Pending excise tax issues: December 4, 2002. (Canadian Department of Finance).

On December 4, 2002, Tax Executives Institute held its annual liaison meeting with officials of the Department of Finance on pending commodity and excise tax issues. Reprinted below is the agenda for the meeting, which was prepared by TEI's Canadian Commodity Tax Committee, whose chair is Martina Krummen of Air Canada.

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 4, 2002, liaison meeting. If you have any questions in advance of that meeting, please do not hesitate to call either Glenn G. Wickerson, TEI's Vice President for Canadian Affairs, at 403.233.1135, or Martina Krummen, chair of the Institute's Canadian Commodity Tax Committee, at 514.856.6675.

Background

Tax Executives Institute is an international organization of more than 5,300 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. Paragraph 169(1)(b) of the Income Tax Act--which allows a taxpayer to appeal to the Tax Court after 90 days from filing an objection to an assessment if the Minister has not notified the taxpayer that the Minister has vacated or confirmed the assessment or reassessed--improves the efficiency and effectiveness of the appeals process. There is no analogous provision in the Excise Tax Act (ETA). Would Finance consider adding a similar provision to section 302 of the ETA?

2. During last year's liaison meeting, TEI followed up on the Department's response to the following question regarding input tax credit (ITC) claims on imports (the de facto importer of record issue):

   A non-resident, GST-registered seller makes a sale
   FOB outside Canada, collecting no GST on the
   sale. The seller utilizes his business expertise to
   arrange transportation and importation of the
   goods into Canada on behalf of the customer. GST
   is incurred at the time the goods clear Customs by
   the seller. Is the seller entitled to an ITC?

   To which the Department responded:

   At the present time, the seller is not eligible to
   take an ITC.... Finance would like to arrange a
   further meeting with some TEI members to discuss
   this issue before they reach any conclusions.

The Department has subsequently met with some TEI members (as well as other associations) concerning this issue and various solutions have been discussed.

TEI also asked whether subsection 231(1) of the ETA provides a deduction with respect to a bad debt written off by a supplier. The deduction is contingent on the supplier having reported the tax collectible on the supply in its return and remitting the tax. If an election under subsection 177(1.1) is made, the agent of the supplier remits the tax and subsection 231(1) currently does not apply.

TEI suggested that relief be granted where the agent is merely a collection agent and is remitting the tax on behalf of the actual supplier, and asked whether the Department would consider permitting the actual supplier to deduct the tax related to a bad debt, even if the tax were remitted by the supplier's agent.

Would the Department please provide an update on both of these issues?

3. A national manufacturer pays a promotional allowance to a third party, based on amounts purchased by the third party's independent retailers (franchisees). This type of allowance does not appear to be covered by section 232.1 of the ETA. Will this section be amended to provide a "no consideration" treatment for such allowances to make it consistent with the underlying policy?

4. The Canadian Payments Association Board has approved a plan to implement a $25-million ceiling for all paper-based payments to be cleared and settled via the Automated Clearing Settlement System (ACSS). The implementation date for the $25-million threshold is February 3, 2003.

CCRA has advised that it will not accept wire payments and has no plans to amend that policy by February. In addition, CCRA apparently is not prepared to accept two cheques totalling the final payment amount, citing reconciliation problems.

Does the Department know what alternatives are being considered by CCRA for payments greater than $25 million? Will the Department be assisting CCRA in resolving this issue?

5. Is the Department considering any changes to the zero-rating provisions for intangible personal property or services to bolster the competitiveness of Canadian companies making supplies to a global marketplace? The following examples illustrate three areas of concern:

(a) Intangible Personal Property--While intellectual property is zero-rated under section 10 of Part V of Schedule VI of the 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 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 non-residents (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 nonresidents), 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 nonregistrant'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.

6. 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?

7. A company that is at least 90 percent owned by credit unions may make supplies of property (by way of lease, license, or similar arrangement) or services to such credit unions or to any other credit union on a GST-exempt basis. The Closely Related Corporations (GST/HST) Regulations specifically identify additional companies that qualify to make such exempt supplies to credit unions. These companies were added to the regulations at a time when they were primarily owned by credit unions and provided services exclusively to them. The effect of the regulations was to provide a result, from a GST perspective, similar to that obtained if the credit unions had performed the services or developed the products in-house.

We understand the ownership and activities of the named companies have changed, yet they continue to make supplies of property and services to credit unions on a GST-exempt basis. Credit unions purchasing supplies get very few, if any, ITCs; therefore, they are sensitive to the amount of applicable GST charges when making purchasing decisions. Since these specifically identified companies are not required to charge GST, this provides them with a competitive advantage over companies making supplies of property and services to credit unions that are not identified. We invite discussion of this issue.

8. If a financial institution that does not carry on exclusively commercial activities makes a voluntary disclosure with respect to Division IV tax (i.e., for imported taxable supplies) and the disclosure goes beyond the two-year period in which input tax credits (ITCs) are permitted, there is apparently no mechanism to enable the financial institution to claim the ITCs. That is, the claim for ITCs is provided in Net Taxes (i.e., in Division II tax) and there is a rule restricting the period in which ITCs are claimed. Such a process seems unfair. During the meeting, we invite the Department's comments on this issue.

9. In a recent meeting that the Canadian Manufacturers and Exporters Association held with Ontario Finance Minister Janet Ecker, a question was raised whether Ontario would consider harmonizing its Retail Sales Tax with the federal GST. Taking this step would make business located in Ontario far more competitive on both a national and international basis. Minister Ecker intimated that although an announcement should not be expected in the next budget, she did believe the issue was worth further examination. Has the Department seen any progress by Ontario in respect of harmonization? Is there anything that TEI could do to assist in the process?

10. In GST/HST Technical Information Bulletin B090, under the section "Place of Supply," a statement is made that services will be considered to be performed--and therefore a supply made in Canada--if "the supply involves doing something to or with a recipient's equipment by accessing it from a remote location, and the recipient's equipment is located in Canada." Although the type of service described in the Bulletin is very narrow, this interpretation seems to be a clear move away from the historical view of looking at where the service provider was physically located when the service was performed. TEI is concerned that this interpretation will be applied to other types of services performed outside Canada in respect of customers located in the country.

Please explain the move away from the use of physical performance in determining where services are performed. Also, given the common meaning of the word "perform," TEI suggests issuing supplemental guidance on what constitutes performance within the borders of Canada.

11. TEI commends the Department for introducing GST and duty relief programmes designed to aid Canadian distribution and processing companies in promoting their goods abroad and to ease their financial burden. These programmes include the Export Distribution Centres, the Export Processing Programme, and the Bonded Warehouse Programme.

The programmes appear very attractive initially. Upon scrutiny, however, the programmes usually include restrictions or requirements that present formidable disincentives. As examples, the Export Distribution Centre provision requires the warehouse inventory to be incorporated into a separate company, and the Export Processing Programme cannot be utilized for a related company and a foreign entity must own the goods. The Bonded Warehouse Programme rules result in the need for duplicate inventory systems and require a reconciliation of inputs to draw-downs when exporting odd lots, including the need to trace the original entries for U.S. drawback purposes. The requirements also increase brokerage fees owing to the increased compliance.

TEI is interested in an update on these programmes. TEI would also like to know if large companies are taking advantage of these incentives. If not, how could TEI assist in easing restrictions to make the programmes more attractive and feasible to our member companies?

12. TEI understands that the Department and CCRA are developing technical amendments in respect of subsection 273(1) of the ETA (the GST/HST joint venture election). Can the Department provide additional details concerning the issues that will be addressed, the timetable for release, and whether additional industry input will be allowed in advance of any legislative or administrative amendments?

13. An election under subsection 156(2) of the ETA (which deems a taxable supply to be made for no consideration in certain circumstances) generally requires that an electing party be a "specified member" of a qualifying group. One element of the applicable definition of "specified member" (subsection 156(1) of the ETA) requires that "all or substantially all of the property of [the member] (other than financial instruments) was last manufactured, produced, acquired or imported by the person for consumption, use or supply exclusively in the course of commercial activities of the person or, if the person has no property (other than financial instruments), all or substantially all of the supplies made by [the member] are taxable supplies." Under this definition, a new corporation with no assets and not yet commencing operations would be ineligible to make the election.

In a reorganization, a new subsidiary will often receive assets from its parent or other members of the related group to be used exclusively in taxable activities that commence immediately after the transfer. If the election were not available, the subsidiary would be required to collect GST. Although the tax would ultimately be recoverable by the subsidiary, it results in a negative cash flow to the corporate group.

This result defeats the purpose of the election to provide GST/HST relief within the qualifying group. Will this election be accepted for the transfer of assets where the subsidiary immediately uses those assets exclusively in commercial activity following the transfer?

To satisfy the requirement, a nominally valued asset could be transferred to the new subsidiary immediately prior to the "main" transfer of assets from members of a qualifying group. There is no apparent time-line in the definition of "specified member" in respect of how long the assets must be used exclusively in commercial activity. Would this scenario be characterized as an avoidance transaction?

Finally, the subsection 156(2) election requires that a closely related group consist of GST-registered residents. Why is the election restricted to Canadian residents and not available to all closely related groups whose members are registered corporations? Further, if a non-resident, GST-registered parent corporation maintains inventory in Canada, would the parent be deemed a resident and therefore qualify for the election?

14. 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.

15. TEI would like to follow up with the Department on concerns that have arisen over the last year regarding the "carrying on business concept" and certain interpretations that CCRA seems to be taking on the subject.

(a) Consider the following example:

   A non-resident corporation of Canada (Non-resident
   Co.) is incorporated outside Canada and has
   not been continued in Canada. All of the officers
   and directors of Non-resident Co. are resident
   outside of Canada (i.e., the central management
   and control of Non-resident Co. is located outside
   of Canada).

   Non-resident Co. is engaged in the business of
   leasing tangible personal property. This business
   is carried on through offices located outside Can
   ada. There are no employees or agents of Non-resident
   Co. who reside in Canada.

   Non-resident Co. has not in the past concluded
   any contracts, manufactured or produced property,
   delivered tangible personal property, or provided
   any services in Canada. Non-resident Co.
   does not have a branch, office, or permanent establishment
   in Canada. It does not operate a
   bank or similar account in Canada, is not listed in
   any directory or publication available in Canada
   (other than directories or publications available
   via the Internet), and does not maintain inventory
   in Canada.

   Non-resident Co. has not previously entered into
   any leases with a Canadian resident company or
   in respect of leased assets that are situated or
   used in Canada.

   Non-resident Co. is not currently registered for
   GST. It is assumed that immediately prior to
   entering into the transactions noted below, Non-resident
   Co. is not carrying on business in Canada.

   A Canadian corporation (Can Co.) is contemplating
   a sale-leaseback transaction with Non-resident
   Co. Can Co. is a corporation incorporated
   under Canadian law. It is a resident of Canada
   and a GST registrant.

   Can Co. and Non-resident Co. will enter into two
   sets of agreements relating to equipment, which
   is currently used by Can Co. in its business.
   Under the first set of agreements (the "Sale Agreement"),
   Can Co. will sell the equipment to Non-resident
   Co. The equipment will be physically
   situated in Canada at the time of sale (i.e., the
   equipment will be delivered in Canada). Can Co.
   will retain physical possession of the equipment
   following the sale to Non-resident Co.

   Immediately after entering into the Sale Agreement,
   Can Co. and Non-resident Co. will enter
   into a lease agreement (the "Lease Agreement"),
   pursuant to which Non-resident Co. will lease the
   equipment to Can Co. The equipment will be physically
   situated in Canada at the time the lease is
   entered into (i.e., the equipment will be made
   available in Canada). The Lease Agreement will
   be executed by Non-resident Co. outside of Canada.
   Under the Lease Agreement, the equipment
   will be leased on a triple net basis, such that Can
   Co. will be responsible for all service, maintenance,
   and insurance of the equipment. Can Co.
   will make all payments under the Lease Agreement
   to Non-resident Co. in U.S. dollars to a bank
   account located outside of Canada.

If it is assumed that Non-resident Co. is not carrying on business in Canada and is not registered, TEI suggests that the two transactions will be taxed, as follows:

* The sale of the equipment by Can Co. to Non-resident Co. will not be subject to GST as a result of the application of subsections 179(4) and 179(2) of the ETA. These sections apply because a registrant (Can Co.) will transfer ownership of the equipment to an unregistered non-resident (Non-resident Co.) and will retain physical possession of the equipment for its use under an agreement for a supply of the equipment by lease made by Non-resident Co. to Can Co.

* The lease of the equipment will not be subject to GST pursuant to subsection 143(1) because an unregistered non-resident (Non-resident Co.) who is not carrying on business in Canada will supply the equipment.

Please confirm that in the above example Non-resident Co. will not be carrying on business in Canada. In particular, please confirm that Non-resident Co. will not be carrying on business in Canada merely because it accepts delivery of the equipment in Canada under the Contract of Sale and makes the equipment available in Canada under the Lease Agreement.

CCRA seems to be taking the position that because the equipment is located in Canada, the non-resident may be considered to be carrying on business in Canada. Presumably, this is based partly on the fact CCRA views the "profit generating apparatus" to be the operation of the equipment. Since the equipment is located in Canada, CCRA would take the position that the "profit generating apparatus" is in Canada. If so, TEI suggests that the "profit generating apparatus" from the non-resident's perspective is the financing operation and the assets used by the non-resident in its financing business (as opposed to the piece of equipment leased in Canada). In addition, even if the "profit generating apparatus" were deemed to be in Canada, this is only one factor to be considered.

If it were CCRA's position that the non-resident is carrying on business in Canada, the non-resident would be required to register and collect the GST. Such a position would basically render the drop shipment rules futile and inapplicable. We invite the Department's comments on this issue.

(b) Assume the piece of equipment in question is an aircraft and Non-resident Co. and Can Co. mutually agree to act conservatively. As a result, the aircraft is flown over international waters or the United States on a ferry flight to conclude the transaction. The transaction is concluded while the aircraft is in the air over the chosen location and the flight log clearly demonstrates this fact. From a legal and GST perspective, the transfer of ownership and possession is clearly made outside Canada. Can Co. now has to re-import the aircraft into Canada and pay the GST upon importation because the aircraft does not qualify as returned Canadian goods.

From a Customs perspective, Can Co. has engendered numerous problems. CCRA apparently believes that because the aircraft did not land in a foreign destination, there is no "foreign point" from which the aircraft can be imported into Canada. In other words, in order to reimport the aircraft, it must have landed in a foreign destination. Because this position does not reflect the commercial and legal reality, TEI invites a discussion of the issue.

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 4, 2001, liaison meeting.