these proposals have a negative impact on Canadian pharmacists, there will be a disproportionately large impact on women. Income Sprinkling Where pharmacies are independently owned, or are franchises, significant start-up capital is required. While this is often financed with external financing, it is common practice that the pharmacist and their spouse will need to provide personal guarantees to lenders. As such, the family as a unit assumes the risk associated with the business. It is also common that family members will directly or indirectly work in the business. The proposals with respect to income sprinkling introduce significant uncertainty regarding the ability of a pharmacist to remunerate their family members for the risk assumed and labour and assets contributed to the business. This uncertainty may result in family members being subject to the highest rate of tax, requiring additional funds to be withdrawn from the corporation to finance this tax liability. This potential additional tax cost puts a strain on cash flow, and reduces an independent pharmacist s ability to compete. Holding Passive Investments Inside a Corporation As stated above, pharmacies are capital intensive businesses to operate, requiring significant investment in leasehold improvements, inventory, and employees. Some of the significant capital costs associated with owning a pharmacy include: Medical equipment, packaging, and compounding that can run well upwards of a $300,000-$750,000 per store which need to be replaced every 7-10 years Compounding regulations require a minimum $45,000 investment for non-sterile (2017 NAPRA compounding standards) and well over $250,000 for sterile. Packaging for long term care and patients at home requires machines varying from $50,000 to $500,000 with year life expectancy. Shelving, IT, computers, dispensing machines, etc. Passive investments enable pharmacies to build saving for these significant investments. Similar to other businesses, pharmacies are subject to the ups and downs of the economic cycle. Due to high ongoing costs, it is paramount that independent pharmacies maintain a pool of capital to protect against uncertain future events. While these funds could be kept as cash on hand, this would result in pharmacists losing money to inflation, therefore it is common practice to invest this excess capital. The proposals will penalize pharmacists for keeping much needed assets in their corporation by subjecting any income earned on these assets to significant rates of tax upon eventual withdrawal. If pharmacists withdraw these funds from their corporation to avoid these punitive taxes, they will have significantly less capital available to reinvest in the business when needed. Converting Income to Capital Gains There is increasing competition in the pharmacy market from large corporate chains. These large organizations often seek to acquire smaller pharmacies to reduce competition in the marketplace. Many pharmacists that operate independently or as franchisees take pride in being part of their local community, and being able to offer affordable options to those in need. It is common practice for these pharmacies to be

6 carried on by multiple generations so that they can maintain their independence and continue to contribute to their communities. The proposed changes will make it significantly more costly for a pharmacist to sell their business to the next generation, compared to selling to a large corporate chain. This will lead to the continued consolidation of pharmacies among large corporate groups, many of which are foreign owned. This hinders the entrepreneurial spirit in Canada, and will undoubtedly lead to increased costs for Canadians to access the medicine that they need. CONCLUSION The Proposals as currently drafted introduce an unprecedented level of complexity, and uncertainty into the Income Tax Act. Small business owners will incur significant costs to simply attempt to comply with the proposed legislation. It will take years of CRA rulings, and court cases to establish a baseline that business owners can look to for guidance in the application of these new rules, and in the meantime, they will be subject to the whims of CRA auditors. The Proposals as currently drafted are sufficiently vague that they will have many unintended consequences. Family will be hesitant to invest in new business ventures; retirees will find they have less money to support themselves in retirement, small business owners will not have the capital required to support their business, and business owners will opt to sell to large companies instead of the next generation. We would implore the government to set aside the Proposals and start over. We need to have a meaningful consultation involving all stakeholders to ensure changes of this magnitude do not harm small business and discourage entrepreneurialism in Canada. Personal stories Over the past several weeks, we have heard many personal stories from pharmacists who fear they will be affected by the changes. Some examples are included below. Story from Manitoba: Since opening our pharmacy in 2000, we have followed the advice of our accountant and spent considerable money creating a corporate structure that optimizes our ability to use our profits to reinvest in our business. Over the past 17 years we have expanded our business which is a real benefit to the rural community where we live. We built a new pharmacy from the ground up. We purchased and currently operate a small motel next door to the pharmacy. We employ % more people than we did in The proposed tax changes really scare us. Not only will future growth be unlikely, we are also concerned that paying more money in taxes will mean a reduced ability to meet our operating costs. Pharmacy in Manitoba is already operating on a shoestring. We can t take any more cuts without drastic changes to services and even loss of services in smaller communities.

7 Story from New Brunswick: I recently opened a new Jean Coutu Pharmacy on University Ave. I left a career with CVS/Pharmacy in the United States in 2008 to move home and open an independent pharmacy. My small business, which began with myself and 2 employees, now employs 35 individuals and we are planning on growing our team this fall. While this has represented a great growth story for the city, it has also occurred with a tremendous amount of investment and accordingly, financial risk, on the part of myself and my family. Having reviewed the proposed changes, I am concerned that the government is potentially discouraging economic growth by removing financial incentives necessary for entrepreneurs to take such risks in order to achieve success. As a pharmacist who maintains an active license to practice in the United States, I understand how easy it is for healthcare professionals to practice in other areas of the world. I worked in New England for four years and only had to show an offer of employment at the border to enter on a TN visa. The proposed tax changes to professional corporations make Canada a less attractive place to practice medicine. This is particularly an issue in New Brunswick where high earners already face some of the highest personal income tax rates in the country. Our residents already face long wait times to see many specialists and thousands of residents in your riding do not have a family physician. This problem will be exacerbated this fall with the impending retirements of several family physicians in Saint John. Sincerely, Alistair Bursey, B.Sc (Hons), B.Sc.Pharm Chair Perry Eisenschmid, BBA, MBA, C.Dir., H.R.C.C.C. Chief Executive Officer