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Comments on February 26, 1991, Canadian budget.

On behalf of Tax Executives Institute, I am pleased to submit the following comments on the Government's February 26, 1991, Budget. In addition, I am pleased to offer the Institute's congratulations on your recent appointment to serve as Minister of Finance. We have worked productively with representatives of the Department on a wide variety of issues, and stand at the ready to serve as a resource to you during your tenure as Minister of Finance.

Background

Tax Executives Institute, Inc. (TEI) is an international organization of approximately 4,600 professionals who are responsible -- in an executive, administrative, or managerial capacity -- for the tax affairs of the corporations and other businesses that employ them. TEI's members represent almost 2,000 of the leading corporations in Canada and in the United States.

Canadians constitute approximately 10 percent of TEI's membership with our Canadian members belonging to chapters in Calgary, Montreal, Toronto, and Vancouver. In addition, a substantial number of our U.S. members work for or are otherwise affiliated with companies with significant Canadian operations or sales. In sum, TEI's membership includes representatives from most major industries including manufacturing, distribution, wholesaling, retailing, real estate, transportation, financing, and resource (including mining, pulp and paper, and petroleum). The comments set forth in this submission reflect the views of the Institute as a whole but more particularly those of our Canadian constituency.

Provicial Capital

& Payroll Taxes

The Budget proposes to disallow, for federal income tax purposes, the current deduction for all but the first $10,000 of provincial capital and payroll taxes incurred annually. The proposal is intended to address two issues: (i) payment of provincial payroll taxes by the Federal Government, and (ii) the reduction of the federal corporate income tax base by the deductibility of provincial capital and payroll taxes. The proposal, however, does not address these issues directly and in our view creates serious injustices.

The Federal Government has asserted that it is under no obligation to pay provincial payroll taxes, but that it will continue to pay such taxes on a voluntary basis. In our view, the Government has contrived the provincial tax disallowance proposal to make both it and the provinces whole at the expense of taxpayers. TEI opposes the proposal because it would overturn a basic tenet of a net income tax system: it would deny taxpayers a deduction for ordinary and necessary expenses of carrying on their business.

The Budget states that "the proposal has been structured to minimize the effect on taxpayers and provincial governments." This may be true in respect of the effect of the proposal on the provinces, but it is decidedly untrue in respect of taxpayers. The Budget proposal endeavors to resolve a basic dispute over tax revenues between the Federal Government and the provinces at the expense of taxpayers. By addressing the issue indirectly -- through tax adjustments to corporations -- serious inequities as well as unexpected benefits are created. Whatever the Government's intent, we submit the proposal's effect on taxpayers is not minimal. although arguebly revenue neutral on an aggregate (or macro) basis, the net annual aftertax cost to many companies -- after considering the deduction of six percent of otherwise taxable income -- will be in excess of several million dollars. The proposal, if implemented, would seriously affect a large number of corporations with substantial capital and large staffs -- companies that employ a significant number of Canadian workers. It would do so at the same time these companies' UIC premiums -- a federal payroll tax -- are increased.

The proposal would affect taxpayers in other ways as well. It would exacerbate the differenes between book and taxable earnings, further complicate the computation of tax, and create additional paperwork burdens, particularly in view of the limiation of the $10,000 exemption for companies in a corporate group. (1) It would also create further inequity between incorporated and unincorporated businesses.

In summary, TEI recommends that the provincial tax disallowance proposal not be adopted and, further, that the Federal Government undertake to address the question of its immunity from provincial taxation directly, either through the transfer-of-payments arrangement with the provinces or otherwise.

Pension Fund Investments

Portfolios

The Budget recognizes the important role that pension plans play in Canadian capital markets and sets forth for discussion a proposal designed to encourage pension funds to further invest in Canadian equity markets. In this regard, the Budget states:

Many pension funds do invest a significant proportion of their assets in equity because pension fund managers recognize the increased return that investments in equity can generate over a longer time horizon. However, the relative level of investment in equity markets by pension funds is less in Canada than in the United States or the United Kingdom.

To address this issue, the Budget sets forth, as a basis for consultation, a proposed combination of a credit and levy that would be applied to holdings of Canadian common equity and other investments respectively; the credit would operate to increase the return on the eligible equity investments held by pension funds, whereas te levy would operate to decrease the return on other investments.

TEI commends the Govenrment for setting forth the proposed credit/levy mechanism for discussion and consultative purposes, instead of moving precipitously toward implementation. Based on our initial review of the proposal and for the reasons set forth below, we regret that the proposal would frustrate, rather tha further, the successful management of pension funds.

This Budget clearly recognizes the pension fund manager's responsibility to earn a return of assets. For money-purchase pension plans, this is of direct importance to the employees covered under the plan; for defined benefit plans, this is important in reducing the total cost of funding the pension payments. Notwithstanding the understandable preference of pension plan managers for equity investments, equity investments of private sector funds in Canada is lower than in the United States (as recognized in the Budget) because the climate for equity investment has been better in the United States recently than in Canada. To illustrate, below we set out investment yields from various market sectors in the United States and Canada for the periods indicated.

The relative returns -- particularly in relation to the Consumer Price Index -- demonstrate why there has been a greater concentration by pensin fund managers in fixed-income

[TABULAR DATA OMITTED]

investments in Canada than in the United States. TEI submits that if the proposed credit/levy mechanism had been in effect during the past decade, the clear result would have been a lower return on investments for pension funds. Thus, the proposal would have penalized pensioners, employees, and those who fund the pensions for choosing successful investments. In this regard, we believe that the role of high interest rates on Canadian funds during the past decade in causing funds to be committed fo fixed-income investments should not be underestimated. We submit that a return to lower, more stable real interest rates would yield higher levels of equity investment without penalizing the intended beneficiaries of pension fund investment decisions.

The credit/levy proposal would have other consequences contrary to a successful investment plan by a pension fund. First, the proposed levy would be considered as a taxation of pension funds. Given the results of the past decade, fund managers might well consider following a government acceptable investment plan (i.e., a levy-free one) to be a less-desirable choice than to pay the levy. Taxation of pension funds is very unpalatable, for it either raises the cost of providing pensions or reduces the actual pensions. We suggest that neither result is desirable in an aging society.

Second, two of the problems that have been faced by pension fund managers are the shortage of suitable stocks available for investment in Canada and the difficulty of diversifying investments. Our markets tend to be over supplied with cyclical stocks or stocks with low-capital levels, which are simply too risky to justify committing large amounts of capital to them. One response to this situation is to expand the level of foreign investment in the pension plans, and we commend the Government for its proposal to gradually raise the permitted level of foreign investment to 20 percent. Under the credit/levy proposal, however, the foreign investment would be subject to the levy. We submit that this would be at odds with the salutary development of an increased permitted level of foreign investment.

Third, the proposed credit/levy mechanism would impose additional monitoring and recordkeeping burdens on fund managers, consuming both time and resources.

Fourth, many pension plans, particularly "mature" plans with a substantial number of pensioners, have matched liabilities with assets under a process known as "immunizing." Under this approach, known fixed liabilities are matched with fixed-income investments that produce a cash flow sufficient to meet the liabilities. The new levy would penalize plans that undertook to immunize their liabilities either explicitly or indirectly by tying the asset-mix decision to anticipated liabilities structures. Indeed, the penalty would be imposed not only in respect of new investment decisions but also in respect of past decisions that were made for proper purposes. We question whether the development of a reasonable transition period would alleviate this problem.

Finally, a significant part of the pensions already in payment plus some of the pensions accrued for have been fully provided for under group annuity contracts. These pensions have been bought and paid for. Consequently, there are no investments to sell and reallocate if the proposed system comes into existence. Thus, group annuity contracts already in existence would seemingly be unduly penalized by the credit/levy proposal.

Conclusion

For the foregoing reasons, TEI strongly recommends that the proposals for non-deductibility of payroll and capital tax and for a penalizing levy on pension funds be abandoned.

TEI appreciates this opportunity to present its comments on these budget issues. If you should have any questions about this submission, please do not hesitate to call either Donald K. Cornborough, TEI's Vice-President for Canadian Affairs, at (604) 828-7315 or Hugh d. Berwick, Chair of the Institute's Canadian Income Tax Committee at (514) 848-8235.

(1) Like other provisions limiting or apportioning a tax deduction or credit among members of a corporate group, the Budget proposal would impose additional administrative burdens on taxpayers. Moreover, the added costs of incorporating and maintaining additional corporations would usually exceed the tax saving of each company's deducting $10,000 of payroll and capital taxes. Consequently, it is unlikely that companies would be incorporated solely for the purpose of obtaining the $10,000 payroll and capital tax deduction.
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Publication:Tax Executive
Date:May 1, 1991
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