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Comments on pending Canadian income tax issues: November 14, 1991.

On November 14, 1991, Tax Executives Institute submitted the following comments to the Canadian De in connection with TEI's December2,1991,liaison meeting with Finance Officials. The comments were pr of the Institute's Canadian Income Tax Committee, whose chair is Hugh D. Berwick of Alcan Aluminium participating in the development of the comments was Andrew G. Kenyon of the Canadian Imperial Bank is the Institute's Vice President-Region I.


Tax Executives Institute welcomes the opportunity to present the following comments on several pending tax issues, which will be discussed with representatives of the Department of Finance during TEI's December 2, 1991, liaison meeting. In the meantime, if you have any questions about these comments, please do not hesitate to call either Andrew G. Kenyon, TEI's Vice President for Canadian Affairs, at (416) 980-3305 or Hugh D. Berwick, chair of the Institute's Canadian Income Tax Committee, at (514) 848-8235

TEI's an international organization of nearly 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 the United States.

Canadians make up approximately 10 percent of TEI's membership, with our Canadian members belonging to chapters in Calgary, Montreal, Toronto, and Vancouver, which together make up one of our nine geographic regions. In addition, a substantial number of our U.S. members work for, or are otherwise affiliated with, companies with significant Canadian operations. In sum, TEI's membership includes representatives from most major industries, including manufacturing, distribution, wholesaling, retailing, real estate, transportation, financial, and resource (including mining, pulp and paper, and petroleum). These comments reflect the views of the Institute as a whole but more particularly those of our Canadian constituency, which is principally responsible for their preparation.


A. Creditability of the Large Corporations Tax

The Large Corporations Tax (LCT) is biased against corporations in capital-intensive industries for several reasons. Their rate of return on capital investments is usually not sufficiently high to absorb the LCT paid over the seven-year carryforward period. Therefore, those corporations bear a disproportionate share of the burden of LCT. The increase in the LCT rate from 0.175 percent to 0.2 percent effective January 1, 1991, has further exacerbated those concerns. This is of particular concern given the independent effect of the proposed disallowance of a deduction for provincial payroll and capital taxes, which will also adversely affect that sector of the economy.

TEI recognizes that not every change in the tax laws can or will affect all taxpayers equally. Nevertheless, from a tax policy perspective, we believe the Government should take steps in designing any tax legislation to minimize the distributional effect of the change. The LCT was introduced as a new levy on the corporate sector to raise additional revenues to help reduce the federal deficit. Under the circumstances, we believe the anti-capital intensive bias of the LCT is unjustified.

Accordingly, TEI recommends that the following changes be adopted to make the distribution of the additional tax revenues raised from the corporate sector with the Part I.3 tax more equitable:

* The corporation's Part I tax, including

the surtax, should fully

offset the corporation's LCT.

(See Comment II.C below concerning

the ordering of creditability.)

* The carryforward period of the

unused Part I.3 tax credit

should be extended indefinitely.

B. Transfer of the Part I.3 Tax Credit Between Related Corporations

TEI recommends that the transfer of the Part I.3 credit within a related corporate group should be allowed. Allowing such a transfer would be a minor move to tax consolidation on a federal-only basis, which would not be accompanied by the problems that a loss transfer system for Part I taxes would have. (See Comment XV below.)

C. Part I Tax Creditability Against the Large Corporations Tax

During last year's liaison meeting, TEI recommended that the LCT be changed to allow the surtax to be fully creditable against the large corporations tax. This inversion would render the LCT eligible for the foreign tax credit treatment for U.S. income tax purposes without affecting a company's aggregate liability for Part I and Part I.3 taxes.

At that time, the Department expressed reluctance to adopt TEI's proposal because of a latent concern that such a change might create an opportunity for foreign controlled companies, particular U.S. companies, to obtain a tax benefit by shifting income out of Can ada. We fail to understand how a company would be encouraged to shift income out of Canada simply because its Part I income tax could be reduced by its LCT. Has the Department undertaken to confirm whether its concern is valid? If the concern cannot be supported by further analysis, we urge the Department to reconsider TEI's proposal.

D. Investment of Which the Carrying Value Has Been Reduced by Reserves

When the carrying value of an investment has been written down with an accounting reserve, paragraph 181.2(3)(b) mandates that the reserve be added back to the company's capital. Unfortunately, the amount of investment allowance on the same item under subsection 181.2(4) is restricted to its carrying value. TEI recommends his inconsistency of treatment be eliminated by changing the words "the carrying value" in the preamble of subsection 181.2(4) to read "the carrying value plus any reserve added back under paragraph 181.2(3)(b)."


Leasing of depreciable property is a very important component in a country's financing of its industrial base. Leasing presents the alternative of off-balance sheet financing as well as 100-percent financing, which is not generally available in lending situations. Canada's major trading partners, including the United States, have large and efficient leasing industries providing financing to companies in competition with Canadian industry.

As part of tax reform, capital cost allowance (CCA) rates were reduced to eliminate undue tax preferences. These general reductions, however, were at the time not considered sufficient for leased assets and, consequently, a more restrictive capital cost allowance system was introduced for leased assets. The deleterious effect of the rules on the competitiveness of Canadian industry was implicitly conceded inasmuch as certain industries were successful in seeking exemption from the revised rules. Non-exempt industries, however, have been rendered less competitive by these revisions to the leasing regulations. Restricted capital cost allowances, combined with burdensome administrative requirements, have made leasing costs for low-value leases prohibitive. It is within this context that we offer the following comments.

A. CCA Restriction Threshold

The current threshold of $25,000 for application of the CCA restrictions is so low that only very small leases are exempted from the leasing restrictions. As previously stated, perhaps in response to the low threshold level, certain segments of the economy have been exempted to permit them to more effectively meet foreign competition.

TEI recommends that the threshold be raised to make leasing available on a competitive basis to Canadian businesses in all industries. We believe that a threshold between $500,000 and $1,000,000 would allow Canadian businesses to obtain lease financing without creating undue tax benefits for lessors.

B. Prescribed Interest Rates

Lessors are required to limit the capital cost allowance on specified leasing property to the amount of principal that would be received if the lease were treated as a loan and the lease payments considered to be blended payments of principal and interest. The interest rate is prescribed by regulation.

The prescribed interest rate in all cases is the rate on Government of Canada bonds with a term to maturity of more than 10 years, plus one percentage point. Most equipment leases, however, have terms of three to seven years and, with declining principal amounts, are comparable to bonds of even shorter terms. In order to better match the prescribed interest rates to actual leasing rates, we recommend that the prescribed rate be based on Government of Canada bonds with a term to maturity of three to five years.(1)

There is a demand in Canada for foreign currency denominated leasing, particularly U.S. dollar leases, so that exporters can obtain financing at the same rates as their foreign competition. Many Canadian lessors are, or wish to be, involved in the offering of U.S. dollar leases. Rates based on Canadian prime can lead to reduced capital cost allowances compared to the amount that would be available if the actual rate of interest were used in computing the deemed principal. This results in accelerated taxation. We recommend that the prescribed interest rate for foreign currency denominated leases be based on comparable foreign bond rates, such as United States Treasury bonds, with terms to maturity from three to five years.

C. Conflict between Capital Cost Allowance Policy and the Leasing Regulations

Department of Finance Release Number 90-17, pertaining to the revised draft leasing regulations, also included a special incentive of a 100-percent write-off of new point of sale (POS) equipment, such as cash registers. This rule was designed to assist retailers in acquiring new equipment capable of handling the Goods and Services Tax (GST). Since no exemption from the leasing restrictions was provided for POS equipment, however, the GST-related incentive is not available to retailers who lease their equipment unless it is part of a lease totalling 25,000 or less. Once again, this reduces the financing choices of Canadian business. TEI believes that targeted incentives such as the one for POS equipment should be neutral as between a purchase and a lease.

D. Lessee's Election

By making an election under section 16.1 of the Income Tax Act, a lessee is permitted to assume some of the tax attributes of leasing that are denied to lessors on specified leasing property. The election must be made by both the lessee and the lessor and must be filed by the due date of each party's tax returns for the year in which the lease is executed.

TEI does not believe that a lessee's entitlement to the benefits of the section 16.1 election should be held hostage to the lessor's failure to file a copy of its election. This is so because filing a leasing company's tax return has been complicated by the requirement for an asset-by-asset CCA calculation, as well as a myriad of elections and other matters under federal and provincial tax laws. Non-filings might occur because the election forms originate in remote offices of many lessors and must be collected at the head office.

To ensure that a lessee will not be penalized on account of the lessor's oversight TEI recommends that only the lessee be required to file the completed election form. Alternatively, the late filing of the election by the lessor should be permitted (with any appropriate penalties). If the section 16.1 election is not one of the elections so far identified in the "Fairness Package" of May 24, 1991, it should be included.


The promulgation of new rules for pensions creates the likelihood that, in the future, the specific rules of the Income Tax Act will frequently contradict the requirements of provincial pension legislation. One example is subsection 147.2(2), which limits the deduction for contributions made to a pension plan where an actuarial surplus in excess of two years' current service contributions exists.

The ability of an employer to utilize a surplus to achieve a "contribution holiday" depends on the specific wording of the pension plan, and there are already some instances where courts have determined that employer contributions must continue, despite the existence of a surplus. Moreover, future legislation in the Provinces may extend this principle to many more pension plans, which could compel an employer to make contributions without benefit to the attendant tax deductions.

TEI recommends that subsection 147.2(2) be amended to extend deductibility to include all contributions required of law, regardless of the existence of an actuarial surplus.


On April 30, 1991, TEI wrote to the Minister to express its concern with the proposal to limit the deduction for provincial payroll and capital taxes. The Minister's reply of August 12 effectively denies the inequity implicit in the proposal. We wish to reiterate our tax policy objection to a proposal that, in our view, arbitrarily creates winners and losers in the form of a tax lottery.

In his reply, the Minister stated that the option of reducing transfer payments to Provinces that continue to use capital and payroll taxes to erode federal revenues -- was rejected because of the complexities involved in establishing an appropriate link between the effects of deductibility and transfer reductions.

If the Department of Finance is serious about eliminating provincial taxes that are deemed to be offensive, we believe that policy can be furthered by a dollar-for-dollar reduction in payments, based on the amount of such taxes collected by the Province in the previous year. The following table illustrates how the budget proposal will affect two different taxpayers. Corporation "A" might be a labour and capital-intensive business, whereas Corporation "B" is less so. (The difference in the two companies' deductible provincial taxes could also result from the revenue and salary allocation formula.)
 Corporation "A" Corporation "B"
Revenue $ 75,000,000 $ 75,000,000
Payroll Taxes (1,000,000) (250,000)
Capital Taxes (800,000) (200,000)
Other expenses 68,450,000) 67,050,000
Taxable Income 4,750,000 7,500,000
Income Tax 2,042,500 3,225,000
TOTAL TAXES PAID $ 3,842,500 $ 3,675,000
Pre-tax income $ 4,750,000 $ 7,500,000
Payroll Taxes 1,000,000 250,000
Capital Taxes 800,000 200,000
Subtotal 6,550,000 7,950,000
Deduction allowed 6% (393,000) (477,000)
Taxable Income 6,157,000 7,473,000
Income Tax 2,647,510 3,213,390
TOTAL TAXES PAID $ 4,447,510 $ 3,663,390
IN TOTAL TAXES $ 605,010 $ (11,610)

The budget proposal suggested that the rules would be revenue neutral for the Government. If so, there obviously will be many taxpayers like Corporation "B" that receive a windfall reduction in tax liabilities. TEI continues to believe that the proposed approach is illogical and inequitable. We renew our recommendation that any initiatives on this problem be limited to a government-to-government approach, either through reduced transfer payments or otherwise.


Canadian industries are increasingly exposed to international competition in markets at home and abroad. A direct consequence of this increased competition is that certain capital investments will experience a shorter useful asset life cycle than was anticipated when the investment occurred. industry segments that are involved in areas of rapid technological change or intense competition likely would be most affected.

Because of the rapidity with which change occurs in today's marketplace and its impact on related industries, TEI recommends that a separate CCA class be established for assets that are no longer it in use by the taxpayer. These assets could be transferred from their original CCA class at their undepreciated capital cost (UCC) amounts (less salvage) to the new class and then be written off at year end. The UCC of individual assets could be calculated on the assumption that the maximum CCA had been claimed in prior years.


Income for income tax purposes is generally determined pursuant to section 9, which is premised on the use of general commercial principles and practices of accounting. This has provided for the matching of expenses incurred against the revenues earned, except where specific provisions have been legislated to accomplish policy objectives. TEI endorses the importation of general accounting and business principles into the realm of interest deductibility (including other financing charges). Allowing general accounting and business principles to dictate interest deductibility would inject more fexibility into the tax rules and thereby better accommodate the new and complex transactions that are now undertaken within the global economy.

The Income Tax Act has not kept pace with the changes that have occurred in his area, and the result has been the creation, through default, of an environment of uncertainty that impedes Canada's ability to remain competitive. We believe that the matching principle underlying section 9 of the Income Tax Act and Generally Accepted Accounting Principles should be used as the foundation for determining interest deductibility under the Act. We would be pleased to consult with the Department on this important issue and, in this regard, request a report on the Department's ongoing study on the deductibility of interest.


The regulations dealing with CCA on Classes 24 and 27 allow an accelerated write-off of pollution-control property over a period of three years (i.e., 25 percent, 50 percent, 25 percent).

Both Classes 24 and 27 state that qualifying property must be acquired primarily for the purpose of pollution control in conjunction with the discharge of pollutants as a result of --

* operations carried on by the

taxpayer at a site in Canada on

which operations have been

carried on by the taxpayer for a

time that is before 1974;

* the operation in Canada of a

building or plant by the taxpayer,

the construction of which

was either commenced before

1974 or commenced under an

agreement in writing entered

into by the taxpayer before

1974; or

* the operation of transportation

or other moveable equipment

that has been operated by the

taxpayer in Canada (including

any of the inland, coastal or

boundary waters of Canada)

from a time that is before 1974.

The entire philosophy of restricting Class 24 and 27 property to sites where the taxpayer has carried on operations since 1974 seems at once counterproductive and unduly harsh at a time when some of the major challenges facing Canada are in the environmental sector. In order to comply with the spirit and intent of applicable laws or regulations in this area, corporations are expending millions of dollars on pollution control and emergency response equipment, only to be effectively penalized by the restrictive Class 24 and 27 limitations.

TEI recommends that consideration be given to the following alternatives, which would reduce or remove restrictions to Class 24 and 27 entitlement:

* Class 24 and 27 treatment

should be expanded to include

any property acquired for the

prevention, reduction, or elimination

of pollution without regard

to whether operations

were carried on or commenced

at the site prior to 1974.

* If the pre-1974 operation concept

is retained, the legislation

should be expanded to include

all sites that have been in operation

since that time regardless

of who the operator was or is.

* If, for whatever reason, neither

of the foregoing recommendations

is acceptable, then at the

very least the pre-1974 operation

concept should be modified

to encompass operations carried

on within a corporate



In response to complaints from a number of Provinces about the lack of flexibility in the existing tax collection system (coupled with threats by some Provinces to withdraw from the Federal-Provincial Tax Collection Agreements), the Federal Government seems prepared to shift the tax base for provincial tax purposes from federal tax payable to taxable income. Under such a system, the Provinces could establish their own graduated rate schedules. Such an arrangement, it is argued, would afford the Provinces more flexibility in shaping their fiscal policies to meet their social and economic priorities.

In assessing the merits of proposed changes in the tax collection system, TEI recommends that the following principles should be taken into account:

1. The income tax collection

agreement should continue to

be administered by the Federal


2. There should be a common tax

base between the Provincial

and Federal Governments,

though a tax base predicated

on taxable income could be

made just as administrable as

one predicated on federal tax

payable. Indeed, taxable income

may well be a preferred

base, since provincial revenues

would not be automatically

affected by changes in

federal tax rates.

3. In order to achieve unity and

neutrality and thereby remove

tax considerations from

economic decisions, significant

variations in the tax burden.

From one Province to another

should not be encouraged;

nevertheless, the Provinces

should be accorded some

flexibility for minor differences

to accommodate the Provinces'

respective economic and

social objectives.

Adherence to these principles (and hence a common taxable income base) should increase the taxpayers' awareness of what is being paid in terms of provincial taxes. This in turn should increase the Provinces' level of accountability In addition, the use of a common taxable income base would allow the Provinces greater flexibility to achieve their economic and social goals. Accordingly, TEI believes that moving toward a common definition of income while maintaining a single collection system would be the least disruptive alternative to the present system. In contrast, a system that permitted different tax bases in the Provinces from that at the federal level would engender complexities and cost burdens that the Canadian economy can ill afford.


Over the past several years, the Department of Finance has successfully, eliminated many tax biases that previously existed between different industries. There remains, however, a tax bias that continues to disadvantage the resource industry. Specifically, subsection 66.1(3) of the Income Tax Act permits; a taxpayer to deduct any amount of Canadian exploration expenditures that are available to the taxpayer, and subsection 66.1(2) stipulates that it principle business corporation must deduct the maximum amount permissible, subject only to the availability of income. TEI recommends that this bias be removed by deleting the subsection 66.1(2) limitation for a principle business corporation.


Paragraph 37(7)(c) defines expenditures for scientific research and experimental development (SR&ED) as expenditures incurred for, and all or substantially all of which are attributable to, the prosecution of SR&ED. In the case of prototypes, Revenue Canada has interpreted paragraph 37(7)(c) to apply only to laboratory prototypes, i.e., experimental models to prove out a technology.

Although Revenue Canada's interpretation of paragraph 37(7)(c) may make sense where the prototype is a new model of a product that will be manufactured or sold, it is not realistic where the prototype is equipment designed to improve the production process. In the latter case, Revenue Canada apparently believes that where a successful prototype may be incorporated into t he production line, it should not qualify as SR&ED equipment. (See paragraph 21 of Interpretation Bulletin IT-151R3.) This interpretation is wrong because it effectively says to a company contemplating such an expenditure that it will qualify as SR&ED only if it is unsuccessful. It thus inhabits research in Canada.

Consequently, we recommend that the Department of Finance examine this issue and propose a legislative change to rectify this situation.


In connection with TEI's January 11, 1990, liaison meeting with the Department of Finance, the Institute made the following representation:

When employees leave a company

(as a result of terminations,

layoffs, or otherwise), frequently

a company's contributions

since the last withdrawal

entitlement date are forfeited.

Such employees will, of course,

receive their own contributions

plus any accumulated return

thereon, but the forfeited amount

reverts to the plan for redistribution

among the remaining

members of the plan. Subsection

144(9) provides that when

forfeitures occur, the affected

employee will receive a tax

credit of 15 percent of the

amount forfeited. This provision

has been in place without

change since 1956.

In our view, the 15-percent tax

credit allowed by subsection

144(9) is inadequate and unfair.

An employee who suffers

such a forfeiture is effectively

taxed on income he will never

receive. This tax is collected at

a rate equal to the difference

between the employee's marginal

tax rate and 15 percent.

Given that the marginal combined

federal-provincial tax

rate can approach or exceed 50

percent (depending on the employee's

Province of residence),

this amounts to a penalty of [up

to] 35 percent on the forfeited

income. The inequity of the situation

is exacerbated by the

fact that forfeitures typically

occur in unplanned situations,

such as terminations and lay-offs.

The Department responded that the inadequacy of the 15-percent credit has been recognized for some time. Nevertheless, we were advised that if the rules were changed, it would require reallocations of the forfeited amounts to the remaining members of the plan who would then be taxed on the reallocated amounts. The Department suggested that the reallocation requirement would spawn greater problems than the 15-percent credit, but did state its willingness to reconsider the matter.

Our understanding of subsection 144(1) is that it already requires plan administrators to allocate to employees all amounts received from the employer, including all forfeited amounts for which there is deemed to have been a tax payment made under subsection 144(9). Furthermore, subsection 144(3) requires an employee to include in income all amounts allocated to him by the trustee. Based on our interpretation of these subsections (coupled with the experience of our members with the actual administration of such trusts), we submit that the reallocations that Finance is seeking to avoid are already required by the Income Tax Act and, indeed, have for some time been effected.

In summary, we urge the Department not to lose sight of the fact that under the current regime substantial double taxation occurs -- the reallocation of forfeited amounts to the remaining members of a plan -- on every dollar forfeited, with the remaining members paying tax at a rate equal to the difference between their marginal tax rates and 15 percent. The practical effect can be to subject the income to an aggregate effective tax rate of 85 percent, which is clearly not justifiable. Consequently, we reiterate our earlier recommendation that subsection 144(9) be amended to provide for a deduction from income of any such forfeitures in lieu of the existing tax credit.


During our November 19, 1990, liaison meeting, representatives of the Department of Finance disagreed with TEI's proposal for general deductibility of interest on income taxes. The Department did agree, however, to review the possibility of allowing corporations to net interest on tax refunds against interest on tax deficiencies. What is the status of this review?


A major expressed concern of taxpayers, professional advisers, and government officials is complexity of the tax law. Al though across-the-board tax simplicity is an elusive goal, TEI believes it is possible to identify and act upon certain causes of undue complexity. A primary purpose of the simplification effort should be certainty: to enable taxpayers to make business decisions with reasonable certainty of tax consequences. That goal is compromised, however, in cases of retroactive and retrospective legislation, excessive between announcement and enactment of a tax change, and unnecessary complexity in the wording of the law. These three issues will be dealt with seriatim.

A. Unnecessary Complexity

Income taxation is of necessity extremely complex. Complexity can exist in the administration of the law as well as in the law itself Our comments here deal with the complexity of the law. Consider the following examples:

* Section 47.1, dealing with indexed

security investment

plans (ISIPs), was a very interesting

concept. It was enacted

during a time of high inflation

in an effort to address in part

the problem of non-indexation

of the cost of capital property.

The introductory sentence of

section 47.1 contained over

2,000 words and was followed

by 25 other subsections. Few

people understood the full details

of the ISIP provisions and

the explanations to investors by

trust companies were, by and

large inadequate. The prolixity

and complexity of section

47.1 were likely principal factors

in sealing the fate of ISIPs.

A fairly simple alternative to

ISIPs which is used in many

countries, would have been to

index the cost of capital property

using some inflation factor.

* The preferred share rules are

a good example of legislative

"overkill." These provisions

are so confusing that they require

renewed study every time

there is a plan to issue any type

of share other than the most

basic common share. Potential

concerns about the preferred

share rules arise during legitimate

transactions such as so-called

butterfly reorganizations

(where the purpose is to

separate the interests of the

shareholders) in ways that we

believe were never clearly intended

when the preferred

share rules were drafted.

These rules were seemingly

drafted to forestall all real, perceived,

and chimerical abuses

conceivable by Finance with

respect to preferred shares as

well as, for good measure, to

accord the Government authority

to attack still inchoate


* Another example of undue complexity

is the Government's

proposal concerning the prepaid

interest bond provisions

under proposed subsections

18(9) and (9.2). As TEI has

previously argued, these provisions

are simply unnecessary

in light of the General Anti-Avoidance

Rule. Nonetheless,

they will be incorporated into

the Income Tax Act, confusing

and perplexing taxpayers for

years to come.

Two steps can be taken to address the problem of complexity. First, Finance should resist the temptation to engage in what we have called "overkill" in an effort to close real and perceived "pinholes in the Income Tax Act. Concededly, there may be times where specific legislation is needed to staunch abuses that the Government feels may exist. We question, however, whether the added complexity and the restrictions on legitimate activities can be justified by the desire to reach all foreseen (and to anticipate unforeseen) evils. Second, more detailed explanations of proposed amendments should be provided. Such explanations of the purpose of the amendments -- and the abuses they are intended to curtail -- would be of considerable use to taxpayers and tax advisers and, ultimately, possibly to judges in understanding the provisions.

B. Undue Delay

Another difficulty for most tax practitioners is differentiating between actual law and proposed law. Some publishers have helpfully included certain proposed amendments in their versions of the Income Tax Act. It remains extremely difficult, however, to provide advice on tax matters where there is uncertainty over whether and when certain proposals will actually become law. This problem is exacerbated by the long interregnum between the announcement of budget proposals, introduction of (draft) legislation, the release of a massive volume of proposed changes, and the final act of Royal Assent. (One obvious example is the recent technical amendment bill, Bill C-18.) The long delay and large number of amendments make it difficult for taxpayers and taxpayer representatives to make meaningful comments on the amendments and, we suspect, more difficult for the Finance Committees to review the proposed legislation.

TEI recommends that the Department of Finance adopt a policy of introducing technical amendments on a yearly basis at a particular time in the year. Such an approach will not remove the possibility of subsequent additional amendments (where absolutely necessary), but it will bring some order out of the chaos that currently reigns. By evening out the workload of drafting, reviewing, and understanding tax law amendments, there will be an enhanced understanding of the revised law within a reasonable time.

C. Retroactivity and Retrospectivity

In the past, TEI has addressed the desirability of protecting taxpayers from increased taxation by way of retroactive or retrospective legislation.(2) We recognize that the courts have consistently ruled that the Federal Government has the power and ability to enact retroactive and retrospective legislation. We also recognize that the Department of Finance has historically been unwilling to cede its ability to tax retroactively. The Government's raw power to tax retroactively, however, in no way imbues such actions with any sound tax policy or moral basis.

Retroactive legislation can impose a higher tax liability on taxpayers for some period and with respect to some transactions than the law actually provided for during the period in question. It additionally raises the possibility of no-deductible interest charges (and, potentially, penalties) being imposed or taxpayers through no fault of their own. This latter concern can be addressed by establishing a policy whereby no interest or penalty will be due on an additional tax for any period prior to the coming into force of the law that g generated the tax increase.

Eliminating interest until (or crediting interest for the period up to) the coming into force of a tax increase would serve several purposes:

* It would reduce the penalty on

a taxpayer who has acted in

accordance with the law that is

actually in force.

* It would create an incentive for

the Government to enact tax

legislation expeditiously.

* It would provide more reason for

technical amendment bills to be

introduced on a regular basis.

We recognize, however, that such a proposal may be impossible to enact on a universal basis. Accordingly, we recommend that, in practice, no interest or penalty be charged for any period prior to (or a credit granted for the period up to) the date on which the amending legislation was introduced. In addition, we recommend that a fixed period -- say, one year -- be set during which legislation that has been introduced must be passed. If not passed during that time, the legislation could be reintroduced, but the period during which a taxpayer could be subjected to interest and penalties would be limited to one year. Finally, we believe that retroactive and retrospective tax increases should, as a matter of principle, be limited to extreme situations.


Tax Executives Institute has consistently urged change in the tax treatment of corporate groups that, because of regulatory or other practical business reasons, are unable to attain any form of consolidated income tax reporting comparable to the various systems enacted by our major trading partners. The need for such reform is not limited to large corporations; indeed, it is perhaps more critical to medium and smaller sized corporations that may not have access to the sophisticated tax advice necessary for tax planning alternatives.

Two years ago, representatives of the Department of Finance stated that some of the Provinces had expressed concern that tax revenues might fall in the short term if a tax-loss transfer system were introduced. We continue to believe that any resulting erosion of revenues could be effectively minimized by making the provisions prospective.

Moreover, we question whether the concerns remain valid in light of the substantial changes worked by tax reform. At our December 1990 meeting, it was suggested that the economic models used to evaluate the effect of a loss transfer system should be revised to reflect the tax information for post-tax reform years. The statistics for the post-reform period first became available last fall, and we assume that the Department has undertaken to revise its economic models accordingly. During the liaison meeting, we request a report on this effort. Specifically, what do the new analyses show, and have meetings been arranged with the Provinces to further the tax consolidation proposals? If not, has further consideration been given to a "federal only" interim solution to the problem?


Tax Executives Institute appreciates this opportunity to present its comments on pending tax issues. We look forward to discussing our views with you during the Institute's December 2, 1991, liaison meeting.

Proposed Canadian Legislation on Prepaid Interest Bonds

November 11, 1991

On November 11, 1991, Tax Executives Institute submitted the following letter to Ian E. Bennett, Senior Assistant Deputy Minister (Tax Policy and Legislation) of the Canadian Department of Finance. The letter, which addresses draft legislation designed to prevent business borrowers from claiming tax deductions for interest payments when those payments are deemed to represent the repayment of the principal of a debt obligation, was signed by TEI Regional Vice President Andrew G. Kenyon of the Canadian Imperial Bank of Commerce, and was prepared under the aegis of the Canadian Income Tax Committee.

On July 22, the Minister released draft legislation designed to prevent business borrowers from claiming tax deductions for interest payments when those payments are deemed to represent the repayment of the principal of a debt obligation. Tax Executives Institute believes that the use of specific legislation to curtail certain pre-paid interest schemes represents another case of excessive rulemaking. If passed, the rules will affect not only the "schemers," but also other taxpayers who have undertaken in good faith to arrange legitimate financing in accordance with extant tax rules.

TEI acknowledges that certain prepaid-interest arrangements may warrant scrutiny on the ground that they ostensibly generate interest deductions that, in the view of many tax professionals, could properly be challenged by Revenue Canada. Indeed, that is the point: an arithmetic analysis of the schemes by itself could well have justified Revenue Canada's concluding that the arrangements constituted an "abuse" under General Anti-Avoidance Rules. In other words, although abuses may well exist, there is no need to introduce legislation of broad scope to combat them. The answer lies in enforcing the current rules, not in legislating further rules to close perceived tax "pinholes."

TEI believes that a better approach would have been for Revenue Canada to have issued an Interpretation Bulletin or other guidance that clearly set forth its position on "abusive" prepaid-interest arrangements. The guidance could have explained Revenue Canada's intention to disallow "unreasonable" deductions and elaborate by including examples of unacceptable arrangements. The result of this would have been identical to the one the Government enunciated in releasing the draft legislation: "abusive" schemes would no longer have been entered into, since tax professionals would have then known the Government's position regarding such schemes. At the same time, taxpayers that engage in legitimate transactions would have retained the ability to proceed with their plans.

TEI appreciates this opportunity to present our views on the proposed legislation and would be pleased to follow up with you or your colleagues. In this regard, please do not hesitate to call either Hugh D. Berwick, chair of the Institute's Canadian Income Tax Committee, at (514) 848-8235, or [Andrew G. Kenyon, TEI's Vice President-Region I (Canada)] at (416) 980-3305. (1) There are relatively few leases written for terms of more than 10 years but, if desired, leases with a term of 10 years or more could be based on the long-term bond rate. (2) Since these words are not always used in a consistent manner, we note that here "retroactive legislation" means legislation that affects the taxation of a period prior to enactment of the legislation, whereas "retrospective legislation" means legislation that involves future periods, yet affects prior events. We note that "retroactive legislation" can also be used to apply to legislation affecting taxation for a period prior to the announcement, or introduction, of the legislation.
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Title Annotation:submitted by Tax Executives Institute to Canadian Department of Finance; includes letter on proposed legislation on prepaid interest bonds, November 11, 1991
Publication:Tax Executive
Date:Jan 1, 1992
Previous Article:Forum on State Tax Administrative Uniformity: December 13, 1991.
Next Article:Indopco v. Commissioner: the Supreme Court takes National Starch to the cleaners.

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