Implementation of a formal loss transfer system: June 20, 2003.

On June 20, 2003, TEI President Drew Glennie submitted a letter to Canadian Minister of Finance John Manley urging the Department of Finance to review its 1985 proposal to establish a corporate loss transfer system, re-propose it for consultation with taxpayers in 2003, and implement such a system legislatively during 2004. The adoption of a formal system for sharing corporate group losses, Glennie said, would remedy a deficiency in the Income Tax Act. TEI's comments were prepared under the aegis of TEI's Canadian Income Tax Committee, whose chair is Monika M. Siegmund of Shell Canada Limited. Contributing substantially to the preparation of the submission was David M. Penney of General Motors of Canada Limited. Also contributing to the development of TEI's comments were Sab Meffe of Canadian National Railway, Ronald L. Cook of TransCanada Pipelines, Limited., Stephen J. H. Drielsma of Manulife Financial, Peter M. Sorenti of Ivaco, Inc., and Morris M. Weinstock of Bell Canada 

On behalf of Tax Executives Institute (TEI), I am writing to urge the government to introduce a formal system to permit the sharing and utilization of tax losses and other tax attributes among groups of related corporations. A formal tax loss-transfer mechanism--or group tax loss relief--has been a matter of discussion in Canada for many years. The government eliminated the previous loss consolidation system in 1952 and a debate, which continues to this day, ensued about developing and implementing a replacement system. In May 1985, the Department of Finance joined the debate by issuing a discussion paper entitled A Corporate Loss Transfer System for Canada, outlining a proposal to remedy this deficiency in Canada's tax system. TEI commented on the Department's 1985 paper and has subsequently raised the issue in multiple forums and in liaison meetings with representatives of the Department of Finance. The time for debate has ended; the time for action has arrived.

Background

Tax Executives Institute is the preeminent 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. 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, and must contend daily with the planning and compliance aspects of Canada's business tax laws. 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 concerns itself with important 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 Be Globally Competitive, Canada Should Implement a Formal Loss-Transfer System

Recent federal budgets have focused on aligning Canada's tax rate structure to be competitive with that of other jurisdictions. To assess the competitiveness of the Canadian tax system and its relative tax burden, the government must consider not only the tax rate but also the tax base. Indeed, the government must consider all aspects of the tax system as a whole and, in respect of tax loss utilization for corporate groups, TEI regrets the Canadian system is too restrictive and subject to considerable administrative uncertainty.

Of thirty OECD countries surveyed in 2001, Canada was one of only four countries that did not provide group tax loss relief directly through its legislation. (1) In evaluating the merits of a formal loss-transfer mechanism (including its potential short-term revenue effect) in the legislation, the government should bear in mind that a formal system will simplify or obviate entirely many transactions that are carried out routinely, though inefficiently, today. Specifically, the current informal ad hoc system for transferring and sharing tax losses among related Canadian companies requires companies to engage in various forms of corporate reorganizations. Such reorganizations are costly--requiring companies to divert time and administrative resources from other projects and incur substantial expenses, including professional consulting fees--and generally depend upon administrative concessions being granted by Canada Customs and Revenue Agency (CCRA).

Even though CCRA administratively permits related parties to transfer losses through various techniques, the tax result in any particular case depends upon the agency's exercise of discretion and that engenders a degree of uncertainty for taxpayers. For example, until the early 1990s, CCRA routinely permitted various arrangements for intra-group loss utilization, but to the surprise of many, CCRA successfully challenged a particular loss-transfer arrangement in Mark Resources. (2) In addition, decisions in other cases have prompted a pause in the issuance of advance rulings on reorganizations and loss transfers while CCRA reconsidered its guidelines for administrative concessions. (3) The adoption of a formal loss-sharing and transfer mechanism in the Income Tax Act would complement the current administrative concessions and provide much needed certainty of result and stability in the law.

As important, some business reorganizations and loss transfers are precluded by regulatory restrictions thereby disadvantaging the regulated companies vis-a-vis unregulated businesses and global competitors. In other cases, the transactions necessary to effect the loss transfer may produce an ineffective management structure, which will generally result in a decision to forgo the tax loss. In today's competitive global environment, where investment capital and labour are highly mobile, TEI submits that the goal of achieving a tax-efficient corporate structure should not be at odds with management-efficient structure. It is time to formally implement an effective and efficient tax-loss sharing and transfer system in the Income Tax Act.

Scope and Form of a Loss-Transfer System

In principle, TEI believes that taxpayers should be entitled to full tax refundability of their tax losses. In other words, each corporate entity in a group should be able to monetize the tax equivalent of the loss in the year incurred to the full extent of the taxes previously paid by that entity. When recoveries from cumulative previously paid taxes are exhausted, loss corporations should be able to obtain refundable tax from other taxable corporations within the group. Indeed, the tax-recovery mechanism should extend to all tax attributes that cannot be fully utilized in a particular year. We recognize, however, that practical administrative and revenue constraints may limit the utilization of losses and other attributes.

In 1985 the Department of Finance proposed a system to allow transfers of losses between subsidiaries and their parents or between subsidiaries within a group. To be eligible corporations had to be taxable Canadian corporations and subject to an ownership threshold of 95 percent. The transfer of losses among the corporations in the group would be effected by an annual joint election and be restricted to current year non-capital losses. The loss corporation would reduce its non-capital loss by the amount transferred to one or more corporations within the group and the tax savings would accrue to the recipients of the loss. The recipients of the transferred loss would not be required to compensate the transferor for the loss or for the tax benefits, but if compensation were paid, the payers would not be accorded a deduction for the payment and the payee would not include the amount as taxable income.

The Department considered three basic systems for group reporting: full consolidation, a refundable or negative tax system, and a deduction or loss-transfer system. In developing its proposal, the Department was mindful of four factors:

1. Complexity. The Department said that it was prepared to compromise on the "purity" of any single proposal in order to reduce overall complexity. Thus, although full consolidation of the members of an affiliated group of corporations was considered the most effective form of loss-transfer system (because it treats the group as though all the separate businesses of the corporate members are operated as divisions of a single entity), a full consolidated tax reporting system was rejected because of the extreme complexity such a system would engender.

2. Single economic benchmark. An important measure of the neutrality of a system was the degree to which the tax paid by a group of corporations was comparable to the tax paid by a single corporation operating through business divisions. The Department said that tax neutrality was important to ensure consistent tax treatment of similarly situated businesses and economic enterprises.

3. Effect on government revenues. The adoption of a loss-transfer system was likely to produce an adverse short-term revenue effect on both the federal and provincial governments. The Department was sensitive to the need to minimize the revenue loss.

4. Provincial loss transfer or consolidation systems. To achieve the full benefits of the system, cooperation from the provinces would be required to produce a harmonized federal-provincial system.

In its proposal, the Department decided to allow group transfers of non-capital losses on a current, single-year basis without a carryforward for pre-system losses.

On November 6, 1985, TEI submitted comments on the Department's proposal, commending the government for opening the consultative process and affirming the proposal in principle. We stated then, and reaffirm today, "... adoption of such a system would represent a significant step forward in the effort to bring Canada's tax policy in line with that of its major trading partners and in making the tax system and tax administration more equitable and efficient for government as well as taxpayers."

Regrettably, more than 15 years have elapsed and, despite repeated urging by TEI and others, Canada has not yet adopted a formal loss-transfer system. Moreover, the Auditor General of Canada and Technical Committee on Business Taxation have both criticized the current informal ad hoc loss-transfer system for creating tax and economic policy inefficiencies. (4) Indeed, the Technical Committee on Business Taxation referred to the Department's 1985 discussion paper as a starting point for the implementation of a formal loss-transfer system.

TEI Urges the Government to Act Now

TEI believes taxpayers should be entitled to full refundability of their tax losses and other tax attributes. As a practical matter, however, this will not be feasible given the fiscal, administrative, and policy constraints the government faces. Accordingly, TEI urges the Department to reconsider the 1985 discussion paper and re-issue a revised proposal by the end of October 2003. The goal should be to generate public consultations and permit the Department to release draft legislation by March 31, 2004. In crafting the revised proposal and draft legislation, the Department should consider the following:

1. Provinces. Because the federal government will likely be unable to harmonize a loss-transfer system with the provinces, TEI recommends adopting a federal-only system. Thus, practicality should carry the day and negotiation with the provinces should be deferred until the federal system is in place.

2. Government Revenue. To minimize the short-term revenue effect, the existing pool of unutilized tax losses should not be part of the new system and should not be available for transfer from one member to another. Rather, as discussed in the 1985 discussion paper, only post implementation current-year losses should be freely transferable within the group. Any existing pool of losses at the implementation date, however, should not expire upon adoption of the new system; they should remain available to be absorbed by taxpayers to the extent that current law and current informal ad hoc techniques would permit their use.

3. Carryforwards. The current provision for a three-year carryback period should be retained, but the carryforward period should be expanded. Ideally, the carryforward period should be unlimited.

4. Non-Capital Loss Utilization. At a minimum, any non-capital loss incurred by an entity within a group should be transferable in that year to any other member or members of the group that would otherwise have taxable income, or carried forward at the election of the loss entity.

5. Ownership Threshold. The required ownership threshold for transferring losses among related corporations should not exceed 90 percent. (5) Indeed, TEI recommends that the government consider adopting the 80-percent ownership threshold utilized in the United States.

6. Capital Losses and Tax Credits. Other tax attributes that cannot be utilized on a current basis should be able to be monetized through a refundable mechanism or through a transfer to another group member.

7. Technical Issues. A number of technical issues will likely need to be resolved in implementing the loss-transfer system. Some of those issues were identified in the Department's 1985 proposal and in TEI's 1985 comments. (A summary of TEI's 1985 comments and recommendations in respect of various technical issues is included in the Appendix to this letter.) As additional technical issues are identified, TEI would be pleased to react to the Department's concerns and provide comments and recommendations.

Conclusion

TEI believes that the implementation of a corporate loss-transfer system, which has been delayed far too long, should be addressed now while the economy and the government's fiscal position afford the opportunity. We urge the Department to pick up its 1985 proposal, revise it as necessary, and issue an updated proposal for discussion by the end of October 2003. TEI would be pleased to assist the Department in that endeavour. Following public consultations on the proposal, the Department should move expeditiously to release draft legislation on a loss-transfer system by March 31, 2004.

TEI's 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.

Appendix

Summary of Non-Policy Related Technical Comments on the 1985 Department of Finance Loss Transfer Proposal

In its November 6, 1985, submission on the May 23, 1985, federal budget proposals, TEI made a number of comments and recommendations on the corporate tax loss system proposed by the Department of Finance. TEI's core recommendations and comments on the policy issues relating to the 1985 proposal are set forth in the text of the letter. In addition, TEI made the following comments in respect of specific technical issues that would arise from the Department's 1985 proposal:

1. The government proposed a rule to prevent "double-dipping" of losses when shares of a loss company are sold. The double dip could occur when the loss benefit moves to the parent and then the share of the subsidiary is sold at a lower price, providing two tax benefits. TEI acknowledged the government's legitimate concerns about loss duplication, but recommended that, in the interest of fairness, a corollary situation should be addressed. Specifically, when a loss is transferred from one subsidiary to another subsidiary within the same group, the parent should be accorded a basis increase in the shares of the subsidiary receiving the loss in order to avoid double taxation on the disposition of the recipient corporation's shares.

2. TEI recommended that, where there is a change in ownership of a loss company other than at a year end, there should be a time-based apportionment of the loss.

3. Concern was expressed that implementation of a loss-transfer system might ultimately result in restrictions in permissive deductions. TEI urged that the principle of permissive deductions be retained.

4. With respect to loss-transfer elections, TEI endorsed the proposal that would permit the Minister of National Revenue to recover the tax where a loss-transfer amount elected is excessive. TEI recommended that a parallel rule be adopted that would permit taxpayers to revise elections following reassessments where additional losses for the particular year are available within the group.

5. TEI recommended that tax installments be based on a group election.

(1) Donnelly and Young, Policy Options for Tax Loss Treatment, 50 CANADIAN TAX JOURNAL 429 (2002).

(2) Mark Resources, Inc. v. The Queen, 93 D.T.C. 1004 (1993).

(3) See Question XVII CCRA-TEI Liaison Meeting agenda of December 7, 1999, in respect of the effect of the decision in C.R.B. Logging Co. Ltd. v. The Queen, D.T.C. 840 (1999), on CCRA's advance ruling process for "in-house" loss transfers.

(4) The Technical Committee on Business Taxation was established in connection with the adoption of the 1996 Federal Budget. The Committee, which was chaired by Professor Jack Mintz, was given a broad mandate to study the Canadian tax system as a whole and make recommendations for improvements, including fundamental tax reform.

(5) Group relief is provided at a 75-percent ownership threshold in the United Kingdom and at an 80-percent threshold under the U.S. consolidated-return system. In addition, the Canadian tax system has only a 90-percent ownership threshold for winding-up a subsidiary on a tax-deferred basis.