Canada is blessed with deep and effective capital markets, quality investment opportunities, as well as the savings to fund attractive projects. We need to seize these advantages in our policy-making.
Just moments after being sworn in as Canada’s 23rd Prime Minister, Justin Trudeau and his cabinet announced that Parliament will reconvene on December 3rd. On December 4th, the Governor General will present the Speech from the Throne, announcing the priorities of the new government in the upcoming sitting.
The Liberal Platform rolled out on the election hustings gave us a glimpse of what we can expect—a focus on building world-class infrastructure, providing a secure retirement for Canadians, and helping businesses and entrepreneurs become more innovative, competitive, and successful. The Investment Industry Association of Canada (IIAC) supports these endeavors.
As the government’s November 20, 2015 Update of Economic and Fiscal Projections highlighted, the near-term outlook for both growth and commodity prices has deteriorated since the previous government presented its budget in April. With a weaker economic outlook comes a weaker budget balance and less room to maneuver.
“The road ahead is challenging, but it is also one of opportunity,” said Finance Minister Bill Morneau. The IIAC couldn’t agree more. We have turned a new page with a new government, with a fresh perspective and opportunity for innovative new policies to rejuvenate growth. Indeed, smart fiscal policy can boost near-term growth and reduce the fiscal impact of budgets.
The Right Policy Touch
Canada is blessed with deep and effective capital markets, has excellent availability of quality investments and the expertise to identify them, as well as the savings to fund attractive opportunities with good returns. We need to seize these advantages in our policy-making.
First, we need a plan to help small businesses raise equity capital to promote entrepreneurship and kick-start the economy.
Second, we must draw private capital to invest in infrastructure, especially for smaller and medium-scale projects (i.e. under $200 million) that are not as attractive for large pension funds because of their relatively small investment scale.
Third, we need to encourage private savings for retirement.
1. Helping Small Businesses Raise Money
While capital sourced from angel networks and domestic and foreign private equity funds is relatively robust, it is the private markets that provide the greatest source of external capital for larger small-sized businesses because: 1) they have outgrown access to angel networks or private equity; and 2) early-stage investors are looking for an exit strategy through an IPO financing.
The IIAC has long called on the federal government to provide for the deferral of income tax on capital gains, if the proceeds from the disposition (up to a limit) are reinvested in eligible small businesses. This would, in effect, unlock capital tied-up in low-return investments and would encourage investors to take advantage of opportunities offered by small-cap publicly listed companies with faster growth potential. It would improve overall financing conditions in the public venture markets.
It is important that Finance Canada carefully scopes the parameters for implementation of a deferral regime, given the need to carefully manage the public purse. For example, the government could place certain conditions on eligibility for the tax-deferred rollover. Additionally, Finance Canada could look to other jurisdictions with rollover provisions (e.g. the UK and the U.S.) to see how they administer and track rollovers to minimize complexity.
The IIAC has also highlighted the need for better availability of early-stage capital to spur investment in start-ups and small Canadian companies. A broader range of people are increasingly interested in this type of risky, but potentially lucrative, investment. To encourage this type of investor, the IIAC has asked the government to consider implementing programs similar to the UK Enterprise Investment Scheme (EIS) and the UK Seed Enterprise Investment Scheme (SEIS). These programs have had a long track record of success in the UK and could be successful in Canada.
The EIS and the SEIS have had a profound impact on financing of UK small businesses and start-ups. Indeed, they have become the most revered government-backed schemes ever created. HM Revenue & Customs (HMRC) data show that since the EIS was launched in 1993-1994, more than £12.3 billion has been invested in over 22,900 small companies. Most notably, 58% of EIS investment has gone to companies raising EIS funds for the first time. Since SEIS was launched in 2012-2013, more than 2,900 start-ups have received over £250m in investment.
How does it work? The EIS is designed to help small UK businesses raise finance by offering a range of tax relief to individuals who purchase new shares in such companies. Tax breaks are offered to offset the high risks associated with investing in small companies. Relief is at 30% of the cost of the shares, to be set against the individual’s income tax liability in the year the initial investment is made. The maximum tax reduction in any one year is £300,000 provided an individual has sufficient income tax liability to cover it. The shares must be held for at least three years or tax relief will be withdrawn. If an individual has received income tax relief on the cost of the shares, and the shares are disposed of, any gain is free from capital gains tax. Additionally, the payment of tax on a capital gain can be deferred where the gain is invested in EIS qualifying shares. In this instance, there is no minimum period for which the shares must be held.
The SEIS was launched to stimulate entrepreneurship and kick-start the UK economy. It offers income tax relief of 50% on a maximum investment of £100,000 for investments in very early-stage companies, with similar conditions as the EIS.
For businesses to qualify for the EIS relief—up to a maximum of £5 million per year—they must have gross assets of less than £15 million and no more than 250 full-time employees. Companies with assets of up to £200,000 and fewer than 25 employees can qualify for SEIS.
An EIS/SEIS type scheme in Canada could achieve similar results and, based on UK tax expenditure data, the benefits to the economy would greatly outweigh the expenditures of the programs.
2. Drawing Private Capital Investment in Infrastructure
The Liberal government’s infrastructure plan is certainly ripe with opportunities for fresh thinking. We do not have to look far to see the benefits of P3 infrastructure initiatives in Canada. Examples that come to mind include the Regina Water/Wastewater Treatment Plant project, Toronto’s pedestrian tunnel at the Billy Bishop Island Airport and the Union-Pearson airport express train.
While large government pension plans have the expertise and scale to invest in large-scale public infrastructure, the primary geographic focus has been international markets. The real need in Canada, however, is funding for smaller and mid-sized projects (i.e. less than $200 million in equity) across the country.
There are many private infrastructure investment funds with the expertise to identify and develop these mid-sized projects. However, the projects are not of sufficient size and scale to attract the large pension funds, and private funds have limited access to individual investors—say through the platforms of the wealth management firms—despite the attractiveness of portfolio diversification and return.
Targeted federal policy could be an important catalyst to stimulate small and mid-sized infrastructure investment financed via private managed funds. First, government could use moral suasion to encourage large pension funds to invest in successful, but small private infrastructure funds, if the sole constraint is investment size. This would provide a catalyst for expansion of these funds. Second, the government could provide a modest tax incentive, whether a personal tax credit or capital gains relief, for purchases by individual investors in infrastructure investment through designated, specialized infrastructure funds.
Another option is to consider a framework that allows for the pooling of smaller projects, where appropriate. Pools could be developed for projects from similar industries or project phases as a means to attract institutional, long-term investors.
3. Encouraging Private Savings for Retirement
The Liberals committed during the election campaign to phase-in a modest expansion of the CPP to supplement Canadians’ pension savings. This change will take some time to implement and, together with the platform promise to roll back the annual TFSA contribution limit to $5,500, consideration should be given to small targeted changes to tax-assisted retirement savings programs.
Almost three million Canadians rely on Group RRSPs for retirement savings, and better tax treatment would encourage more Group RRSP offerings. Compared to Defined Contribution pension plans and Pooled Registered Pension Plans, Group RRSPs have some tax disadvantages that impede Canadians from saving cost-effectively. For example, employer contributions to a Group RRSP are treated as earnings and, hence, payroll taxes like CPP and EI are deducted. Additionally, employers must make automatic payroll deductions for employee contributions. This uneven treatment is justified on the spurious grounds that Group RRSPs are not really a pension plan as funds can be withdrawn before formal retirement.
Measures could include extending the eligible age for RRSP contributions beyond age 71. Consideration should also be given to increasing annual RRSP contribution limits. Yes, there is unused RRSP contribution room amongst Canadians overall, but individuals closer to retirement are most likely maximizing their RRSP contributions and could benefit from increased limits. Strengthening the voluntary component of Canada’s retirement income system would also enhance Canada’s ability to attract and retain the best and brightest people. While budgetary revenue will be lower, it is important to recognize that this is largely a deferral.
Additionally, life events such as layoffs or sabbaticals can affect one’s ability to contribute to an RRSP. Compensatory adjustments should be put in place for people who have missed annual RRSP contributions due to a temporarily interruption of their working careers.
Finally, Canadians with Registered Retirement Investment Funds (RRIFs) are required to withdraw a set minimum percentage from their account annually. With life expectancy steadily increasing and real returns on investments expected to remain low, many Canadians face a significant risk of outliving their savings. The government should eliminate the rules mandating minimum yearly drawdowns from RRIFs and similar accounts to provide seniors with more flexibility and longer income tax deferral.
On a broader scale, higher household saving provides funds for new capital investment and business expansion needed to promote economic growth.
Unwavering Support for the Cooperative Capital Markets Regulatory System (CCMRS)
The IIAC has long supported a single national securities regulator. The Cooperative Capital Market Regulatory System (CCMRS) will reduce the regulatory fragmentation and duplication that exist with having 13 provincial/territorial securities commissions; protect regional interests; and enhance the ability of law enforcement and prosecutors to achieve better criminal enforcement outcomes across Canada.
The CCMRS will also deliver cost-effective regulation to strengthen the competitiveness and integrity of Canada’s capital markets; improve opportunities for savers and investors; make it easier for smaller and emerging companies to access capital; position Canada as an attractive destination for foreign investment; and provide one voice on the international stage.
Finally, the CCMRS will provide, for the first time, effective oversight and accountability of securities regulation in our national markets through an expert Board of Directors representative across the regions of the country. This oversight would also align the rule-making effort with the broad economic and financial objectives of the country.
The IIAC has actively encouraged the Canadian provinces/territories to participate in the CCMRS. The federal government and the participating provinces/territories issued draft legislation in September 2014 and did so again in August 2015. The IIAC has formed a Steering Committee and working groups to comment on the Act and Regulations.
The policy touch needed to link capital with successful investments is to design specifically targeted market-driven incentives to act as a catalyst in the savings-investment process—the right incentives to draw new capital to small new enterprise to boost entrepreneurship and economic growth, and the right incentives to draw private capital investment in infrastructure, especially smaller-scale projects.
These may have been described as the worst of times to form a new government, given the mild downturn in the economy in the first half of 2015. But, to paraphrase Dickens, they can also be the best of times. The new government, coming in with a clean policy slate, has a unique opportunity to implement powerful, innovative policies to lift the country to new heights of prosperity, generate job opportunities, and assist Canadians to save for their future.