Draft legislation relating to Foreign Investment Entities and Non-Resident Trusts: December 16, 2002.

On December 16, 2002, TEI submitted a letter to the Minister of Finance John Manley urging the Canadian government to withdraw proposed legislation released on October 11, 2002, relating to Foreign Investment Entities and Nonresident Trusts. The letter recommended as an alternative that the implementation date at least be deferred until taxation years beginning after December 31, 2003, to afford taxpayers time to study the legislation and consult further with the government. (TEI commented on two previous drafts of the legislation. The most recent comments on the second draft of the legislation are reprinted in the November-December 2001 issue of The Tax Executive, beginning at pages 467 and 469. The earlier comments on the first draft of legislation were reprinted in the March-April 2001 issue, beginning at page 138.)

TEI's comments were prepared under the aegis of its Canadian Income Tax Committee, whose chair is Monika M. Siegmund of Shell Canada Limited. Contributing to the development of TEI's comments were Vince Alicandri of Hydro One Networks, Carmine A. Arcari of Royal Bank of Canada, Hugh D. Berwick of Alcan Inc., and Alan Wheable of Toronto-Dominion Bank.

A draft of proposed legislation relating to Foreign Investment Entities (FIE) and Non-Resident Trusts (NRT) was announced by the government on October 11, 2002. Although the draft FIE and NRT legislation has been revised substantially from the previous versions of the legislation, Tax Executives Institute believes the legislation remains fundamentally flawed and unworkable. Hence, on behalf of TEI, I am writing to urge the government to withdraw the legislation.

Equally important, after more than two years of work by the Department of Finance to develop, revise, and fine-tune the legislation, TEI believes that it is unreasonable for the government to impose an implementation date of January 1, 2003. Taxpayers have been afforded less than eleven weeks prior to the legislation's implementation date to analyze the draft legislation and submit comments to the government on the third and latest version of the proposed legislation. Moreover, even assuming the revised rules are sound--and our preliminary analysis suggests that the regime remains over-inclusive and would benefit from additional consultations--taxpayers will need substantially more lead time to modify or develop the information systems necessary to comply with these mind-numbingly complex provisions. Consequently, we urge the government to immediately announce a deferral of the implementation date to taxation years commencing after December 31, 2003.

Background

Tax Executives Institute is the pre-eminent association of business tax executives. The Institute's 5,300 professionals manage the tax affairs of 2,800 of the leading companies in Canada, the United States, and Europe and must contend daily with the planning and compliance aspects of Canada's business tax laws. Canadians constitute 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 eight geographic regions. Our non-Canadian members (including those in Europe) work for companies with substantial activities in Canada. In sum, TEI's membership includes representatives from most major industries including manufacturing, distributing, wholesaling, and retailing; real estate; transportation; financial services; telecommunications; and natural resources (including timber and integrated oil companies). The comments set forth in this letter reflect the views of the Institute as a whole, but more particularly those of our Canadian constituency.

TEI is concerned with issues of tax policy and administration and is dedicated to working with government agencies in Ottawa (and Washington), as well as in the provinces (and the states), to reduce the costs and burdens of tax compliance and administration to our common benefit. We are convinced that the administration of the tax laws in accordance with the highest standards of professional competence and integrity, as well as an atmosphere of mutual trust and confidence between business and government, will promote the efficient and equitable operation of the tax system. In furtherance of this principle, TEI supports efforts to improve the tax laws and their administration at all levels of government.

To that end, TEI submitted detailed comments on the previous drafts of the FIE and NRT legislation in February and October 2001. In addition, we met with representatives of the Department of Finance several times in order to discuss our concerns about the scope and operation of these provisions. We are pleased that the consultative process has been so open and forthright and pleased also that the government has incorporated several of TEI's recommended changes in the draft legislation. Despite the substantial restructuring of the latest proposed rules from the prior drafts, the legislation remains deeply flawed, and we are especially disappointed by the seeming rush to implement the legislation.

Discussion

The draft Non-Resident Trust (NRT) and Foreign Investment Entity (FIE) legislation released by the Department of Finance on October 11, 2002, is intended to replace the current rules in respect of foreign trusts in section 94 of the Income Tax Act (hereinafter "the Act") and the "offshore investment fund" rules found in section 94.1 of the Act. The October 2002 draft legislation supersedes the previous drains that were released June 22, 2000, and August 2, 2001.

The current rules in sections 94 and 94.1 are anti-avoidance provisions intended to prevent taxpayers from inappropriately deferring or avoiding tax (including conversion of income to capital gains in specific situations). Current section 94 applies where a person resident in Canada transfers or loans property to a foreign trust that has one or more beneficiaries resident in Canada. Current section 94.1 applies where a taxpayer has invested in an offshore investment fund and one of the main reasons for the investment is to reduce or defer the tax liability that would have applied to the income generated by the underlying assets of the fund if such income had been earned directly by the taxpayer.

In announcing the June 2000 draft legislation, the Department's press release explained the general purpose of the provisions to expand the scope of the anti-avoidance rules, as follows:

   It is important that the income
   tax system not provide
   a means for Canadians to
   avoid Canadian income tax
   by transferring funds to offshore
   trusts or accounts. The
   proposed rules intend to provide
   a fair and workable approach
   to dealing with this
   complex area.

Regrettably, the FIE rules are far more complicated and potentially apply in many more circumstances than stated in the press release. Indeed, instead of crafting a remedy narrowly targeted at curbing the perceived abuses, these far-reaching proposals sweep compliant taxpayers--those whose ordinary business transactions and operations are not the intended targets of this legislation--into a complex and confusing thicket of rules that will challenge them and their advisers to find an applicable exemption in order to avoid the draconian tax results that flow from classification of an entity as an FIE.

Although the October 2002 draft legislation includes important and substantial revisions from the previous drafts, TEI believes the latest proposed rules remain overbroad, extraordinarily complex, confusing, and, in the case of the FIE provisions, overlap and conflict with the entire foreign affiliate regime, including section 17 as it applies to loans to non-residents. As a result, the provisions will interfere with legitimate business operations. Moreover, the structure of the proposed legislation has been substantially revised in the latest draft, making a detailed analysis and comparison with previous drafts (as well as current law) even more challenging for taxpayers who desire to remain "on-side" and comply with the law.

At its core, the draft legislation remains unworkable and TEI urges as its principal recommendation that the government withdraw the proposals. If new anti-avoidance rules are necessary, the structure of the proposed legislation should be completely revised and based on narrower, targeted objectives with a more limited scope and effect than the October 11, 2002, draft.

If the government will not withdraw the legislation, the implementation date should at least be deferred until taxation years commencing after December 31, 2003, in order to afford taxpayers and practitioners time to undertake a proper analysis of the rules and provide comments to the Department of Finance. The purpose of this draft legislation is too important and the potential effect on ordinary business transactions too extreme for the government to "get it wrong." We believe that additional consultations are necessary to ensure that the rules do not overreach their target and impair ordinary business transactions and operating entities. The abbreviated period between the announcement of the labyrinthine legislation and its proposed implementation date poses a substantial risk that the rules will miss the targeted abuses and instead hit compliant taxpayers.

Finally, as a matter of fundamental fairness, the government should afford taxpayers time to digest and understand this legislation in order to modify company information systems to capture and report the required information. When the final draft of legislation as complex as this is ready for implementation--and TEI does not believe this legislation is ready--taxpayers should be given more than eleven weeks notice to implement the necessary system changes and comply with it. Thus, we urge the government to reconsider the legislation generally and its implementation date specifically.

Conclusion

TEI is continuing its analysis of the October 11, 2002, draft of the proposed FIE and NRT legislation and will submit additional, detailed comments as soon as possible. We shall be pleased to meet again with the Department to explain and elaborate on our concerns about the latest draft of these provisions.

These comments were prepared under the aegis of the Institute's Canadian Income Tax Committee, whose chair is Monika M. Siegmund. If you should have any questions about the submission, please do not hesitate to call Ms. Siegmund at 403.691.3210, or Glenn G. Wickerson TEI's Vice President for Canadian Affairs, at 403.233.1135.