Pending excise tax issues: December 3, 2003.

On December 3, 2003, Tax Executives Institute held its annual liaison meeting with the Canadian Department of Finance on pending commodity and excise tax issues. The written agenda for the meeting, which was prepared under the aegis of TEI's Canadian Commodity Tax Committee, whose chair is Sherrie Ann Pollock of the Royal Bank of Canada, is reprinted below.

Tax Executives Institute, Inc. welcomes the opportunity to present the following comments and questions on pending commodity and excise tax issues, which will be discussed with representatives of the Department of Finance during TEI's December 3, 2003, liaison meeting. If you have any questions in advance of that meeting, please do not hesitate to call either Mario M. Tombari, TEI's Vice President for Canadian Affairs, at 514.932.6161, ext. 2943, or Sherrie Ann Pollock, chair of the Institute's Canadian Commodity Tax Committee, at 416.955.7373.

Background

Tax Executives Institute is an international organization of more than 5,400 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 2,800 of the leading corporations with 53 chapters in Canada, the United States, and Europe.

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 eight 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; telecommunications; 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.

Questions

1. During last year's liaison meeting, TEI asked whether any changes were under consideration to bolster the competitiveness of Canadian companies making supplies to a global marketplace. The following examples were offered to illustrate areas of concern:

(a) Intangible Personal Property--While intellectual property is zero-rated under section 10 of Part V of Schedule VI of the Excise Tax Act (ETA), analogous provisions do not exist for other intangible personal property. Because the place of supply rules (outlined in paragraph 142(1)(c) of the ETA) tax intangible personal property if it can be used "in whole or in part" in Canada, the potential exists for taxing supplies that actually have very limited use in Canada. GST-registered suppliers are thus placed at a competitive disadvantage compared with non-registrants providing similar global solutions. The place of supply rules can also put suppliers who are unfamiliar with the limited application of zero-rating provisions in a position of unintended noncompliance. Expanding the zero-rating provisions to apply to all intangible personal property would permit GST-registrants to compete more effectively on a global basis. TEI invites discussion of this issue.

(b) Telecommunication Services--Currently, section 22.1 of Part V of Schedule VI of the ETA, limits the zero-rating provision for telecommunication services to supplies that are made to a person carrying on the business of supplying telecommunication services. Because products that are characterized as telecommunication services are growing exponentially, this narrow exemption puts GST-registered suppliers at a competitive disadvantage when providing telecommunication services to persons located outside Canada.

Many customers using these services are not in the business of supplying telecommunication services, and the inability to zero-rate these services makes GST-registered suppliers uncompetitive in a global marketplace. One solution would be to restrict the types of services that are considered to be telecommunication services. Combining this with a broadening of the zero-rating provision so that it applies to all non-registered nonresidents similar to section 10 of Part V of Schedule VI of the ETA) would provide a longer-term solution.

(c) Services--Because the words "rendered to" in paragraph (a.1) of section 7 of Part V of Schedule VI of the ETA (which attempts to zero-rate certain services made to non-residents) are interpreted to refer to the party who takes advantage of the service being provided--rather than the party who has contracted for the service--the provision has the effect of putting GST-registered suppliers at a competitive disadvantage when marketing their services to global customers.

As an example, consider a GST-registered supplier establishing a call centre in Canada. The supplier contracts with a non-resident to provide information to the non-registrant's customers (the services provided are not considered to be professional, advisory, or consulting services). The persons that request information are not the non-registrant's employees, but may be its customers or potential customers. Most parties to whom information is provided are located outside Canada, but if any of the parties requesting information are located in Canada, the services will be "rendered to" the latter party and therefore fall outside the zero-rating provision.

Canadian-based call centres serve a global clientele. The inability to use the zero-rating provisions in situations where some requesters (who are not the contracting party) are situated in Canada makes the Canadian-based centre less attractive than one situated outside the country. The wording of section 7 of Part V of Schedule VI of the ETA should be amended to add the word "recipient" after "individual" (viz., "a service that is rendered to an individual recipient while that individual is in Canada") to put Canadian suppliers on an equal footing with their foreign competitors situated outside the country.

During this year's meeting, TEI requests a progress report on efforts to broaden the zero-rating provisions for intangible personal property and services.

2. During last year's liaison meeting, the following question resulted in a discussion of the barriers that a financial institution faces when it decides to "outsource" services to a third party that were previously provided by "in-house" employees. At that time, the Department representatives suggested that they were interested in undertaking an overall review to determine whether the GST burden currently borne by financial institutions is appropriate. Please provide an update on this issue, including the need to address the issues outlined in the following question:

   Financial institutions considering using a third party to
   outsource services currently being performed in-house
   by its own employees are unable to recover the GST
   paid for services that are not subject to the GST when
   provided by employee labour. This creates a disincentive
   for financial institutions to outsource, and limits
   their ability to take advantage of third-party services
   that would otherwise assist them in reducing costs and
   increasing competitiveness. Other jurisdictions have
   either implemented solutions to address this issue, or
   are in the process of reviewing proposals that would
   resolve it.

   Australia currently allows financial institutions to make
   a recovery of 75 percent of the value-added tax (VAT)
   charged to them for any supplies that fall under its
   definition of outsourcing services. The remaining 25
   percent of VAT charged is subject to normal recovery
   rules. Such a design applied in Canada would effectively
   remove the disincentives created by the GST
   when financial institutions review the costs and benefits
   related to replacing employee labour with supplies by
   third parties.

      New Zealand has issued a discussion paper
   proposing zero-rating of financial services supplied
   to a registered business, whose supplies of taxable
   services (including zero-rated services) are at least 75
   percent of its total supplies.

      The European Commission is reviewing the feasibility
   of applying a VAT to financial services. This design,
   applied in Canada, would allow financial institutions to
   increase their recoveries of GST, reducing their costs
   and making them more competitive.

      Any of the designs outlined above would allow
   financial institutions to take greater advantage of the
   services that are available from unrelated third parties
   (the Australian design may be easier to implement from
   an administrative standpoint). Is the Department considering
   any options to alleviate this concern? Would
   the Department consider either adopting a design
   similar to that adopted in Australia, or allow financial
   institutions to deem some services taxable and others
   exempt based on customer types?

3. Section 156 of the ETA was amended to allow GST tax relief for supplies being made within a related group to partnerships. The equivalent section 150 of the ETA used by financial institutions to provide similar relief has not been amended to reflect the use of partnerships. Is Finance contemplating any change to the section 150 election to permit qualifying partnerships (similar to the section 156 definition) to receive the same GST treatment as corporations? If not, please explain the policy rationale for instituting partnership changes under section 156, but not section 150.

4. (A) Section 156 of the ETA allows GST tax relief for supplies being made within a closely related group. In the definition of "closely related" under subsection 156(1.1), there is a 90-percent ownership threshold test. Section 156 provides a good example of an efficient mechanism that helps closely related groups comply with the law. Many GST-taxable organizations with less than 90-percent common ownership threshold are managed as single entities and consequently experience great difficulty in identifying internal supplies being made within their closely related group. Would the Department consider lowering this threshold test to, say, 80 percent?

(B) Section 128(1) states that a closely related group must be comprised of registered residents. To take advantage of the election for nil consideration under subsection 156(2) of the ETA, a U.S. parent corporation cannot be part of the closely related group. Why is this election restricted to Canadian residents and not available to all closely related groups so long as all members of the group are registered corporations? In our current global environment there are many ownership structures that include a foreign parent and it seem inequitable that these types of structures should be excluded from the benefits of the section 156(2) election. Does the Department contemplate any changes to this provision?

5. For many years, TEI has submitted questions to Canada Customs and Revenue Agency with respect to methodologies to recover input tax credits (ITCs) on company-issued procurement cards. Many Canadian companies are under extreme competitive pressures and are seeking cost efficiencies such as those offered by the procurement card plans. These efforts are hampered, however, by the issues associated with the recovery of ITCs.

Would the Department consider a technical amendment to the Excise Tax Act to formally extend the application of the expense account factors of section 175(1) to procurement cards that are issued only in the name of the company?

6. Paragraph 169(4)(a) of the ETA states that a registrant may not claim an ITC for a reporting period unless, before filing the return in which the credit is claimed,

   the registrant has obtained sufficient evidence in such
   form containing each information as will enable the
   amount of the input credit to be determined, including
   any such information as may be prescribed.

Paragraph 3(b) of the Input Tax Credit (GST/HST) Regulations provides a list of prescribed information, including the registration number assigned under subsection 241(1) of the ETA to the supplier. There are several court cases on this issue (e.g., Nix, Helsi, and Tremblay) with differing results. The validity of the registration number given to a purchaser by the supplier has always been assumed as long as it appeared to be a correct number (i.e., nine digits) without the need for an investigation by the supplier. These court cases cast doubt on that practice.

Please answer the following questions:

(i) What must the purchaser supply to the auditor to substantiate that the vendor has given a valid registration number?

(ii) The current verification method for registration status and number is via telephone [phone]). Because of confidentiality concerns, CCRA will either confirm that a person is a registrant, or that a particular registration number is valid, but will not match the number with the registrant. How can a supplier prove in audit that this step was taken?

(iii) If the registration number is valid but belongs to a different registrant, how can a supplier get this information?

(iv) Will CCRA release lists of valid numbers for verification purposes?

(v) Will CCRA confirm registration numbers if a corporation sends a list of suppliers registration numbers each year for verification?

7. On October 3, 2003, the Department of Finance released "Proposed GST/HST Amendments" that included a section on "Import Arrangements for Goods Supplied Outside Canada." See News Release 2003-046. Proposed new section 178.8 of the ETA would address circumstances in which a person is the recipient of a supply made outside Canada of goods that are imported into that country for that person's consumption, use, or re-supply, but another person effects the physical importation of the goods. The notice otters the example of a supplier of the goods who may effect the importation and account for any applicable taxes or customs duties on the goods at that time. This section provides two elections: first, an option "in certain cases, for the recipient and the supplier of the imported goods to elect for an alternative treatment that would avoid the need for the exchange of import documentation"; and second, an election where the recipient of the imported goods and the supplier do not opt to treat the supply of the goods as if it had been made in Canada.

What has been the reaction to the proposed changes? Will the Department revisit the proposed wording of section 178.8 if valid concerns are raised?

8. For a variety of business reasons, GST registrants often undertake business reorganizations, either acquiring assets or internally transferring activities or assets from one corporate unit to another. These transactions are often significant in value.

Several provisions of the ETA address these reorganization transactions:

* Section 221(2) provides that, in respect of the acquisition of commercial real property, no tax is due if the property is acquired for use in commercial activities;

* Section 167.1 provides for the tax-free transfer if there is a transfer of: (i) a business by the supplier, and (ii) 90 percent or more of the assets necessary for the purchaser to carry on the business; and

* Section 156 permits an election to treat the transfer of assets as made for nil consideration where both the supplier and the purchaser qualify as members of a closely related group. (The election is predicated on registration status and meeting certain ownership and commercial activities tests.)

These provisions, however, may not apply to many corporate reorganizations because--

* The assets sold at arm's length do not constitute the sale of a business;

* It is difficult to determine whether the purchaser is acquiring 90 percent or more of the assets necessary to carry on the business; or

* Assets transferred through a new company within a closely related group do not constitute a business.

The inability to use the relief provisions results in compliance costs for both the CCRA and GST registrants, as well as significant cashflow issues. Solutions to the problems include--

* Simplifying and expanding the rules for tax-free transfers of business assets;

* Modifying the closely related group election to address the use of a new company;

* Broadening section 221(2) to include significant asset transfers when in the course of commercial activities; and

* Introducing specific GST rules aimed at divisive reorganizations.

Is the Department considering implementing these or other changes to the reorganization rules?

9. Section 186 of the ETA allows a parent corporation to claim ITCs in respect of any property or service acquired in relation to its ownership of shares in a subsidiary (another corporation). With respect to a corporation being a member of a partnership, paragraph 272.1(2)(b) of the ETA allows the corporation to claim ITCs to the extent the property or service acquired is consumed, used, or supplied in the commercial activities of the partnership. CCRA, in administering this provision, has differentiated between costs incurred by a partner that relate to the activities of the partnership and costs that relate to the holding of the partnership interest. CCRA therefore would deny any ITCs for costs relating to the partnership interest such as accounting and legal expenses.

Section 123 of the ETA defines "financial instrument" to include both a share and an interest in a partnership. TEI believes that both corporate structures should be treated in the same manner for GST purposes, and suggests that paragraph 272.1(2)(b) be modified in order to provide relief similar to section 186 of the ETA where a holding company holds partnership interests instead of shares. We invite the Department's reaction to this proposal.

10. Given the recent changes in the political landscape in Canada, please provide an update on the state of sales tax harmonization in Canada.

Conclusion

Tax Executives Institute appreciates this opportunity to present its comments on pending excise and commodity tax issues. We look forward to discussing our views with you during the Institute's December 3, 2003, liaison meeting.