Pending Canadian excise tax issues.

On December 8, 1993, Tax Executives Institute held its annual liaison meeting with officials of the Canadian Department of Finance on Excise and Goods and Services Tax issues. In connection with the meeting, the Institute submitted the following comments, which were prepared under the aegis of the Institute's Canadian Commodity Tax Committee, whose chair is Paul J. deWinter of Imperial Oil Limited. Also participating in the liaison meeting was Hugh D. Berwick of Alcan Aluminium Limited, the Institute's Vice President-Region 1, and other members of the Canadian Commodity Tax Committee. A report on the liaison meeting will be included in a future issue of The Tax Executive. (A separate liaison meeting was held with the Department on pending income tax issues.)

Tax Executives Institute welcomes the opportunity to present the following comments and questions on several pending commodity and excise tax issues, which will be discussed with representatives of the Department of Finance during TEI's December 8, 1993, liaison meeting. In the meantime, if you have any questions about these comments, please do not hesitate to call either Hugh D. Berwick, TEI's Vice President for Canadian Affairs, at [phone] or Paul J. DeWinter, Chair of the Institute's Canadian Commodity Tax Committee, at [phone].

I. Background

Tax Executives Institute is an international organization of approximately 4,800 professionals who are responsible--in an executive, administrative, or managerial capacity--for the tax affairs of the corporations and other businesses by which they are employed. TEI's members represent more than 2,400 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 companies with significant Canadian operations. In sum, TEI's membership includes representatives from most major industries, including manufacturing, distributing, wholesaling, and retailing; real estate; transportation; financial services; and natural resources (including timber and integrated oil companies). The comments set forth in this submission reflect the views of the Institute as a whole, but more particularly those of our Canadian constituency.

II. Section 141: Use in Commercial Activities

The eligibility of certain costs for input tax credits is a paramount concern for businesses subject to Canada's Goods and Services Tax. The repeal of subsection 242(5) of the Excise Tax Act (ETA) and the consequent elimination of the language relating to costs incurred "in furtherance of commercial activity" may have a significant effect on the eligibility of some costs for input tax credits. We request your views on the effect of the repeal of the section on various commercial and financial activities including (1) entering into commodity futures, options, or forward contracts solely to preserve a net, fixed cost for goods acquired for resale and (2) hedging of foreign exchange and interest rate exposures through trading of financial futures, options, or forward contracts.

III. Foreign "Conventions" and "Seminars"

The requirements to register, collect, and remit GST differ depending upon whether an event or activity is deemed a foreign convention (a defined term) or seminar (an undefined term). Neither the demarcation between the two types of events nor the purpose served by this statutory distinction is altogether clear. In our view, the rule permitting an exemption from GST where fewer than 25 percent of the "expected attendance" consists of Canadian residents should apply regardless of whether the event is considered a seminar or convention. Where the vast majority of expected attendees are non-Canadian, the imposition of GST registration and payment requirements will likely drive foreign "seminar" business away from Canada. We request that the Department clarify its position with respect to the distinction between the two events.

IV. Bad Debt Recovery

Under current excise tax provisions only listed financial institutions are permitted to recover GST input tax credits in respect of bad debt write-offs relating to nonrecourse charges from a member of a closely related group. We are unable to discern the policy rationale underlying the limitation on the scope of relief to listed institutions. One of the purposes of the "deemed financial institution" rules is to provide equitable tax treatment for competing financial intermediaries. We wonder whether the purpose of those rules would be better served by extending comparable treatment with respect to recovery of GST input tax credits on similar related-party non-recourse loans made by deemed financial institutions.

V. Deemed Financial Institutions

A. Threshold Tests

A company may be deemed to be a financial institution where it earns more than 10 percent of its income or $10 million, whichever threshold is less, from financial services activities. We recommend that the $10-million threshold be repealed because we believe that the 10-percent test is the only realistic test of whether a company maintains a significant presence in the financial services business. Many larger companies may easily earn more than $10 million from investment sources that are entirely unrelated to providing financial services. For example, a company may hold a portfolio of passive investments (none of which is a controlling position) or it may simply be investing surplus funds that arose from any number of operating businesses or from a windfall recovery in litigation (including perhaps refunds of customs or income taxes). In none of these cases is the company competing with the financial services sector. Yet, the $10-million threshold may be easily exceeded, leading in turn to deemed financial institution status. We urge the Department to abolish the $10-million rule for deemed financial institution status.

B. Definition of Financial Services

The definition of "financial service" in paragraph 123(g) of the ETA includes "...the granting of credit..." For a manufacturing, services, or distribution company that is deemed to be a financial institution, the entire accounts receivable may be deemed financial services and, hence, ineligible for input tax credits because the essence of any receivables system is the "granting of credit" to trade customers. We recommend that this provision be revised to clarify that input tax credits from billing and receivable processes are available for deemed financial institutions.

VI. Non-Resident Contractor Reimbursements

Currently, a non-resident contractor that is not carrying on business in Canada is not required to register for GST. Where such a contractor incurs expenses in Canada that are chargeable to a Canadian registrant, the registrant is not permitted to claim an input tax credit for the GST that is included in the contractor's expenses reimbursed by the Canadian registrant. For example, a foreign software supplier may incur travel and accommodation expenses for employees performing after-sales service in Canada. Similarly, a non-Canadian equipment vendor may send employees to Canada to train Canadians in the use of the equipment. In each case, reimbursements of the contractor's expenses are legitimate business costs. TEI urges that the Department amend the GST to permit the Canadian registrant to recover input tax credits in the same fashion as permitted in respect of reimbursement of its employees' expenses.

VII. Intercompany Charges -- Related Entities

Charges between related entities may take a number of forms. Three common types of charges are:

1. Sales of tangible goods or services between entities, where an invoice is issued and the sale is recorded in the selling entity's unconsolidated books. The goods and services involved in these transactions typically are those that the selling entity provides to independent third parties.

2. Internal charges for goods sold or services rendered from one member of a commonly controlled group to another member. These charges are typically imposed solely to provide internal users and suppliers of the goods and services an appreciation of the costs incurred for the specific use of the goods or services. Examples include an internal print shop and computer processing and programming charges. Typically, no invoice is issued (as would be in the case of an arm's-length buyer) because the supplier is generally a cost center for the company and is not otherwise normally engaged in providing goods or services outside the group. Indeed, the charge for the service or goods is often "billed" through a journal entry rather than an invoice and there is generally no profit markup added. The transactions are generally not recorded as sales even in the unconsolidated statements of the provider.

3. At the end of a month, quarter, or year, an allocation of head office costs may be made to operating entities in order to assess the profitability of the entity on a fully absorbed cost basis. Typical components of these charges are executive costs and centralized services such as payroll, personnel, legal, and centralized accounting services. Such allocations may or may not be recorded in the books of account because the charges are often calculated under a formula (e.g., net sales) and are applied consistently across the group to reflect management costs. To the extent the costs are reflected in the books, they are generally treated as increases or decreases in costs (and not as revenues on the credited company's books).

Informally, Revenue Canada has commented that GST should be charged in all three situations, especially where a deemed or listed financial institution forms part of the group. TEI submits that, at least in respect of the latter two cases, RC's position is tenuous because of doubt concerning whether taxable "supplies" were provided. We also believe that the government will derive precious little net revenue in the latter two situations while imposing a substantial administrative burden on companies. In addition, the policy discriminates in favor of related groups that do not charge-out internal costs or allocate head office overhead expenses (and against those that reflect the charges on their books).

In TEI's view, GST should always be charged under circumstances described in the first situation above, but never charged in the third case. In the second situation, GST should be charged only where internal charges are actually invoiced between the companies; otherwise, valuation of the internal services would be a difficult task. In addition, we wonder what limits exist to circumscribe a "deemed" provision of supply? For example, where an in-house lawyer or tax adviser gives advice by telephone to a related entity, is the adviser required to value that time and issue a GST invoice? In our view, it is impractical and administratively burdensome to apply GST in the second case, and we recommend that the Department adopt a pragmatic approach and refrain from imposing GST.

VIII. Form of GST

There continues to be considerable public debate on the issue of revising or replacing the GST. In order to engage in that debate and contribute in a constructive fashion, TEI desires first to understand the rationale underlying the various policy decisions that were made in crafting the present GST system. We request that the Department provide an explanation of the policy and administrative reasons impelling the selection of the present GST form over other possible formats.

IX. Conclusion

Tax Executives Institute appreciates this opportunity to present its comments on pending commodity tax issues. We look forward to discussing our views with you during the Institute's December 8, 2993, liaison meeting.