Pending Ontario income, sales, and capital tax issues.

On January 27, 2000, members of the Toronto Chapter met with representatives of the Ontario Ministry of Financy to discuss pending Ontario income, sales, and capital tax issues. The agenda, which is set forth below, was prepared under the aegis of the Toronto Chapter Ontario Tax Committee, whose chair is Alan Wheable of Toronto Dominion Bank. The agenda was approved in accordance with the Institute's procedures on technical and legislative activities.

In connection with the upcoming liaison meeting between members of the Toronto Chapter of Tax Executives Institute and representatives of the Government of Ontario, I am pleased to submit the following agenda of pending income, sales, and capital tax issues. In addition, we confirm that the tentative meeting time is 9:00 A.M., January 27, 2000, in the president's lounge, 32nd Floor, Canada Trust Tower, 161 Bay Street, Toronto, Ontario.

Background

Tax Executives Institute is the preeminent association of business tax executives. The Institute's 5,000 professionals manage the tax affairs of the leading 2,800 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 make up 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).

TEI is concerned with issues of tax policy and administration and is dedicated to working with government agencies 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.

We currently have liaison meetings with senior officials at various levels including Ottawa, Washington, Alberta, and Quebec. Given the importance of Ontario to the administration of Canadian taxes, we are very much looking forward to our first such meeting. We have set out below an agenda covering a number of issues that we feel would be fruitful for discussion. We believe this agenda fairly represents the interest and concerns of the Institute's members, especially those who live and work in Ontario. Should the government or TEI believe it necessary or warranted by the discussion, we shall be pleased to prepare and submit written comments expanding or clarifying the Institute's position concerning these or other matters identified during the meeting.

1. Large Business Tax Strategy

Numerous studies, including those conducted by the Alliance for Manufacturers and Exporters and the Business Council on National Issues, have concluded that taxes are a significant cost of doing business and are a substantial variable affecting the decision on where to make incremental business investments. A report by the Conference Board of Canada on taxes and investment makes the same point: "Taxes are perception shapers -- visible and measurable. Other factors determining the attractiveness of a country are significantly less so." Companies in Ontario are part of a global economy but tax rates are uncompetitive compared with other provinces, especially Alberta. Example 1 provides a snapshot summary.

Example 1

                                         Ontario   Alberta   Quebec
Corporate Income Tax Rates (%)
  (a) Non-manufacturing                   15.5      15.5      8.9
  (b) Manufacturing                       13.5      14.5      8.9
PST rate (%)(Quebec refundable
on many business inputs)                   8.0       0.0      7.5
Capital tax rate (non-financial)(%)        0.3       0.0     0.64
Payroll tax rate (%)                      1.95       0.0     4.26

Alberta is clearly attempting to be competitive in every tax area -- note the initiatives in its last budget. In addition, other provinces have targeted business tax reductions, including, for example, Quebec's tax rate on general active business and scientific research and experimental development (SR & ED) incentives. In contrast, Ontario's tax incentives tend to have low dollar value amounts and higher administrative costs associated with claiming the benefits (e.g., the co-op student tax credit).

The picture of the overall tax burden does not brighten when comparing Ontario to our major trading partners either. Indeed, Ontario companies bear an increasing array of surtaxes and capital taxes that other countries have been eliminating or reducing. The United States, for instance, has no national capital tax at all and only a handful of states levy one.

To promote economic growth and job creation and to enable Ontario businesses to remain competitive in the global economy what, from the government's tax policy perspective, is the roadmap for addressing the tax burden on large, multi-jurisdictional businesses?

2. Web Site

Ontario is Canada's largest province, the heart of the economy, and the high-tech center of the nation, yet the Ministry of Finance lags behind other Canadian jurisdictions in developing and using a web site to disseminate information to taxpayers. Will the Ministry consider expanding the use of its web site to include posting of guidance (including interpretations, rulings, and bulletins), prescribed forms, gas-guzzler charts, telephone directory listings, etc.? In addition, a fully functional search mechanism, updated frequently, would be beneficial.

On a related subject, would Ontario please brief us on any initiatives relating to electronic tax filings or reports by corporations?

3. Adjudication of Disputes

While Ontario attempts to avoid litigating multiple actions on the same facts through the designated assessment process, this procedure does not address all issues where multiple litigation on same issues may arise (e.g., provincial allocation matters). Would Ontario consider discussing with the other provinces and the Federal Government the prospects for transferring jurisdiction for adjudication of all tax disputes to the Tax Court of Canada?

4. Corporate Minimum Tax

Is there any support for abolishing the Ontario Corporate Minimum Tax? The tax adds substantial complexity to tax filings and it is questionable whether the additional tax generated from large taxpayers justifies the administrative burden to comply.

5. Capital Tax

In the federal paper on financial industry reform, the Federal Government indicated that it would be consulting with the provincial governments about reducing capital taxes. What is Ontario's view of this issue?

6. Appeal Process

A. Our members believe that appeals of income, capital, and sales tax matters move at an extremely slow pace in Ontario. Does Ontario share this view? If so, are any steps being considered to expedite the process? Would Ontario share its performance measurement goals and its statistical data comparing the targeted and actual timeframes for the disposition of cases submitted to Appeals?

B. Would the government explain the measurement criteria that are used in evaluating tax auditors, case managers, and the audit divisions generally? Are taxpayer reassessments or other numerical data relating to tax collections a factor in either individual, group, or departmental performance evaluation criteria? If so, what weight is assigned to that data and what are the implications for the affected government employees (whether individually or as part of a group, division, or department) and taxpayers? In the event that taxpayer reassessments are a factor in such performance measures, is the success of a taxpayer's appeal in reducing a reassessment factored into the evaluation process as well?

7. Unified Administration of All Taxes for Multi-jurisdictional Taxpayers

Would Ontario indicate its level of interest in using the new federal Agency to administer taxes that are not currently administered by the federal government? Alternatively, has Ontario discussed cross-delegation of the PST audit function among PST provinces?

Some non-Ontario members have inquired why the Ontario government devotes the resources it does to auditing companies with a minimal presence in Ontario, especially where other jurisdictions audit the same information. Where an audit by another jurisdiction has occurred (or is likely to occur because of the size of the company), a desk review by Ontario should disclose whether material errors on a capital tax return require adjustments. We invite the government's views.

Does the Ontario government perform risk assessments in determining which companies to select for audit? Where possible, does it co-operate with other governments in selecting companies for audits?

8. Central Paymaster Rules

The Ontario Central Paymaster rules were implemented with effect for year ends commencing after November 1, 1996. On implementation of the provisions, Ontario stated publicly that it would defer enforcement of the rules until parallel legislation was enacted by the other provinces. Despite those assurances by the government and notwithstanding the absence of parallel rules in other provinces, TEI members report that the Central Paymaster rules are currently being enforced.

   a. Would Ontario confirm that these rules are being applied even where they
   produce double taxation?

   b. We understand that Ontario has a Memorandum of Understanding (MOU) with
   other governments to prevent double taxation. Please explain how, or
   confirm that, these MOUs are being applied to assessments raised under the
   Central Paymaster rules to eliminate double taxation.

   c. Would Ontario comment on the appropriateness of one province, especially
   a head-office province, acting unilaterally to enforce non-uniform
   allocation rules against Canadian companies subject to multi-jurisdictional
   taxation?

9. Capital Tax Interpretations

Would Ontario consider providing expanded interpretative guidance on capital tax issues?

10. Harmonized Sales Tax (HST)

In 1989, TEI expressed regret that the federal tax reform proposals did not encompass the provincial sales tax (PST) systems and argued that an integrated federal-provincial program would reduce the complexity and administrative costs associated with separate tax systems. TEI was mindful that significant political, fiscal and administrative hurdles would have to be surmounted to satisfy the provinces' concerns in respect of a fully harmonized consumption tax systems. We offered the following guidelines for tax reform:

   We urge the Government ... [to] adhere to certain key principles that we
   believe are fundamental to sound tax policy and administration. Among the
   core principles are revenue neutrality, simplification of the tax system,
   minimizing the burden of compliance, promoting common or uniform
   administration and tax regimes without material exceptions, fostering
   extensive taxpayer consultations, providing timely, prospective legislation
   and form release, and ensuring adequate transitional rules.

In 1994, TEI wrote to all the provincial Ministers of Finance (Floyd Laughren was Ontario's Minister of Finance at that time) urging the Ministers to continue meeting with representatives of the federal government in an ongoing dialogue concerning alternatives taxes to replace Canada's GST. The letter encouraged the Ministers toward the adoption of consumption tax systems that were fully harmonized with the federal GST. At that time, the federal government proposed a 12 percent integrated sales tax (IST), which would have yielded 7 percent to the federal government and only 5 percent to the Ontario provincial government. Mr. Laughren replied that such a proposal would "... fly in the face of our promise not to raise new taxes. Ontario would have to start applying PST to purchases that are now exempt, including home heating, books and children's clothing." Mr. Laughren also noted that Ontario's counterproposal to the federal government to offset the loss of sales tax revenue from the elimination of Ontario's PST was for the federal government to reduce its share of Personal Income Tax (PIT). The federal government, however, declined to adopt Ontario's proposal.

In late 1996, TEI again sent a letter to the provincial ministers of finance (The Honorable Ernie Eves for Ontario) re-confirming its position on fully harmonizing with the GST and expressing TEI's regrets that Ontario had chosen not to harmonize at this time as had the provinces of New Brunswick, Newfoundland, and Nova Scotia. Again, TEI urged Ontario (as well as the other non-harmonized provinces) to continue its dialogue with the federal government with the long-term objective of establishing a single national sales tax.

In connection with this liaison meeting with the Ontario Ministry of Finance, TEI again reiterates that it supports a national sales tax system with a single rate, common tax base, and unified administration. We believe the complexity and the costs of compliance with, and administration of, multiple sales tax systems can be substantially reduced for the benefit of taxpayers and the government alike through the adoption of a harmonized sales tax.

Even though we generally support a harmonized sales tax system, we note that a decision by Ontario to harmonize will likely trigger the introduction of tax-included pricing (TIP) under Division XI [s. 364 to s. 368] of the Excise Tax Act. This section automatically introduces tax-inclusive pricing when more than 51 percent of the population lives in harmonized tax jurisdictions, effective on a day fixed by order of the Governor in Council. Our understanding is that the provinces of Alberta, Quebec, Nova Scotia, New Brunswick, and Newfoundland are currently considered "harmonized." As a result, action by Ontario to implement HST would trigger the TIP provisions.

TEI members strongly question the necessity for tax-included pricing, since it adds significant and unnecessary complexity and substantial costs. If adopted, Canada would be the only country in the world where multiple tax-included rates must be factored into every price. Would Ontario advise us about their current position concerning harmonization, as well as its views on tax-included pricing?

11. Procurement Cards (P Cards)

The use of P Cards by Canadian companies for routine purchasing transactions has escalated dramatically during the past year. P Cards enable an employee of a company to acquire goods and services and to charge them to a credit card. While the cards are issued in the name of the employer and the employee, liability for payment lies with the employer. The cards are used to acquire low dollar cost items, generally from a specified list of suppliers.

The card issuers are able to pass through to the user whatever information they receive from the retailer/supplier. In practice, there are three levels of information available. Level I information consists of very basic information: date of transaction, vendor, total amount of the sale, and location of the point of sale. Level 2 information provides, in addition to that in Level 1, sales taxes paid, and the supplier's province, city, and postal code. Level 3 information is the most detailed and provides, in addition to the information in Levels I and 2, item quantities, product description, the taxability of the individual items, the taxes charged by jurisdiction, and other information, including vendors' GST and QST registrations numbers. In effect, Level 3 provides the same information as in an EDI transaction.

The Ontario Ministry of Finance has confirmed in writing that the information supplied by the card issuer will satisfy the documentation requirements of the Retail Sales Tax Act. Does the ruling apply equally to all levels of documentation? If not, what steps are being taken by the Ministry to develop a standard for Level 1 and 2 documentation that would satisfy the requirements of the Act without imposing an obligation that purchasers retain each piece of paper documentation for every transaction?

12. Ordinary Course Sales

For purposes of the Ontario Retail Sales Tax (ORST), would you please confirm the circumstances under which a sale would be considered to be other than "in the ordinary course of business" (and therefore outside of the scope of vendor collection responsibilities) as described in the definition of "vendor" in subsection 1(1) of the Ontario Retail Sales Tax Act? Must all or substantially all of the assets of an ongoing business be sold, or would the exemption apply in circumstances involving the sale of a smaller set of business assets (such as the sale of all the assets of a single division or perhaps even fewer)? If a vendor is uncertain whether a sale is considered outside of the ordinary course, would the provision of a purchase exemption certificate by the purchaser relieve the vendor of its obligation to collect tax?

Is there any public guidance available to vendors explaining their tax collection and remittance responsibilities in these instances? If not, will Ontario consider providing such guidance soon?

13. Warranty and Maintenance Obligations

A. Ontario is the only province where the warrantor of goods initially sold subject to a provincial retail sales tax must pay that retail sales tax on any parts and third-party labour consumed or used in providing the services required under the warranty obligation. Ontario does allow a return and exchange period of not more than 90 days if the vendor records a return as a canceled sale rather than a taxable warranty repair.

Similarly, Ontario is the only province where a supplier of a service, maintenance, extended warranty agreement, or similar contract (hereinafter referred to collectively as an "agreement") (initially sold subject to a provincial retail sales tax) must pay the retail sales tax on any replacement parts and third-party labour consumed or used in connection with fulfilling its obligation under the agreement. There is no parallel "90-day rule" in respect of these agreements.

Will Ontario consider bringing its taxation policy in respect of these supplies into line with the other four PST provinces (as well as the provinces of Alberta and the three harmonized provinces of Newfoundland, Nova Scotia, and New Brunswick) in order to assure that Ontario businesses are on an equal playing field with businesses in these other provinces?

B. Ontario government representatives have explained in the past (during roundtable discussions at public meetings, in private discussions between TEI members and employees of the Ontario Tax Advisory Office, and in written responses to questions posed at TEI's "Ontario Day" Conferences) that, where a person acquires fixed-fee maintenance services from an unrelated party for resupply as fixed-fee maintenance services, the purchases are exempt from ORST. Where a person acquires parts or third-party labour on a time-and-materials basis, however, the purchaser could not avail itself of the same exemption. In the latter case, Ontario's position that the exemption is not available was based on the view that there were two purchasers, one being the end user of the maintenance agreement and the other being the party that supplied the parts and labour to fulfill the agreement.

It recently has come to our members' attention that Ontario has seemingly revised its position on the avail ability the ORST exemption. Specifically, fixed-fee maintenance services can no longer be acquired on a tax-exempt basis even where it will be re-supplied as a fixed-fee maintenance service. As a result of the revised interpretation, an additional tier of sales tax will be levied on each transaction pursuant to tiered warranty or maintenance agreements. In other words, there will be cascading sales taxes on each transaction wherever there is a series of contractors (or subcontractors) providing goods or services in connection with providing the warranty or maintenance service to the product end user on behalf of the original seller of the goods. Would the government please confirm and explain its position in respect of the sales tax treatment for fixed-fee warranty or maintenance agreements? More specifically, would it describe the circumstances under which fixed-price warranty or maintenance contracts can be obtained on an ORST-exempt basis?

14. Subsection 2(9)

The recent Court of Appeal decision in Ontario Hydro v. The Minister of Revenue, 99 GTC 7156 (Ontario Court of Appeal), has raised concerns about the use of subsection 2(9) by the government. Could Ontario please clarify what rights it believes subsection 2(9) confers for purposes of the ORSTA in respect of deeming a fair value for taxable goods or services acquired in Ontario? Will contract prices between unrelated parties be challenged? Will contracts be linked together when a purchaser acquires a non-taxable service from one party and uses the results of the services to acquire taxable goods or services from another party? Would the answer to the last question change if, or be dependent on whether, the party providing the non-taxable service has arranged for the provision of the taxable goods or services to be made to the purchaser by a third party that is unrelated to the purchaser or sellers?

15. First Copy Software

Where a company manufactures tangible property or goods for resale, the costs of components or materials incorporated in the manufactured goods are generally exempt from ORST. Similarly, manufacturing equipment used to produce tangible goods is frequently purchased on an ORST-exempt basis. Special exemption rules apply, however, in the case of software developers. In particular, the cost of equipment used in developing one-of-a-kind or "custom software" is generally ineligible for sales tax exemption for manufacturing equipment whereas an ORST exemption is available on the purchase of equipment used in the production of software intended for sale or distribution in a mass market.

In view of the prevalence of third-party contracting arrangements in connection with the development and distribution of software, we invite a discussion of the facts and circumstances under which the sales tax exemption for manufacturing equipment will be available. Specifically, the distinction between "custom software" and software intended for "mass market" distribution is confusing, especially in determining the proper treatment of the software development costs for the "first copy" of software that is intended to be widely distributed. To frame the discussion, assume the following facts for a software development contracting arrangement. Company A develops (or writes the code for) the "first copy" of software that Company B will, in turn, reproduce or distribute to multiple customers in a mass market. On the transfer of the first digital copy of the software from Company A to Company B, A retains no substantial rights to the software. Are Company A's expenditures for the purchase of computers or other equipment used in connection with the software development for this project eligible for an ORST manufacturing exemption? Alternatively, are Company A's costs for the purchase of equipment used in such software development considered to be for the production of "custom software" and, hence, ineligible for the manufacturing exemption? In other words, is the fact that there is only a single customer for Company A's "first copy" software dispositive of the issue of whether A is producing "custom" software even though the software is eventually sold or distributed by Company B to a mass market? We believe there is a need for public guidance clarifying the availability of the sales tax manufacturing exemption for equipment used in software development costs, especially the treatment of the costs associated with the development of the "first copy" of software intended for mass distribution. We request that the government clarify its position.

16. Software Activities

Would the government please clarify the types of activities "provided in respect of software" that are considered taxable for purposes of the Ontario Retail Sales Tax? We are especially interested in your views on the taxability of the activities listed in (a) to (i) below, but invite comments on other activities as well. In responding, assume that the vendor separately invoices each activity.

   a. Vendor configures software and sets the necessary parameters to allow
   its effective operation.

   b. Vendor provides training to demonstrate how to use the software
   effectively.

   c. Vendor analyzes the customer's operations, makes recommendations about
   the type of software to purchase, and advises generally about the potential
   uses of that software.

   d. Vendor provides help desk advice only (no software code fixes, upgrades,
   or new releases of software).

   e. Vendor provides bound technical manuals outlining how to use the
   software (but separately and not as part of a shrink-wrapped piece of
   software).

   f. Vendor transfers data from one system to another.

   g. Vendor develops a spread sheet.

   h. Vendor types letters using word processing software.

   i. Vendor uses database software to create a database for use in mailing
   information to customers.

In responding to parts (g) to (i) above, please consider that a company might hire a person from a temporary agency in order to fill in for someone on leave in the accounting department or in a secretarial position. As part of their normal duties, this person may create spreadsheets, type letters using word processing software, or use a piece of database software to create distribution lists for customer mailings. They may also input data from another system or source into this spreadsheet, letter, or database in order to carry out their assigned tasks. In such alternative circumstances, would the government confirm our understanding that the use of software in this manner to create worksheets, letters, or databases is outside the scope of the definition of "software" or "taxable services rendered in respect of software"?

Would the government also confirm whether the taxability of these services in each of the above cases depends on whether the services are provided at the time the software is installed or after its implementation?

17. Interest

We invite a discussion of the government's policies and procedures in respect of the calculation of interest on refund requests for all types of Ontario taxes. We note that there is a seeming lack of guidance on this issue. Is there a legislative rule, interpretation bulletin, policy statement, or other document to which companies may refer for guidance?

When a return or transaction is reassessed and additional tax is due, the starting date for purposes of calculating the interest is the date on which the tax amount was originally due. For the sake of consistency and equity, where the government owes a refund to the taxpayer should not the start date for calculating the interest owed to the taxpayer be the same date as when taxes are due? In view of the lack of guidance, we are uncertain what date Ontario actually uses as the start date. To aid our understanding of the rules, assume a taxpayer submits a validly signed refund request on January 1, 1999. The taxes were remitted in error in January 1998. The refund request is approved on August 1, 1999, and the cheque is processed by Ontario on September 1, 1999. On these facts, what is the start date for determining the proper amount of interest on the overpaid taxes? Would the starting date change if a delay in approving a refund is attributable to an ongoing audit and the auditor has agreed to review the facts underlying the refund request in the normal course of an audit of the taxpayer making the claim for refund? Where there is an undue delay in processing the reassessment or refund, would the government consider using the formal refund request date as the interest start date?

18. Multi-Jurisdiction Transactions

Where software is initially delivered to a location in Ontario, but is licensed for use both inside and outside of Ontario, will Ontario permit companies to prorate the price of the software and assign the taxable value to each of several jurisdictions (based on, say, the number of licensed users located in each province) for purposes of determining the appropriate retail sales tax to be paid to each province? We understand that British Columbia currently permits such a proration and that Ontario is currently reviewing its position on this issue.

19. Exemption Certificates

In its 1999 budget, Ontario announced that it would undertake a review of its administrative rules requiring the creation and filing of Purchase Exemption Certificates in order to exempt sales from the Ontario Retail Sales Tax. Currently, Ontario is, at ]east administratively, the only province that continues to require the creation and retention of certificates (where a "G" permit is not employed) to exempt all taxable supplies from retail sales taxes. All other provinces only require that the licence number of the customer be provided to the vendor. This is similar to the provisions Ontario currently affords to "G" permit holders. Would Ontario consider restricting its requirements for documentary evidence to the provision of the customer's vendor permit number in situations where products are being acquired on a conditionally exempt basis? Where the purchaser does not have a vendor permit number, purchase exemption certificates could continue to be used. Would Ontario consider allowing non-residents of Ontario to complete purchase exemption certificates even though they do not have a vendor permit number? This is allowed in certain situations in British Columbia.

20. Compliance Forms on Tendering

Tendering documents seemingly require an absolute certification that all Ontario tax reporting requirements have been satisfied. It is problematic, however, for large companies to certify with absolute certainty that all tax reporting obligations have been satisfied since, notwithstanding substantial internal controls, mistakes can be made in the recording and reporting of the facts giving rise to the companies' reported tax liabilities. As important, the complexity of the tax law and its application to myriad facts and circumstances can frequently produce good faith disputes about the proper amount of tax liability to be reported in respect of particular transactions. Those disputes frequently require substantial time and resources to resolve. Hence, would the government consider tempering the certification statement relating to compliance forms on tendering so that the certification is less "absolute?" For example, would the government consider adding a statement to the forms that says the signer's attestation is true and correct based on his "knowledge" or "information." Alternatively, would the Ontario consider tempering the compliance forms for tendering to include a statement that the company's tax obligations have been "materially" satisfied?

21. EHT -- Employees Outside Ontario

The decision in Progressive Packaging Ltd., [1999] 5015 ETC (Ontario Court of Justice), highlights that the Employer Health Tax (EHT) applies to all employees who are considered "employed" in Ontario, even those who do not reside in the province and therefore cannot benefit from access to the Ontario health-care system. We invite Ontario to comment on the tax policy rationale for imposing the EHT on employers for employees residing outside of Ontario and whether the tax is consistent or at odds with the principle of ensuring a proper nexus between the benefits and burdens of taxation. In addition, does Ontario believe the EHT applies neutrally to companies with head-offices in- and outside Ontario?

Conclusion

The Toronto Chapter of Tax Executives Institute appreciates this opportunity to meet with representatives of the Ontario government on January 27, 2000. The agenda was prepared under the aegis of the Toronto Chapter's Ontario Tax Committee, whose chair is Alan Wheable. If you should have any questions about this agenda, please do not hesitate to call Mr. Wheable at [phone], or me, at [phone].