Rollback of corporate tax reductions: November 24, 2003.

On November 24, 2003, the Toronto Chapter of Tax Executives Institute sent the following letter to Minister of Finance Greg Sorbara in reaction to the announcement of the intention to rollback corporate income taxes to 2001 levels. The comments were prepared by the Toronto Chapter, whose president is John M. Allinotte of Dofasco Inc.

On behalf of Tax Executives Institute (TEI), I am writing to express TEI's disappointment with the announced intention to legislate a rollback of corporate income taxes to 2001 levels. TEI is also concerned about the new government's statement that it will maintain other corporate taxes, including potentially the Ontario capital tax, at today's rates.

Background

Tax Executives Institute is the pre-eminent association of business tax executives. The Institute's 5,400 professionals manage the tax affairs of 2,800 of the leading companies in Canada, the United States, and Europe and must contend daily with Canada's business tax laws. The comments set forth in this letter reflect the views of the Institute as a whole, but more particularly those of our Canadian constituency who constitute 10 percent of TEI's membership. TEI is concerned with issues of tax policy 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. TEI has over the years established a good working relationship with officials of the Ministry of Finance.

The November 20, 2003, Speech from the Throne confirmed previous announcements from the Ontario government of its intent to introduce legislation rolling back the general corporate tax rate reductions legislated by the previous government. Such legislation will increase the current corporate income tax rate from 12.5 percent to 14 percent for most taxpayers, and from 11 percent to 12 percent for manufacturers and processors. Moreover, since the phased future reductions of the corporate income tax rate will not be implemented, the effective Ontario income tax rate for 2006 will be increased from the previously scheduled 8 percent to 14 percent.

As an additional matter, Premier McGuinty's letter of September 16, 2003, to the Chief Election Officer said that the new government would "maintain all existing other corporate taxes at today's rates." Although the full scope and effect of the Premier's letter is unclear, the new government is apparently not committed to the previously announced phased elimination of the Ontario Capital Tax (OCT).

We offer the following comments for your information and consideration.

Rollback of Corporate Income Tax Rate Reductions

The effects of the government's proposal to roll back the corporate income tax rate reductions will be immediate and detrimental to Ontario's business climate:

(i) Under financial accounting rules, all tax assets and liabilities recorded in a company's balance sheet must reflect legislated tax rates. The announced rollback in the rate reductions effectively increases current and future corporate income tax rates and, thus, all corporations doing business in Ontario must revalue assets and liabilities that were recorded under the previous tax rate schedule. Most companies will likely record a reduction in earnings, effectively reversing the financial statement benefit recognized in 2001 when the tax rate reductions were enacted.

(ii) The sudden reversal of the rate reductions will undermine investor confidence in the stability of Ontario's fiscal regime because business investments were made in Ontario during the past two years based on the short-lived promise of reduced tax rates.

(iii) The competitiveness of Ontario businesses will be eroded vis-a-vis businesses in other provinces, including Alberta, where the tax rate is scheduled to decline to 11.5 percent effective April 1, 2004, and especially against U.S.-based businesses. (1) The combined federal and Ontario rates, including the Ontario Capital Tax and withholding tax on dividends, generally exceeds the combined U.S. tax rate. (2)

(iv) The increased effective income tax rates reduce companies' annual returns on capital employed, reducing share-price performance and access to capital.

(v) The cumulative effect of the foregoing is a reduction in business investment in Ontario, which will lead in turn to a reduction of gross domestic product and jobs in Ontario. (3)

Although Ontario's current fiscal situation may not permit the government to proceed with the scheduled corporate income tax rate reductions, TEI strongly encourages the Ontario government to consider freezing corporate tax rates at their current levels rather than rolling the rates back to 2001 levels. Although such a policy would require companies to revalue their tax balances for the reversal of future tax rate reductions, the adverse effect would be smaller. Moreover, freezing the rates at current levels and deferring the effective date of future reductions would provide a positive signal to the capital markets. We understand that additional reductions may have to be deferred until fiscal conditions improve, but a permanent rollback of the rates to 2001 levels implies a harsh, even anti-business, climate. In addition, by keeping the tax rates at the current level, Ontario will remain competitive with Alberta, mitigating the loss of business and migration of head offices. Maintaining the current rate with a deferral of the future reductions to eight percent would forestall an immediate, material erosion of Ontario's competitive business advantages. We believe this is critical in order to maintain and encourage investment in Ontario, especially in high-paying, value-added jobs and operations, by both Canadian companies and foreign investors.

Ontario Capital Tax

TEI has consistently advocated the elimination of all capital taxes at the federal and provincial levels not only because of competitiveness reasons, but because we agree with the policy view expressed in Chapter 5 and Annex 9 of the 2003 federal budget paper: Capital taxes are a significant impediment to investment in Canada. Indeed, repeal of the Federal Large Corporations Tax (LCT) was one of the principal recommendations that TEI and others made during the 2002 Pre-Budget Discussions held by the House of Commons Standing Committee on Finance. We are pleased that the federal government has adopted this recommendation and, in our testimony on the 2003 Pre-Budget Discussions, urged the federal government to implement the repeal of LCT as quickly as possible. In a similar vein, we urged the Quebec government to reinstate and accelerate its planned reduction in capital taxes.

Accordingly, because Ontario's capital tax discourages investment in buildings and equipment and kills jobs in Ontario, we urge the new Ontario government to announce in its first budget the gradual elimination of the OCT during the same period that the federal government will eliminate the LCT. Indeed, we encourage the Ontario government to consider accelerating the elimination of the OCT in order to ameliorate its negative effect on the economy. Specifically, we recommend that the Ontario government consider reducing the OCT tax rate for all corporations for 2004 to 0.2 percent and completely eliminate it effective in 2005. (4)

TEI's Toronto Chapter appreciates this opportunity to present its comments on the government's announced intention to roll back the corporate income tax rates and possibly not follow through on the repeal of the Ontario Capital Tax. Before the government embarks on either course, representatives of the Institute would appreciate the opportunity to meet with you and your staff in order to discuss the matters.

If you should have any questions about the submission or would like to arrange a meeting to discuss the comments, please do not hesitate to call me at 905.548.7200, ext. 6821, Robert G. Westlake, chair of the Toronto Chapter's Ontario Tax Committee at 905.858.5379, or Monika M. Siegmund, chair of TEI's National Income Tax Committee, at 403.691.3210.

(1) Investors in Ontario businesses whether private, multinational corporations or public Canadian companies that are listed on the New York Stock Exchange must consider Canadian withholding tax burdens on dividends in addition to the effective corporate tax rates. When withholding tax rates are added to the combined federal and Ontario income tax rates and capital taxes, the proposed Ontario rollback would result in a tax rate (42.4 percent) that exceeds that of U.S. competitors located in neighboring states, as listed in the Ontario 2002 Budget. The 42.4 percent tax rate assumes a federal rate of 22.1 percent, an Ontario rate of 14 percent, a capital tax rate of 3.3 percent (as estimated by the federal Department of Finance), and a withholding tax on net income available for distribution equal to approximately 3 percent of net income (($100 of pre-tax income X (1-39.4 % combined income and capital tax rate)) x 5% withholding tax).

(2) In a recently published study by the C.D. Howe Institute, the authors compare the projected rates of tax on capital for large corporations in Canada in 2008 with the anticipated rate in the United States. After giving effect to the rate reductions announced previously by the federal and provincial governments (and assuming no rollback in Ontario), the study shows that the effective Canadian tax rate on capital in 2008 would be 27.4 percent, which is lower than the 2003 rate of 31.8 percent, but is much higher than the effective rate of only 20.1 percent in the United States. The study notes that if Ontario eliminates its capital tax and Alberta reduces its corporate income tax rate to eight percent by 2008, the combined Canadian tax rate on capital would decline to 24.6 percent, but that rate would still compare unfavorably with the anticipated U.S. rate of 20.1 percent. See Chen, Duanjie and Mintz, Jack M., Taxing Investments: On the Right Track, But at a Snail's Pace, C.D. Howe Institute (June 2003), at 3.

(3) The Organisation for Economic Cooperation and Development (OECD) estimates that every incremental dollar of revenue raised from corporate income tax results in an output loss and other inefficiencies of $1.55. In other words, the cost to the economy is 55 percent more than the incremental corporate tax revenue collected. See OECD Economic Surveys: Canada 1997.

(4) Ernst & Young estimates that for each dollar of revenue raised through capital taxes, output is reduced by an alarming seven dollars! See Ernst & Young Tax Policy Bulletin (Spring 2002).