There are thousands of Canadians engaged in the important work of corporate oversight. The best known group are corporate directors. A second, less well known, corporate oversight role in Canada is independent review committees (IRCs) for financial institutions. IRCs for mutual fund families have the role of reviewing transactions involving potential conflicts of interest, such as transfers of securities from one fund to another in the family, or the purchase of securities issued by the manager of the mutual fund (for example a bank). This blog is a wake-up call about a potential threat to their independence.
The Canada Revenue Agency (CRA) treats corporate directors as employees of the corporation. The basis in law for this is that the Canada Pension Plan Act lumps them together with judges, MPs, senators, MLAs, lieutenant governors, and other people elected or appointed in a representative capacity as “officers.” Looking at the list, the glaring anomaly in it is corporate directors; all the others are employees of the state. The role of a corporate director is to provide independent oversight of a corporation, and treating them as employees undermines their independence. The Internal Revenue Service in the United States, in contrast, treats directors as independent contractors, and directors report their earnings as income from self-employment.
Members of IRCs, as far as I can determine from conversations with colleagues, report their fees as self-employment income. The rationale for our doing this is that we are providing independent arms-length oversight in conflict-of-interest issues for the mutual funds family. As one of my colleagues has pointed out, the key word in “independent review committee” is “independent.” The Canadian Securities Administrators’ National Instrument 81-107, which governs IRCs, stipulates that IRC members “have no material relationship with the manager [of the mutual funds family], the investment fund, or an entity related to the manager.” This restriction rules out employees.
The CRA has approached the mutual funds family on which I serve on the IRC, and, likening us to corporate directors, decided we are employees of the mutual funds family. We are appealing this decision under the current law. It may well be that we are a test case, and that if our appeal is not accepted CRA will make the same ruling for every other IRC in Canada.
In our view, the CRA is making a fiction of the independence of IRCs. The government, therefore, is sending IRC members a mixed message. Our governing regulations say we are independent, but CRA says we are not. By treating IRC members as employees, CRA can influence the mindset of both fund managers and IRC members to start acting like employees taking their direction from the manager, rather than professionals exercising independent judgment. As self-employed professionals IRC members can deduct from their IRC fees expenses they think appropriate to performing their job effectively. As employees, they may not necessarily be able to deduct such expenses, so they would ask the funds manager to pay for some or all of those expenses, which would change the dynamic of the relationship.
A better approach would be for the definition of “officer” in the CPP Act to be changed to explicitly exclude members of IRCs. It is in the interest of good corporate governance for IRCs to be independent in every possible way, including having earnings taxed as income from self-employment rather than having earnings taxed as though we were employees.
If the definition of “officer” in the Canada Pension Plan Act were changed to exclude corporate directors, then that would not only remove CRA’s rationale for taxing IRC members as employees instead of independent contractors, but it would do the same for the much larger group of people who serve as corporate directors. Promoting the independence of corporate directors in that way is good public policy.
Corporate overseers, whether directors or members of IRCs, are not employees. If we were, we would not be independent. Since we are not employees, we should not be taxed as employees.
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