Pending Canadian income tax issues.

On December 3, 1992, Tax Executives Institute held its annual liaison meeting with officials of the Canadian Department of Finance. In connection with the meeting, the Institute submitted the following comments, which were prepared under the aegis of the Institute's Canadian Income Tax Committee. The chair of the committee is Vincent Alicandri of INCO Ltd. Also participating in the development of the comments was J. Lawrence Martin of Mobil Oil Canada, is the Institute's Vice President. Region I, and other members of the Canadian Income Tax Committee.

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 3, 1992, liaison meeting. In the meantime, if you have any questions about these comments, please do not hesitate to call either J. Lawrence Martin, TEI's Vice President for Canadian Affairs, at [phone] or Vincent Alicandri, chair of the Institute's Canadian Income Tax Committee, at [phone].

I. Background

Tax Executives Institute is an international organization of approximately 4,700 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; and resource (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. Tax Competitiveness

In the past, TEI has focused during its liaison meetings primarily on the policy and administration implications of specific tax proposals. Given the growing interdependence between tax, trade, and economic policies -- together with the burgeoning importance of international competitiveness (highlighted most recently by the North American Free Trade Agreement (NAFTA)) -- the Institute believes it is prudent to address the competitiveness and efficiency of the Canadian tax system on a so-called macro basis. This new approach is manifested in this section of the submission, which analyzes recent developments in Canada and in other parts of the world.

A. Background

In the last six months, two research organizations have addressed the competitiveness of Canada's income taxation system vis-a-vis the United States and expressed concerns about Canada's ability to compete in the global market. These organizations are the Conference Board of Canada Business Centre for Tax Research and the Prosperity Secretariat Initiative Steering Group, which was established by the Minister of Industry, Trade, and Technology.

The Conference Board's conclusions are contained in the Board's interim report entitled Canada-U.S. Tax Competitiveness in Manufacturing Industries, which will be published later this year. In 1990, the Conference Board expressed the view that Canada's relative tax competitiveness vis-a-vis the United States had slipped in recent years. That study reviewed four specific industries -- Petrochemicals, Steel, Forest Products, and Telecommunications.(1)

The Prosperity Secretariat's findings are contained in its publication, Prosperity Through Competitiveness, which was published in June. The report analyzes the role the financing of investment plays in the global competitive scene. At the request of the Steering Group on Prosperity, the Prosperity Secretariat undertook a cross-country consultative process, commencing in April of this year. According to the Steering Group, the study was needed because Canada's economic prosperity was at stake: "Unless we adopt a new approach to the challenges of competing in the New World Order, we run the risk of falling even further behind the leading players." In this regard, the Prosperity Secretariat reported that the message from across the country was clear and concise; there was an exceptionally high level of consensus among "stakeholders" on the important issues and recommendations and on the immediate need for action.

The study focused on the cost of capital, availability of capital, and the efficiency of the markets. One of the key areas was taxation. The stakeholders canvassed included executives in High Technology Businesses, Small and Medium-sized Enterprises, Multinationals, Institutional Investors, Banks, Venture Capital Firms, Investment Dealers, and other professionals, including accountants and lawyers. In all, the Prosperity Secretariat interviewed 280 senior business and financial industry leaders.

The principal themes regarding tax policy were, as follows:

* The importance of international

tax harmonization and coordination.

* Ensuring that the United

States remains the focus of our

competitive tax regime comparison.

* Concern that the country's relative

tax competitiveness vis-a-vis

the United States has

slipped since 1984.

* Consternation over the complexity

and inefficiency of the

tax system.

* Bitterness at the way tax dollars

are spent.

* Irritation over the multi-jurisdictional

lack of tax coordination

among Governments in

Canada.

Against this background -- together with the Canada-U.S. Free Trade Agreement and the recent progress on NAFTA between Canada, the United States, and Mexico -- TEI recommends that the Department of Finance review the recent developments in the European Economic Community (EEC) with respect to direct taxation and corporate income taxes. In particular, the Department should focus on those changes designed to strengthen the EEC's competitiveness in world markets and to help eliminate distortions within the internal market, created by the existence of differing taxation systems. These developments are summarized below.

B. European Economic Community Experience

Although most of the emphasis in the EEC initially was to harmonize the value-added tax (VAT) system, in recent years more attention has been given to the subject of direct taxation and to corporate taxation in particular. This is especially the case with the expected completion of the VAT initiative by the end of 1992.(3)

In 1960, the Neumark Committee, a group of tax experts, was established by the EEC to examine tax competitiveness. Although primarily concerned with indirect taxation and border transactions, the committee also addressed the impact of direct taxation on competition. In 1962, it recommended that the first phase of tax harmony deal with the taxation of dividends and interest as well as the avoidance of double taxation.

In 1966, the Segre Report on "the establishment of an integrated capital market within the Community" was issued. Dealing extensively with the fiscal obstacles to the free movement of capital, the committee concluded that tax considerations should not influence the choice of location of investments or transactions. The chief obstacles to competitiveness within the Community were found to be the international double taxation of investment income, the existence of tax advantages or disadvantages affecting investment in certain countries, and the different treatment of investment income payable to non-resident and corporate investors.

A number of the recommendations of the Neumark Committee and Segre Report were adopted by the Commission of European Communities in 1967. Taxation was seen by the Commission as a major obstacle to the free flow of capital. In the long term, the alignment of national tax systems would be required in order to create conditions of fiscal neutrality. Among the first matters that should be dealt with, the Commission agreed, were withholding tax on dividends and interest; the elimination or reduction of double taxation of dividends; tax arrangements applicable to holding companies; and the tax treatment of investments through financial intermediaries. The Commission also recommended the removal of obstacles to industrial combinations and the harmonization of certain taxation rules.

In 1985, a White Paper on "Completion of the Internal Market" was issued. The paper, which was commissioned by the EEC, urged the adoption of three incentives aimed at removing obstacles to cooperation between European entities: the tax treatment of dividends flowing between subsidiary and parent; the taxation of mergers within the EEC; and the avoidance of double taxation.

These three initiatives were the subject of Community Directives, which were released in 1990. The Parent-subsidiary Directive has been implemented or is in the process of being considered by all 12 Member States. The Tax Merger Directive has been implemented or is in the process of being considered by ten Member States (excluding Germany and Greece). And to date, the Arbitration Directive -- for the avoidance of double taxation -- has been implemented or is being considered by five Member States -- the United Kingdom, the Netherlands, Germany, France and Denmark.(4)

1. The Parent-subsidiary Directive. This Directive requires parent companies to hold at least 25 percent of the capital of the subsidiary, although Member States may stipulate a less onerous burden in their domestic legislation.(5) The Commission has since recommended this holding requirement be reduced to 10 percent.

This Directive applies only to specific types of corporations, which are listed in a schedule to the Directive, and would cover public and private limited liability companies. Both corporations must be situated in Member States and be subject to tax in an EEC country, and not be resident in another jurisdiction under a bilateral treaty. Under this Directive, the profits of the subsidiary distributed to the parent company are exempt from withholding tax. Member States may also exempt the parent company from taxation on the dividend or provide a tax credit for the underlying tax paid by the subsidiary. The Directive deals with profits but not capital gains.(6)

2. The Corporate Reorganizations Directive. This Directive also applies only to companies within a Member State and only to certain defined types of entity, which are set out in a schedule to the Directive. Residency and taxation requirements similar to those set out in the Parent-subsidiary Directive also apply here. This Directive applies to mergers, divisions, transfers of assets, and exchanges of shares in which companies from two or more Member States are involved; it essentially allows for tax-free rollovers under given conditions between companies of Member States. Prior to the enactment of this Directive by Member States, a cross-border reorganization between companies subject to taxation in the 12 Member States frequently left the parties worse off from a tax perspective than if they had entered into a purely domestic reorganization.(7)

3. The Arbitration Directive. This Directive deals with transfer pricing issues. The Member States have executed a multi-national treaty on the elimination of double taxation of profits of associated or related companies. This Directive has not yet been passed into law by the Member States, but enabling legislation has been presented in the Netherlands and the ratification process in the United Kingdom has also begun. The Treaty does not apply to residents of non-member States. It applies only to profits and adopts the arm's-length standard set out in the OECD Model Convention.

The Directive provides for mutual agreement and arbitration procedures. Notification, similar to that set out in Article IX of the Canada-U.S. Treaty, is required. Under the Convention, a taxpayer who claims the arm's-length standard of the Convention has not been properly applied may submit a case to the appropriate Competent Authority, irrespective of any other remedy available under domestic law. If the Competent Authorities jointly fail to resolve the matter within two years by an agreement that eliminates the double taxation, they must then establish an Advisory Committee in accordance with established procedures. The parties themselves, or their representatives, may appear before the Committee. The Advisory Committee is required to render its decision within six months. Within another six months, the Competent Authorities are required to make a decision. They may deviate from the Advisory Committee opinion, but if they cannot reach an agreement, they must act in accordance with that opinion.

Two exceptions are provided. The Competent Authorities may not settle a case by mutual agreement if the agreement would abrogate a court decision on the matter or if a serious penalty has been, or may be, imposed in judicial or administrative proceedings as a result of the proceedings.

C. The Ruding Committee Report

In 1990 Dr. Onno Ruding, former Finance Minister of the Netherlands, was asked by the EEC to form a committee of independent tax experts to consider whether differences in taxation among Member States cause major distortions in the internal market, particularly with respect to investment decisions and competition. The Ruding Committee was asked to determine whether any such distortions that did exist could be eliminated through the interplay of market forces and tax competition between Member States. If not, what specific measures would the Committee recommend to remove or mitigate these distortions?

The Ruding Committee found that there were wide differences in tax systems across the EEC Member States, and that some of these did distort the functioning of the internal market for both goods and capital, especially in the financial area. Specific concern was identified in relation to tax competition in the area of withholding taxes on cross-border flows of interest from portfolio investment. Most revealingly, the Committee also found that it was unlikely that these distortions would be removed through independent action of Member States. Accordingly, it recommended action at the Community level.

The Committee recommended that a number of measures be implemented over time, including the following:

* Extension of the Parent-subsidiary

Directive to any corporation

subject to corporate tax,

regardless of their legal form.

* Establishment of a procedure

for determining transfer pricing

adjustments.

* Establishment of a common approach to the definition and

treatment of thin capitalization.

* Establishment of common rules

for the allocation of headquarters

costs.

In addition, the Ruding Committee recommended additional proposed directives on the elimination of withholding taxes on interest and royalty payments, as well as a proposed directive on loss carryovers.

D. Recommendation

Tax Executives Institute recommends that the Department of Finance initiate a dialogue with the United States and Mexico with a view toward identifying and removing distortions caused by differences in taxation, particularly with respect to investment decisions and competitiveness. We request an opportunity to participate in such an initiative, to provide further information or assistance, and to participate in any Government-Industry Committee that might be established to study these matters.

With respect to tax competitiveness generally, we request a report on what the Government is doing to respond to the criticisms of the Canadian taxation system laid down in the Prosperity Secretariat Interim Report or the Conference Board of Canada Taxation study. Similarly, is the Department considering implementation of any of the measures adopted by the EEC?

III. Corporate Tax Measures for Difficult Economic Times

For many companies represented by TEI's membership, especially those in the manufacturing and resource sectors, the current recession represents the worst economic downturn since the Great Depression. Extraordinary measures by governments will likely be required to help rebuild Canada's industrial base. Thus, the Federal Government has announced that its top priority is to help Canadian industry maintain and enhance its international competitiveness. The Federal Government has already taken positive steps by setting up the Prosperity Secretariat and holding consultations with a broad range of industries to determine what steps must be taken by both the private sector and governments to enhance the international competitiveness of Canadian industry.

TEI believes that the Federal Government should re-think some of the policies which led to the elimination of most tax incentives for corporations in the 1987 tax reform proposals. In 1987, Canadian corporations were, generally speaking, financially healthy and able to weather the elimination of tax incentives. Today, however, that is not the case. All levels of government are experiencing record levels of lost tax revenues caused by record drops in corporate profits, rising levels of unemployment, and personal and corporate bankruptcies.

Industry and consumers are not in a position to turn the economy around without some intervention by government, for example, in the form of tax incentives. To dismiss the proposition on the ground that |we cannot afford tax incentives because of the deficit' is to miss the point. Many analysts believe that Government properly cannot afford not to do something to nurse industry and the economy back to good health. Recent press reports of the Government's intention to spend up to $25 billion to improve the country's infrastructure underscore the Government's intention to create jobs. TEI believes that the private sector can play a pivotal role in energizing the economy by capturing or retaining cash for growth. Tax measures such as the following would assist corporations in achieving both the short-term goal of "economic survival" and the long-term goal of enhancing "international competitiveness":

* Increase the loss carryback period

five years.

* Provide accelerated write-offs

of machinery and equipment.

* Eliminate the available-for-use

rule.

* Provide refundable investment

tax credits.

Each of these measures, which are discussed in more detail below, would simply accelerate receipt of the tax benefit rather than increase the benefit.

A. Increase Loss Carryback Period

Cash is the life line of any corporation and the key to survival. The recession has depleted the cash reserves of many corporations. Corporate losses have been so large and the period covered by losses so long (because of the protracted nature of this recession) that many corporations either have not been able or will not be able to avail themselves of the tax benefit of those losses on a current basis through carrybacks to profitable years.

Under these extraordinary economic circumstances, the Government should give serious consideration to increasing the loss carryback period from three to five years. This measure would help corporations replenish their cash reserves or lines of credit that have been severely depleted by losses. TEI acknowledges that a five-year carryback rule in Canada would be more generous than the comparable rule in the United States, but suggests the proposal is warranted by the depth of the recession in Canada.

B. Accelerated Capital Cost Allowance and Proposed Elimination of "Available- for-Use" Rule

The 1987 tax reform proposals adversely affected capital intensive industries by dramatically reducing the incentive for new investment in manufacturing and processing equipment. Lengthening the write-off period on new manufacturing equipment from 3 years to 12 or more years, together with the introduction of the available-for-use rule, dulled the important edge that Canadian manufacturers had and now need to maintain and enhance their international competitiveness.

New free trade agreements with the United States and Mexico will now create competitive pressures. If Canada is to enjoy the promise of free trade, Canadian businesses will need to make heavy investments to develop and maintain world-class, modern, efficient, and environmentally friendly manufacturing and processing facilities. TEI is encouraged by the Government's proposal to enhance the capital cost allowance (CCA) rate on manufacturing and processing equipment as outlined in the 1992 Federal Budget. We believe, however, that the Government should give consideration to further accelerating these write-offs and to eliminating the available-for-use rule which is biased against long-term projects.

C. Refundable Investment Tax Credits

TEI urges the Government to consider a system of refundable investment tax credits as an alternative to the above proposal for accelerated CCA. Such a system would assist a corporation immediately by providing cash during the construction stage of a project when there are large cash outlays with no corresponding revenue coming in from the project. Thus, refundable ITCs would be as effective and possibly a more efficient and direct way to assist corporations to make major new investments.

IV. Class 24 and 27

For the purposes of classes 24 and 27, clauses 17 and 18 of the draft regulations released on December 23, 1991, deem an amalgamated corporation or a parent of a wound-up corporation to be the same corporation as, and a continuation of, the predecessor corporation or the wound-up subsidiary.

This approach corrects the problem whereby a reorganization involving an amalgamation " wind-up places a taxpayer "offside." The proposed amendments, however, do not address the situation where the problem is caused by a reorganization that does not involve either an amalgamation or wind-up.

TEI recommends that further amendments be made to classes 24 and 27 to provide that where a taxpayer has acquired operations from a person with whom the taxpayer was not dealing at arm's length, then the taxpayer shall be deemed for the purposes of these classes to be the same person as the transferor.

V. Recycling

There are many situations where large manufacturers of certain types of products cannot recycle their products themselves in an economical manner. These large manufacturers, however, may be willing to assist smaller, independent enterprises in establishing recycling centers that are economical (assuming financial support from larger companies). To encourage this type of recycling program, consideration should be given to establishing a tax mechanism to permit the larger manufacturers to assist the smaller enterprises in purchasing the recycling equipment on a tax-deductible basis.

For example, the Province of British Columbia has established a program whereby it enters into "partnerships" with industry to encourage recycling. Although laudable, there is clearly a limit to the amount of public monies available to fund such programs directly. One alternative would be to permit a corporation that is willing to assist with recycling for its products to make a "gift" to the Crown, in right of the province. The Province would then direct these funds to the recycling enterprise chosen by the donor. Such a mechanism would allow the Province to ensure that the money will be spent on a bona-fide recycling project. Under current law, there would be some question whether such a directed donation to the Crown would constitute a gift for tax purposes because the funds would be earmarked for a special project. Enactment of a specific provision to permit a deduction in these circumstances would encourage more recycling in Canada and should be considered.

VI. Deductibility of Financing Costs

A. Draft Legislation, Tax Treatment of Interest Expense

TEI iterates the position outlined in its May 1, 1992, submission on the Draft Legislation on the Tax Treatment of Interest Expense. TEI supports the Government's decision to legislate the tax policies on interest deductibility contained in the June 2, 1987, Notice of Ways and Means Motion. We believe, however, that the December 20, 1991, draft legislation fails to accomplish its intended purposes. We continue to have concerns that the draft legislation will create serious problems for many corporations, including --

* higher financing and administrative

costs;

* uncertainty and unnecessary

complexity; and

* a relative disadvantage compared

with foreign businesses.

The proposed rules relating to interest on money borrowed to make "future distributions" (i.e., dividends, share redemptions, return of capital, etc.) are of primary concern. The "future distribution" rules will penalize holding companies and capital intensive corporations that have spent billions of dollars on the basis that Canada was a stable environment in which to place investments. In fact, as far as we are aware, Canada is the only G-7 country that is considering such draconian measures.

Proposed sections 20.1 and 20.2 adopt a property measurement test for purposes of determining the deductibility of interest on monies borrowed by corporations and partnerships to make distributions. TEI's principal concerns about the test relate to the measurement of assets at "tax cost" and the exclusion from "equity" of shares in companies owned 10 percent or more by the Canadian taxpayer. The problems created by these two issues are discussed in our May 1, 1992, submission, and many of our members have written separately to the Minister to express their individual concerns. In view of the seriousness of the matter, we wish to re-emphasize the concerns raised with respect to the use of tax costs to measure equity and the exclusion of shares from "equity."

1. "Tax Basis Equity." The requirement in the draft legislation that equity be computed on a tax basis, rather than a book basis, results in major reductions in equity for capital-intensive corporations that have claimed accelerated CCA (as clearly sanctioned for tax purposes) in excess of the amounts deducted for book purposes. This is no small matter, the book-to-tax adjustment for fixed assets results in a reduction in equity in excess of $1 billion for a number of the companies represented by our membership. Depending on the circumstances, the use of tax cost to value assets will penalize companies by raising the possibility of interest on loans for distributions being non-deductible. The very companies so penalized, moreover, will be those that acted upon the various tax incentives that were implemented to encourage them to make large investments in fixed assets.

2. Exclusion of Shares from Equity. TEI members have also raised serious concerns about the proposal requiring the exclusion of investments in shares of subsidiaries and interests in partnerships from the computation of equity. As with the use of "tax basis" in determining equity, the exclusion of investments in shares from equity will cause very substantial adjustments to equity and hence serve to further restrict borrowing for distributions. The expressed double-counting concern is simply not valid in respect of foreign subsidiaries and ignores the economic realities for Canadian subsidiaries.

3. Current Distributions -- Exclusion of Intercompany Profits. From a policy perspective, TEI believes that it is improper to exclude intercompany profits from equity for current distributions. TEI's supporting arguments for this position are outlined in detail in the May 1, 1992, submission.

4. Summary. TEI believes that the policy problems raised by using tax cost to measure assets and excluding shares from "quity" are fundamental and, regrettably, cannot be righted with technical corrections. We believe the proposals should be eliminated and that the policy underlying the limitation of deductibility of interest on borrowing for distributions should be fully reconsidered. Interest on borrowing for the purpose of distribution should be considered as a deductible business expense, by way of section 9 of the Income Tax Act or otherwise.

We acknowledge that this topic was discussed by officials of the Department of Finance during TEI's May 1992 Hull conference. We request a written response, however, that reflects the current thinking of the Department on the issues raised in our May submission.

B. Currency Swaps and Hedging

During TEI's liaison meeting of November 19, 1990, the Institute requested a status report on the review by the Department of Finance and Revenue Canada, Taxation of the Government's policy regarding "swaps and hedging transactions." We were informed that the review had been subsumed in the Interest Deductibility Study then being conducted.

The draft legislation issued on December 20, 1991, concerning interest deductibility, however, did not address the treatment of "swaps and hedging transactions." We therefore repeat our request for a status report, including some estimate of when proposed changes will be announced.

C. Deductibility of Compound Interest

Interest, including any accrued compound interest, is required to be brought into income on an annual accrual basis. On the deduction side, however, compound interest is not deductible until it is actually paid. This particular dichotomous treatment is inappropriate and inequitable, and undermines the ability of Canadian corporations to raise funds through the use of zero-coupon bonds and similar term financing where the interest component is not paid until maturity.

To rectify this problem, TEI requests the Department of Finance to recommend an amendment to paragraph 20(1)(d) of the Act to permit compound interest to be deducted on an annual accrual basis.

VII. Proposed Non-Deductibility of Provincial Capital and Payroll Taxes 

On several occasions, TEI has expressed its concern over the inequities that will be created by the proposal to limit the deduction for provincial payroll and capital taxes. We renew our tax policy objection to a proposal that, in our view, arbitrarily creates winners and losers among industry sectors and particular business taxpayers.

TEI acknowledges the desire of Finance to protect the corporate tax base from further "erosion." We suggest, however, that this goal may be better achieved by engaging in direct discussions with the Provinces, the purpose of which will be to determine the rates for capital and payroll taxes for which Finance is willing to provide federal tax deductibility. This approach has been used to develop limitations for tax-assisted contributions to registered retirement savings plans, registered pension plans, and deferred profit-sharing plans.

Surely, in this era of cooperation between the Federal and Provincial Governments, it should be possible to reach agreement on this issue. In the absence of any such agreement, the proposal to limit the deductibility of provincial capital and payroll taxes should not be adopted.

VIII. Netting of Interest

At last year's liaison meeting, we were informed that the Department of Finance would consider the netting of interest with respect to several types of taxes. What is the status of this review?

IX. Federal Tax Treatment of Ontario's Super Allowance and Current Cost Adjustment

Revenue Canada was asked in November 1990 to confirm that Ontario's super allowance and current cost adjustment would not be taxable under the Income Tax Act. The response given was that the Departments of Finance and Justice were conducting policy and legal analyses of the issue. Has this review been completed?

X. Foreign Affiliate Held By A Partnership

Partnerships are an increasingly common vehicle for owning assets, including shares of corporations. Revenue Canada has been asked to re-examine its view with regard to the status of a partner for purposes of paragraph 95(1)(d) where the partnership is the owner of shares of a foreign affiliate. Should Revenue Canada be unable to reach the conclusion that its prior view was in error -- a conclusion we believe to be proper -- then we recommend the Department of Finance make appropriate amendments.

XI. Non-Residents: Intercompany Loans and Deemed Dividends

At present, when a Canadian company lends money to a non-resident shareholder or to a related non-resident corporation, subsection 15(2) and paragraph 214(3)(a) may be applied to deem a dividend to have been paid on which Part XIII tax is then imposed. If the loan is later repaid, there is no provision for recovery of the Part XIII tax and a subsequent dividend would again be subject to withholding tax.

We recommend that the Act be amended to provide for a refund of the initial tax paid in the event of a repayment of the amount to which subsection 15(2) applied.

XII. Non-resident Information Requests by U.S. Tax Authorities

The United States in recent years has enacted legislation such as section 6038A of the Internal Revenue Code, which requires foreign taxpayers with "related" U.S. affiliates to comply with very stringent reporting requirements; failure to comply will expose the U.S. related entity to substantial penalties.

What is the reaction of the Department of Finance to what can only be described as an exertion by the United States of extraterritorial jurisdiction on foreign taxpayers such as Canadian companies? Inasmuch as Canada and the United States have in place, as part of the Canada-U.S. tax treaty, exchange-of-information procedures that are designed to alleviate any concerns of the U.S. Treasury Department, we believe that U.S. taxpayers with "related" Canadian taxpayers should be exempted from the section 6038A requirements. We encourage the Department of Finance to pursue such an exemption.

XIII. Prescribed Tax Elections

A. Are All the Prescribed Tax Elections Really Necessary?

Currently, the Canadian tax statutes and tax authorities impose far too many prescribed election requirements. Apart from the administrative costs involved, taxpayers may incur costly penalties or experience undesirable tax consequences, even if their noncompliance was wholly unintentional.

TEI is pleased that, pursuant to the "Fairness Package," late or amended tax elections will be permitted in certain circumstances. Nevertheless, TEI recommends that the prescribed tax election requirements be reduced to a minimum. As a general principle, we do not believe a separate election form should be required in respect of any election by a corporation if the tax results have already been incorporated in its tax returns and would not affect the tax position of another taxpayer. Some examples of these questionable tax elections are:

* subsection 13(29) on the adoption

of the long-term project

rule;

* subsection 20(9) on amortization

of representation expenses;

* section 21 on capitalization of

interest expense;

* subsections 12(2.2) and 13(7.4)

on the application of inducement 

payments; and

* regulation 1103 on transfers between

different classes of depreciable 

property.

B. Section 22 Election

Subsection 22(2) provides that a statement in a section 22 election by the vendor and purchaser jointly on the consideration paid on the sale of accounts receivable is binding upon the vendor and purchaser. Similarly, paragraph 5 of Interpretation Bulletin IT-188R provides "the amount that is stated in the election to be the consideration for the accounts receivable is final for tax purposes as far as the vendor and purchaser are concerned and cannot later be altered."

In some cases, however, the proceeds on the sale of accounts receivable may be subject to subsequent adjustment. For example, the vendor may agree to reimburse the purchaser for accounts receivable uncollectible after a certain period (say, 90 to 120 days). Alternatively, the vendor may warrant the collectibility of accounts receivable. Consequently, if there is a considerable loss on the accounts receivable, the vendor may find itself in the position of having to repay the purchaser a portion of the sale price of the accounts receivable several months after the sale.

A section 22 election is generally completed and filed as close as possible to the sale date, e.g., congruent with the closing of the sale. Contingent payments that adjust the consideration paid in situations such as the above, however, may not become evident for several months after the closing date. Currently, there is no provision for amending a section 22 election where contingent payments become exigible in situations such as that described above.

TEI believes that an amendment to a section 22 election should be permitted in such cases. The most straightforward method of effecting this recommendation would perhaps be to add section 22 to Regulation 600 as one of the "Prescribed Provisions" where the Minister may accept amended elections pursuant to subsection 220(3.2).

TEI would welcome any opportunity to provide additional consultation on this matter.

XIV. Withholding Tax on Heavy Industrial Equipment Leases

Leasing of heavy industrial equipment, such as railway rolling stock and large-ticket plant equipment, is an important component of financing Canada's industrial base at the lowest possible cost. In the increasingly globalized economy, Canadian equipment users should be able to turn to the most effective mode of financing in order to remain competitive. But for the withholding tax on rentals, leasing from a foreign lessor would often be the preferred mode of financing.

Because many foreign lessors are not able to utilize withholding tax as a tax credit, they often require the Canadian lessee to absorb the withholding tax. As a result, many foreign leasing transactions are not consummated. The withholding tax is then not so much a revenue-raiser for the Government as an obstruction that raises the cost of doing business in Canada and, ultimately, may reduce aggregate Canadian taxable income.

The December 1991 announcement by the Department of Finance of a withholding tax exemption on lease payments for aircraft, related equipment, and spare parts represents a particular response to this problem -- one sensitive to the special needs and requirements of the airlines. TEI believes that the policy basis for the exemption can properly be extended to heavy industrial equipment generally.

We have consulted a number of banks and financial institutions as well as equipment manufacturers of products that are acquired by purchase or by lease. Generally speaking, the businesses surveyed either favour the elimination of the withholding tax on heavy industrial equipment or are neutral on the issue. One leasing institution did recommend, however, that such an exemption should generally be negotiated on a bilateral basis.

In the context of the Canada-U.S. Free Trade Agreement and NAFTA, TEI is concerned that the withholding tax on heavy industrial equipment represents an unnecessary and counterproductive barrier to trade. We further believe that the Canadian heavy equipment leasing industry does not need this type of "protection" and, indeed, may become more competitive by expanding into other markets. Consequently, TEI recommends that the withholding tax requirements on heavy industrial equipment be reviewed. If bilateral negotiations with other countries to remove the withholding tax are not possible in the short term, the Department of Finance might consider providing a unilateral exemption for a five-year trial period.

XV. Partnership as a Shareholder of a Joint Exploration Corporation

Since a shareholder of a joint exploration corporation (JEC) must be a corporation, a partnership conducting a resource business is seemingly unable to take advantage of the renunciation rules by making direct advances to, or investments in, a JEC. For corporate partners that prefer to conduct their resource business in the form of a partnership, the alternative of investing directly in the JEC should be available.

TEI recommends that the definition of "shareholder corporation" in paragraph 66(15Xi) be expanded to include a partnership, each of the members of which is a corporation. In this manner, subsections 66(10) to (10.5) would apply to the subject partnerships without need for further amendments.

XVI. Non-Deductible Club Dues -- Taxable Benefits

TEI has previously expressed its concern to Revenue Canada, Taxation that Interpretation Bulletin IT-148R2 contains language implying that the possibility exists of (i) club dues' being treated as a taxable benefit to the employee without (ii) the employer's being entitled to a deduction in respect of such taxable amount. This would clearly constitute double taxation. We have recommended that either Interpretation Bulletin IT-148R2 or section 6 of the Income Tax Act be amended to prevent this possibility of double taxation.

XVII. Conclusion

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 3, 1992, liaison meeting. (1) Tancredi Zollo & Stelios Loizides, Canada-U.S. Tax Competitiveness in Manufacturing Industries (July 1990). (2) The Steering Group on Prosperity, The Prosperity Secretariat, Financing Investment -- The Consultative Process: Overview and Final Recommendations 1 (June 1992). (3) See generally Alex Easson, Harmonisation of Direct Taxation in the European Community: From Neumark to Ruding, III Canadian Tax Journal 603. (4) Price Waterhouse, 5 EC TAX NOTES 10 (June-August 1992). (5) The Directive does not stipulate whether the percentage ownership requirement refers to direct or indirect ownership. (6) Jonathon S. Swarcz, The Journal of International national 181 (September-October 1991). (7) Jonathon S. Swarcz, The Journal of International Taxation 51 (May-June 1991). TEI recognizes that paragraph 8 of Article XIII of the Canada-U.S. Tax Convention (1980) addresses, at least in a limited extent, the problem of intra-country mergers between Canada and the United States. Canadian Department of Finance Responds to TEI's Excise Tax Comments

On May 1, Tax Executives Institute filed comments with the Canadian Department of Finance on certain proposed changes to the Excise Tax Act. The Institute's comments were reprinted on pages 223 and 224 of the May-June 1992 issue of The Tax Executive. On July 14, the Minister of Finance responded to the Institute's submission, and his response is reprinted below.

Thank you for your submission of May 1, 1992, on behalf of the Tax Executives Institute, requesting changes to the Excise Tax Act (the Act).

I have noted your request that the government withdraw its March 10, 1992, proposal to amend the Act to clarify that inventories of goods held on December 31, 1990, for use in fixed-price maintenance contracts do not qualify for the federal sales tax (FST) inventory rebate. In this regard, I would point out that the intention has always been that goods held for use in fixed-price maintenance contracts would not qualify for the rebate. this was communicated through Revenue Canada Information Bulletins as early as May 1990. While we were confident that the courts would uphold our interpretation of the Act, the decision was taken to amend it so that the intent of the legislation would be clarified once and for all.

I have also noted your view that, under the current rules, there is a potential for confusion over the GST treatment of "unreasonably low" automobile allowances paid to employees. I understand that officials from the Sales Tax Division discussed this issue with representatives of the Tax Executives Institute on May 5, 1992.

I am in general agreement that it would be desirable to provide businesses with greater certainty in this area; however, I have some concerns about the complexity that your proposal would involve, both for employers and employees. I have asked my officials to examine whether there are simple alternatives that would achieve a fair result. I understand that an informal working group, consisting of TEI representatives along with officials from the Departments of Finance and National Revenue, has been established to examine ways in which the GST treatment of employee benefits generally can be simplified. I expect that my officials will be in touch with TEI representatives on this issue during the course of these discussions.

I trust that my comments address the matters you have raised. Thank you once again for writing.