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Pending Canadian income tax issues.

On December 8, 1993, 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% Canadian Income Tax Committee, whose chair is Vincent Alicandri of Xerox Canada Limited. Also participating in the liaison meeting was Hugh D. Berwick of Alcan Aluminium Limited, the Institute's Vice President-Region L and other members of the Canadian Income Tax Committee, as well as TElPresident Ralph J. Weiland. (A separate liaison meeting was held with the Department on pending GST and excise tax issues and will be reported on in the next issue of The Tax Executive. Anyone wishing copies of the attachments referred to in the submission should send a written request to TEl Headquarters.)

Tax Executives Institute welcomes the opportunity to present the following comments on several pending tax issues, which will be discussed with representatives on the Department of Finance during TEI's December 8, 1993, liaison meeting. In the meantime, if you have any questions about these comments, please do not hesitate to call either Hugh D. Berwick, TEI's Vice President for Canadian Affairs, at (514) 848-8235 or Vincent Alicandri, Chair of the Institute's Canadian Income Tax Committee, at (416) 733-6762.

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.

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 natural resources. The comments set forth below reflect the views of the Institute as a whole, but more particularly those of our Canadian constituency.

II. Benchmarking Canada's

Tax System with the

United States and Mexico

In TEI's 1992 submission to the Department of Finance, we highlighted "Tax Competitiveness" as a key issue. We recommended that the Department follow the example of the European Economic Community in examining the best practices among member nations and study tax regimes in the United States and Mexico to determine what changes are needed to keep Canadian business competitive. We also suggested that the governments of the three countries seek to eliminate distortions caused by differences in taxation. Has any specific action been undertaken in regard to our recommendations?

TEl continues to be concerned about the issue. Although we believe Mexico will develop closer economic links with Canada as a result of NAFTA, the United States remains as Canada's primary "business competitor." Considered in isolation, some tax rules are more favourable in the United States while some Canadian tax rules compare favourably with the U.S. treatment. It is unclear, however, whether Canada's tax regime, on balance, promotes or discourages investment in Canada.

Many businesses employ benchmarking studies to compare their products and processes to those of their competitors. As we envision the application of the benchmarking methodology to Canada's tax system, a comprehensive comparison of the U.S. and Canadian regimes would be undertaken to identify the strengths and weaknesses of the Canadian system. Just as a smaller business can use the advantages of small size to offset advantages enjoyed by larger competitors, Canada should identify and build on those strengths that exist vis-a-vis both the United States and Mexico. Ontario's Department of Finance attempted this exercise several years ago, but the tax rules in both countries change annually, so the resulting provincial document is out of date. TEI recommends that the federal government conduct such a study and update it regularly, perhaps as often as annually. Benchmarking Canada's tax system to that of the United States and Mexico is a necessary step to eliminating unnecessary barriers to trade and investment in Canada.

III. The Federal Government

Role of Leadership and

Harmonization with

the Province s

In the recent federal election, all the major political parties identified deficit control as a priority concern, in part because interest costs on the accumulated governmental debt is eroding Canada's ability to make new investments in education, health care, and infrastructure. During the last two years the federal government's initiatives to control taxation and spending levels and to encourage investment have been undermined by provincial initiatives that have shifted the relative tax burden between the federal and provincial governments. This trend, combined with diminished harmonization, may cause a number of negative effects for Canada, including:

1. Waning coordination between federal and provincial tax rules, engendering wasteful administrative and compliance costs for business and government.

2. Rising competition among provinces bidding against each other to entice individuals and businesses with tax incentives or disincentives, fragmenting the tax harmonization that does exist.

3. Weakened fiscal and monetary control over the Canadian economy, reducing Ottawa's ability to implement federal policies on a uniform, nationwide basis.

4. Rising perceptions of economic fragmentation in Canada in international debt and monetary markets, increasing borrowing costs for Canadian businesses and governments.

5. Increased double taxation of companies carrying on business in multiple provinces. (For example, Ontario's 1993 budget unilaterally imposed certain new taxable income allocation rules that are inconsistent with both federal rules and those in the other provinces.)

6. Curtailed international capital competitiveness. Investors may view Canada as a country with a tax burden at least as high as the United States and encumbered by complicated rules whose difficulty to contend with is not justified by the potential returns.

The federal government is the logical entity to take a leadership role in countering this trend. At a minimum, we recommend that a coordinating body be created to meet regularly (at least annually) to address inconsistencies in tax rules and administration. To be successful, this must be more than a forum for discussion. We appreciate that the federal government itself has no constitutional authority to compel harmonization, but Ottawa should use the levers it does possess to persuade the provinces to establish and support such a coordinating body. TEI stands ready to provide assistance or consultation in this endeavour.

IV. Part 1.3 - Large

Corporations Tax

A. Capital Taxes'Harmonization

of Federal and Provincial System

Currently, some form of corporation capital taxes are levied by the federal government and most of the provincial governments. Federal and provincial capital tax statutes, however, are not uniform, with numerous differences existing with respect to the administration of these taxes. In order to minimize the time and effort involved in the computation of a taxpayers' capital tax liabilities and to avoid costly objection and litigation procedures, we recommend that the Department undertake an initiative to encourage harmonization of the federal and provincial capital tax systems.

B. Investment Allowance

The December 1991 Technical Amendments (Bill C-92) introduced a new paragraph, 181.2(4)(d.1), under which a corporation is entitled to an investment allowance for certain debts owed to the corporation by a partnership, where all of the members of the partnership are corporations (other than financial institutions or corporations that are exempt from tax under Part 1.3).

We recommend that paragraph 181.2(5)(a) be amended to include a reference to the new paragraph 181.2(4)(d.1), to ensure that certain debts owed by one partnership to another partnership also qualify for the investment allowance.

C. LCT Relief for Companies

in Loss or Minimal Profit


When the Large Corporations Tax (LCT) was introduced in 1989, one justification was that a significant number of corporations consistently reported accounting profits while consistently incurring negative taxable income. Regardless of the reasons for those tax losses, policy makers decreed that all large corporations should pay some tax.

Since enactment of the LCT, the economy has changed radically and mostly for worse. Recession has eliminated, or severely slashed, the reported profits of most Canadian corporations. In many cases, the associated tax losses carried forward to future years may never be utilized. Thus, despite negative, or minimal, accounting income, corporations continue to incur a significant level of federal tax as a result of the LCT. In extreme cases, where the continued viability of capital intensive businesses is in doubt, LCT may operate perversely to increase the risk of failure.

We believe that there should be some mitigation of LCT for corporations in financial difficulties. Subsection 181.1(3) provides that a corporation is not liable for Part 1.3 Tax where the corporation is a bankrupt. We believe that, overall, revenues (from taxation of gainfully employed personnel and from profitable companies) would be enhanced were LCT relief provided prior to bankruptcy. One method of providing relief would be to limit the maximum LCT payable in any taxation year to the lower of a (specified) percentage of the reported accounting income or a specified percentage of taxable capital. Such an approach will eliminate undue hardship to and excessive taxation of corporations in financial difficulty while remaining faithful to the LCT principle that profitable corporations should pay tax.

V. Deductibility of

Provincial Business Taxes

In its 1991 Budget, the government proposed to deny deductions for provincial business taxes, such as payroll and capital taxes, permitting instead an allowance of six percent of taxable income. At that time, TEI protested that the proposed measure was discriminatory because it penalized businesses that operate in provinces levying such taxes, particularly where the business reported low taxable income relative to the amount of provincial taxes incurred.

We reiterate our recommendation that this measure be abandoned. It is discriminatory and divisive because it helps, or hurts, corporate taxpayers based on where the business is conducted or resident--a counterproductive tax result at a time when elimination of real and perceived provincial trade barriers should be a priority for all levels of government. We continue to believe that if there are concerns about the type and manner of tax levied by provincial governments, they should be addressed directly in government-togovernment discussions. Corporate taxpayers should not be held hostage to resolve inter-government disagreements.

We note that the government recently announced its intention to further delay implementation. We urge the government to totally remove this plank from its corporate tax platform.

VI. Expense Deductibility

Relating to Real Estate

The recession has left the Canadian real estate industry in particularly poor economic condition. While there are many complex factors contributing to the moribund level of economic activity, increased taxation of real estate companies by all levels of government exacerbated the decline and, more important, continues to retard the recovery of this vital sector of the economy.

Recent amendments to the Income Tax Act require taxpayers to inventory the carrying costs of real property including interest expense, land transfer taxes, and realty taxes. In addition, other costs are no longer deductible on a current (or as-incurred) basis. A crucial distinction between real-property inventory and other types of inventories held for sale is the length of time the inventory is held by the taxpayer. In ordinary circumstances, land inventories may be held for sale for periods in excess of five years. In other cases, substantial delays in obtaining necessary approvals from various levels of government may cause the development and marketing period to exceed 10 years.

We believe that the costs to carry real property inventories should be deductible as incurred by taxpayers in the same manner that carrying costs for other inventories are deducted. Real estate developers should be accorded similar treatment on the value of their inventories held for sale as is permitted to, say, retailers and wholesalers of general merchandise.

VII. Non-Resident

Withholding Taxes

A. In its 1992 Budget, the government announced its intention to negotiate with treaty partners to obtain a reduction in withholding tax on dividends remitted between the treaty countries to five percent. In its 1993 Budget, the government announced its intention to expand the scope of its negotiations to obtain a reduction in withholding taxes levied in respect of royalties on intangibles, such as computer software, to five percent as well. TEI fully supports the government's initiatives in this regard. To increase the flow of international free trade and capital, we believe that the government should seek ultimately to eliminate all such withholding taxes.

TEI is particularly interested in securing the implementation of these announcements within the Canada-- U.S. Income Tax Treaty. Revisions to this treaty have been under discussion for some time and we appreciate the difficulty of resolving some very complex issues to the satisfaction of both countries. We believe, however, that there is no substantial disagreement between Canada and the United States with respect to a reduction in withholding tax rates. As a result, we urge the government to pursue all available avenues to develop a protocol agreement to implement these reductions as soon as possible. We further urge the government to seek to implement the entire reduction effective immediately with the year of the agreement's entry into force rather than delay or ratchet the reductions down over a period of years.

B. The 1993 Budget announced plans to eliminate the withholding tax requirement on cross-border payments for computer software through bilateral treaty negotiations. What progress has been made on this initiative with various countries since the Budget date? Is there a target date for renegotiation of Canada's treaties with major trading partners such as the United States and the United Kingdom?

VIII.Butterfly Transactions

A. Refinancing Prior to a Divisive Corporate Reorganization

A tax-deferred divisive reorganization of a corporation must be accomplished within the limitations imposed by subsection 55(2) of the Income Tax Act, and by making use of limited relief provided by subsection 55(3). In an arm's-length situation, the parties must frequently rely on the provisions of paragraph 55(3)(b) for relief. Such reorganizations are colloquially referred to as "butterfly transactions."

One of the conditions that must be met for subsection 55(3)(b) to apply is that no property may become property of the corporation "in contemplation of and before the transfer" of property in the reorganization. Revenue Canada (RC) has taken the position that the cash received as a result of a share subscription is considered to be property acquired, and that if the subscription takes place at a time when a reorganization is being planned, RC will consider the property to have been acquired in contemplation of the reorganization. In such circumstances, RC will not provide a favourable advance ruling with respect to the proposed butterfly transaction.

Given the complexity of these transactions and the amount of time normally required to obtain a favourable advance income tax ruling from RC, the capital and debt structure of a corporation that is to undergo the butterfly transaction may be effectively frozen for some period of time, resulting in adverse operating or financial effects to the corporation. This may occur even where the allocation of assets among the recipient shareholders is not affected by the cash received from the share subscription.

1. When evaluating the applicability of paragraph 55(3)(b) to a proposed butterfly transaction, will the Department consider a purpose-and-effect test to determine whether a share subscription is offensive? (A similar question is being put to Revenue Canada.)

2. Is the Department of Finance prepared to promulgate regulations under subparagraph 55(3)(b)(viii) identifying the types of refinancing activities that would be permitted during the period a butterfly transaction is under consideration?

B. Certain Shares Deemed

to be Capital Property

Section 54.2 provides that where a person has disposed of property that consisted of all, or substantially all, of the assets used in an active business for consideration that included shares of the corporation, the shares shall be deemed to be capital property.

In a butterfly transaction, the shares that are received as consideration for the transfer of the property (i.e., to a NEWCO) are generally redeemed and, accordingly, are not the shares to which section 54.2 would apply. We recommend that the application of section 54.2 be expanded to include any shares issued as part of the series of transactions forming the butterfly reorganization. This would provide taxpayers with the necessary certainty that the shares of the NEWCO would be capital property.

IX. Recapture of Additional

Allowance for Research

and Development

Section 37.1 of the Income Tax Act provided an additional deduction of 50 percent of the excess of current year's qualified expenditures over the corporation's "expenditure base" for the year. This "research allowance" ceased to be available for taxation years ending after October 1983, except in respect of corporations electing the 50-percent allowance in lieu of Investment Tax Credit. For companies electing the 50-percent allowance, the provision expired for years ending after 1989.

The section also contains a provision for recapturing the benefit of the deduction upon the disposition of research property for which the allowance was claimed. TEI believes the recapture provision should now be repealed. Since the useful life of such property is quite short, generally 3 years or less, it is highly unlikely that such property used to perform research prior to 1990 will be disposed of in 1994 or a later year. In addition, the benefits accruing from the performance of the research and development for which the property was originally acquired and its current use (if any) is highly attenuated after so many years. We do not believe taxpayers should be expected to account for an indefinite period for this equipment or to repay the benefit in the event the property is disposed of. Accordingly, we ask whether the Department has given any consideration to repealing Section 37.1?

X. Deferral of Capital Gain

on Replaced Debts

Under existing tax legislation, a taxpayer will be deemed to have disposed of a capital debt ("the former debt") upon its maturity and may thus realize a capital gain for income tax purposes if the debt was designated in a foreign currency. There is no provision to defer the taxation of this capital gain even if the former debt is replaced by a new debt ("the replacement debt") of substantially the same amount denominated in the same foreign currency.

This situation creates undue hardship for taxpayers because a tax may be due in respect of an exchange gain that resulted in no real economic benefit. In terms of the foreign currency denominated indebtedness, the taxpayer is in the same economic position as before the debt was replaced. If the replacement debt has a term in excess of three years (as is typically the case to qualify the interest for exemption from withholding tax under subparagraph 212(1)(b)(vii) for debt with a maturity in excess of five years), any capital loss subsequently realized upon the maturity of the replacement debt cannot be carried back to recover the tax that may have been paid with respect to the previously realized capital gain. The capital loss would not be of use to the taxpayer until it has offsetting capital gains.

TEl recommends that a provision be introduced according a taxpayer an election to defer the recognition of any capital gain arising from the disposition of its indebtedness of a capital nature if such indebtedness is effectively replaced on a basis similar to the existing "replacement property rule" under subsection 44(5) (which defers the taxation of capital gain realized on the disposition of "former property").

XI. Automobile Operating

Cost Benefit

For employees who have not made the election to use the "1/2 of the standby charge" in computing the automobile operating cost benefit, an employer must determine the operating cost benefit to be included in the employees's income on the basis of a fixed rate per kilometre of personal use. Commencing in 1993, this method supersedes the method of tracking actual operating costs. Thus, when an employer pays any amount of operating costs, the operating cost benefit must be determined by using the new method: $0.12 per kilometre driven for personal purposes, less any reimbursement paid by the employee to the employer.

The $0.12 per kilometre rate has been established in respect of costs, such as gasoline, insurance, license, and maintenance normally incurred to operate an automobile and includes a $0.006 per kilometre GST component. Where an employer pays only the fixed operating costs, such as license and insurance, and does not pay for gasoline consumed in driving a car for personal use, the $0.12 rate is unrealistic and the employee could be taxed on a benefit amount greater than the actual operating costs paid by the employer. The interpretation has been confirmed by representatives of the Department of Finance.

TEl recommends that the above inequity be alleviated by permitting employers to calculate the benefit on the basis of either the actual operating cost or the fixed allowance (i.e., $0.12 per kilometre) basis.

XII. Carryback of Investment

Tax Credit (ITC) of



In the December 1991 Technical Amendments (Bill C-92), the Income Tax Act was amended to permit an amalgamated company to carryback non-capital losses to offset the taxable income of the original parent company in a taxation year prior to the amalgamation (new subsection 87(2.11)). The carryback provision for ITC was not amended to be consistent with the loss carryback provision. Will the Department consider amending the ITC carryback provision to be consistent with subsection 87(2.11)?

XIII.Update on Proposed

Interest Deductibility


We request a status report on the Interest Deductibility proposal released in December 1991. In particular, what guidance will the Department offer to taxpayers if these proposals are not enacted in 1993?

XIV. Retroactive Legislation

In past submissions, we have raised the issue of retroactive legislation. In our view, retroactivity undermines a key principle of tax law: that taxpayers should be able to manage their tax affairs with certainty. We strongly believe that legislation should only be changed prospectively.

The Technical Amendments dated August 30, 1993, contain proposals that are to be effective for the 1993 taxation year. Of particular concern are the proposed revisions to section 6 that affect employee benefits that may require recalculation back to January 1, 1993. In addition, because parliament has been dissolved, it is unclear whether these amendments will be enacted before employers must issue T4 statements to employees in respect of the 1993 taxation year. As a result, employers are placed in the position of having to predict whether or not the proposed amendments will become law for the 1993 taxation year. If the employer's crystal ball is cloudy and it guesses incorrectly when preparing the T4 statements, the employees suffer and the employer is blamed for the government's tardiness. We believe it is improper to place employers and employees in this position. Should these measures be enacted, we recommend that the effective date be deferred until the 1994 taxation year.

XV. Pension Reform

In our meeting of November 19, 1990, TEI raised a number of issues regarding pension reform. At that time, the Department of Finance indicated that pension reform would be reviewed in three years. Please advise whether the review has been or will be undertaken. Upon what areas in particular is the review focused?

One of the issues raised in the 1990 meeting was the elimination of the Pension Adjustment Reversal (PAR). We understand that PAR was eliminated because of concerns expressed by employers regarding the administrative complexity of the retirement savings proposals. The complexity was justified originally as being necessary to achieve the stated purpose of creating equity between different taxpayers in different situations. The present system, which represents the culmination of six years of debate and change, supposedly struck a delicate balance between equity and complexity. Arguably, PAR was a key feature of the original proposal for the current system, making it reasonably fair.

Much of the complexity in the present pension system arises from Pension Adjustments (PA) and Past Service Pension Adjustments (PSPA). In contrast, PAR would have been a relatively straightforward calculation for the vast majority of pension plans. By eliminating PAR from the system enacted, the balance was shifted significantly away from equity without materially simplifying the system. Thus, the elimination of PAR has generally resulted in a decrease in retirement income for individuals who are unable to accrue a substantial number of years of service with the same employer, including particularly years of service beyond the age of 50 where the benefits mount rapidly. Given the rapid restructuring in the Canadian and global economies in recent years, it is likely that the majority of the Canadian workforce may experience this, resulting in diminished private pension incomes and increased demands for public benefits to offset the loss.

Because of the very substantial negative effect this will have on the retirement income of a large segment of the Canadian population, we urge the government to consider reinstating PAR.

XVI. Business Foreign Tax

Credit vs. Non-Capital

Loss Carryforward

When a business foreign tax credit is claimable in the same year that non-capital losses can be carried forward (or back), a potential problem exists because the benefit of one provision or the other is eliminated. Specifically, a taxpayer may be forced to choose between using a loss carryforward to pay no tax or paying taxes in order to claim the business foreign tax credit. The more prudent business decision would likely be to claim the loss carryforward, even where this choice reduces reported financial statement earnings.

The problem is illustrated by way of a model Form T2S(21)(E) provided on Attachment 1. The assumptions employed in completing Attachment 1 are:

* Net income for tax purpose and taxable income prior to non-capital loss claim $1,000

* Non-capital loss carryforward opening balance $ 3,000

* Foreign source net income $ 600

* Business foreign tax paid (33 1/3% foreign tax rate) $ 200

* Federal tax rate 30%

In our illustration, the taxpayer would be able to deduct $142--and only $142--of non-capital losses without impairing his ability to claim a business foreign tax credit.

* Taxable income prior to non-capital loss claim $1,000

* Non-capital loss claim $142

* Taxable income $ 858 Federal Tax Calculation

* Tax at 30% $ 257

* Less: Business foreign tax credit (see Attachment 1) $(200)

* Federal tax liability $ 57

The problem highlighted by the above example is that the taxpayer must pay $57 of current taxes in order to use the $200 of business foreign tax credit. The problem arises from the denominator of the fraction as prescribed in subsection 126(2) of the Income Tax Act. In other words, it results from Box A on the back of Form T2S(21)(E). There is no line in Box A in which to deduct the amount of non-capital losses carried forward or back by the taxpayer. TEl does not believe that this was the intent of the Department of Finance when it established the business foreign tax credit.

This problem is not resolved by claiming the loss carryforward and leaving the business foreign taxes to be claimed in a future year because the "foreign business income tax paid" would rise to $400, assuming $200 of foreign taxes is paid again in the following year. The "net foreign business income," however, would only be $600 in the second year. Consequently, the amount of foreign tax credit that may be claimed is severely diluted.

We believe that the adverse effects described above may be eliminated by amending clause 126(2. l)(a)(ii)(III) to provide a deduction for non-capital losses claimed in the computation of "adjusted net income.'' Under our proposed solution, the revised tax computation would be:

* Taxable income prior to non-capital loss claim $1,000

* Non-capital loss claim $ 333

* Taxable income $ 667 Federal Tax Calculation

* Tax at 30% $ 200

* Less: Business foreign tax credit. (See Attachment 2) $(200)

* Federal tax liability NIL

We urge the Department to consider our proposed amendment to ameliorate what we believe to be an unintended and unduly harsh consequence.

XVII. Foreign Sales


In order to keep high-wage manufacturing jobs in Canada and to put Canada on a level playing field with the United States in respect of exports, the Department of Finance should explore the feasibility of establishing an export-related tax incentive comparable to the Foreign Sales Corporation (FSC) in the U.S. Internal Revenue Code.

Through the FSC incentive, the U.S. government attempts to reduce the cost of doing business in the United States to put U.S. companies in approximately the same tax position that they would have been in had they taken their manufacturing operations offshore. The revenue loss to the U.S. Treasury of providing the FSC incentive is offset by increased revenues from several sources. In particular, by increasing (or retaining) manufacturing jobs within the United States, increased (or maintained) revenues from individual income and business payroll taxes are generated. In addition, the greater amount of investment and consumer demand from the increased (or maintained) levels of macroeconomic benefit will generate other jobs, spending, etc., all of which generates additional taxes for the Treasury. The legislation enacted in 1984 in sections 921 to 927 of the Internal Revenue Code is still in place.

If Canada is to compete with the United States in manufacturing and trade, it surely needs a level playing field. Although the manufacturing and processing incentives introduced in the early 1970s were intended to assist Canadian companies compete with U.S. corporations (following the introduction of the FSC-predecessor legislation in the United States on Domestic International Sales Corporations), those benefits have been so eroded that it is not possible to determine whether the present rules are on a parity with the FSC benefit.

With a new government committed to keeping jobs in Canada and enhancing the competitiveness of Canada generally, this might well be the time for the government to seriously consider an initiative such as the FSC. We stand ready to assist the government in this endeavour.

XVIII. Master Trusts

A. Proportional Holding


A Proportional Holding Election is available to a trust pursuant to Section 259 if the trust is a "Qualified Trust." For purposes of the Part XI Tax Calculation in respect of investments in foreign property, the effect of the election is to exempt the trust from Part XI tax and treat each beneficiary as though it holds a proportionate share of each of the trust assets directly.

Proposed amendments to section 259 contained in the December 21, 1992, Draft Legislation define a Qualified Trust. A Qualified Trust may borrow money only for periods of less than 90 days, and the borrowing may not be part of a series of loans or other transactions and repayments. In addition, the Qualified Trust must not accept deposits. The requirements for a Master Trust are set forth in Regulation 5001. Master Trusts are subject to the same restrictions as Qualified Trusts with respect to borrowings and deposits.

It would appear that where a trust violates one of the restrictions common to both Qualified and Master Trusts as noted above:

(1) The trust would not qualify as a Master Trust, thereby causing a beneficiary's interest in the trust to be foreign property (per Regulation 5000(1.2), and

(2) The trust could not avail itself of the Proportional Holding Election set forth in section 259 (because it is no longer a Qualified Trust).

We believe the result to be improper and recommend that section 259 be amended to remove the two requirements noted to eliminate an unfair Part XI tax penalty.

B. Foreign Property Rules

For purposes of the Part XI Tax, paragraph 206(1)(i) defines "foreign property" to include any interest in a trust, except as prescribed by regulation. Regulation 5000(1) states that an interest in a Pooled Fund Trust (PFT) shall not be foreign property provided the PFT does not hold foreign property in excess of a 20'percent limitation. Regulation 5000(1.2) states that an interest in a Master Trust (MT) is not deemed to be foreign property so long as the MT and the beneficiary of the MT did not hold foreign property at the same time. The overall effect of these regulations is to permit a PFT and its beneficiary to hold foreign property at the same time, but not to allow an MT and its beneficiary to hold foreign property at the same time.

What is the policy rationale underlying the disparate treatment of a PFT and a MT? Because we are unable to discern the policy rationale for this difference to exists, we suggest that the rules should be amended to ensure parallel treatment of a PFT and MT, particularly with respect to the flexibility to hold foreign property within the specified limits.

XX. 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 8, 1993, liaison meeting.

U.S. Postal Service




(Required by 39 U.S.C. 3685)

IA. Title of Publication: The Tax Executive. lB. Publication No: 615940. 2. Date of Filing: November 22, 1993.3. Frequency of Issue: Bi-monthly. 3A. No. of Issues Published Annually: Six. 3B. Annual Subscription Price: $90.00. 4. Complete Mailing Address of Known Office of Publication: Tax Executives Institute, Inc., 1001 Pennsylvania Avenue, N.W., Suite 320, Washington, D.C. 20004-2505.5. Complete Mailing Address of the Headquarters of General Business Offices of the Publisher: Tax Executives Institute, Inc., 1001 Pennsylvania Avenue, N.W., Suite 320, Washington, D.C. 20004-2505. 6. Names and Complete Addresses of Publisher, Editor, and Managing Editor: Publisher--Tax Executives Institute, Inc., 1001 Pennsylvania Avenue, N.W., Suite 320, Washington, D.C. 20004-2505; Editor--Timothy J. McCormally, Tax Executives Institute, Inc., 1001 Pennsylvania Avenue, N.W., Suite 320, Washington, D.C. 20004-2505; Managing Editor-Timothy J. McCormally, Tax Executives Institute, Inc., 1001 Pennsylvania Avenue, N.W., Suite 320, Washington, D.C. 20004-2505. 7. Owner: Tax Executives Institute, Inc. (No shareholders. A not-for-profit organization of New York State). Address: 1001 Pennsylvania Avenue, N.W., Suite 320, Washington, D.C. 20004-2505. 8. Known Bondholders, Mortgagees. and Other Security Holders Owning or Holding 1 Percent or More of Total Amount of Bonds, Mortgages or Other Securities: None. 9. For Completion by Nonprofit Organizations Authorized to Mail at Special Rates: The purpose, function, and non-profit status of this organization and the exempt status for Federal income tax purposes-Has Not Changed During Preceding 12 Months. 10. Extent and Nature of Circulation (first figure is the average number of copies of each issue during preceding 12 months and second figure is the actual number of copies of single issue published nearest to filing date). 10A. Total No. Copies Printed (Net Press Run): 5653; 5720. lOB. Paid and/or Requested Circulation: 1. Sales through dealers and carriers, street vendors, and counter sales: 50; 50. 2. Mail Subscriptions (Paid and/or requested): 5413; 5479. 10C. Total Paid and/or Requested Circulation (Sum of 10B1 and 10B2): 5463; 5529.10D. Free Distribution by Mail, Carrier, or Other Means; Samples, Complimentary, and Other Free Copies: 143; 153. 10E. Total Distribution (Sum of 10C and 10D): 5606; 5682.10F. Copies Not Distributed: 1. Office use, left over, unaccounted, spoiled after-printing: 47, 38. Returns from news agents: None. lOG. Total (Sum of E, F1 and 2 -- should equal net press run shown in 10A): 5653; 5720. 11. I certify that the statements made by me are correct and complete. TAX EXECUTIVES INSTITUTE, INC.,/Timothy J. McCormally, Editor.

On October 1, 1993, Tax Executives Institute submitted the following comments to the Ontario Ministry of Finance concerning the provincial government's 1993 tax-related budget proposals. The Institute's submission was prepared under the aegis of the Toronto Chapter, whose President is Vincent Alicandri of Xerox Canada Limited, and approved in accordance with the Institute's procedures.

On May 19, 1993, the Ontario Ministry of Finance exposed the budget proposals for the year. During a liaison meeting held June 24, 1993, members of the Toronto Chapter of Tax Executives Institute met with representatives from the Ontario Ministry of Finance to discuss issues of mutual concern regarding the 1993 Ontario Budget. The discussions were informative and the Institute is pleased to follow-up on the meeting by submitting its written comments on the 1993 Ontario Budget.


Tax Executives Institute, Inc. is an international organization of approximately 4,800 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. (Our Toronto Chapter has 200 members.) 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 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.

Income and Capital Tax

A. Corporate Minimum Tax

1. General. The budget proposals would introduce a new corporate minimum tax (CMT), thereby engrafting another layer of administrative and compliance costs to conducting business in Ontario. The additional burdens posed by CMT--combined with increased corporate and individual costs resulting from higher income tax rates, retail sales tax rates, payroll expenses, and a dual sales tax system--provide a reason for corporations to locate in or relocate to other jurisdictions. (1)

2. Audited Financial Statements. Under the CMT proposal, companies would be required to attach audited financial statements to their income tax returns. The requirement to attach audited financial statements will tremendously increase the administrative costs for (i) companies that are part of a larger corporate group (which prepares consolidated financial statements), (ii) small companies that ordinarily would not prepare audited financial statements, (iii) companies with a deemed year-end for tax purposes, (e.g., where there is a change in control); and (iv) inactive companies.

TEl submits that the preparation of audited financial statements is not necessary to assure that CMT liability is properly assessed. For large

corporate groups that heretofore have prepared audited financial statements on a consolidated basis, providing audited financial statements for each legal entity in a consolidated group will dramatically increase the costs of the annual audit--possibly by hundreds of thousands of dollars.2 Indeed, for nearly every company subject to CMT, and for which separate audited financial statements are not otherwise required or prepared, the cost of obtaining the annual certified financial statements will likely exceed the additional tax to be collected from each and every company. Furthermore, the requirement that audited financial statements be prepared and submitted in connection with the determination of CMT liability represents a substantial departure from the administrative requirements imposed upon companies doing business in Ontario because generally the starting point for determining federal and provincial income tax liability (as well as the federal large corporation tax and the provincial capital tax) are unaudited financial statements prepared in accordance with generally accepted accounting principles (GAAP).

We recommend that the requirement for audited financial statements be eliminated and that the government accept unaudited financial statements, prepared in accordance with GAAP, as a proper basis upon which to compute CMT.

3. Credits Against CMT Liability. Under the proposed CMT, the tentative CMT liability will be offset and reduced by a credit for the Ontario income taxes payable by the company for the year. This offset would mitigate some of the potential double taxation of corporate earnings. We believe that the Ministry should expand upon this equitable relief by recognizing that the Ontario capital tax represents a form of minimum tax because it is imposed on the net worth of the company regardless of its profitability. If a third level of corporate tax in the form of CMT is to be imposed, TEl recommends that Ontario reform the capital tax system to integrate the corporate income and minimum tax systems. Specifically, we recommend that the net tax payable under the Ontario corporate income tax or the Ontario corporate minimum tax be creditable against the Ontario capital tax. Integrating the three systems would mitigate substantially the cascading levels of tax faced by Ontario companies without undermining the concept animating the introduction of the minimum tax system.

B. Central Paymasters

The budget proposal would require a Central Paymaster company within a corporate group to include the wages and salaries deducted in the calculation of taxable income as the amount of wages and salaries to be allocated to Ontario for the Central Paymaster. The proposal does not state, however, whether the actual employer corporation would be permitted or required to deduct the salary and wage amounts attributed and allocated to the payor-entity in computing the employer's Ontario provincial allocation. We believe that such a deduction is necessary to avoid double counting the wages and salaries-- once in the calculation of the Central Paymaster company's provincial allocation and again for the employer corporation's allocation.

In addition, the budget proposal appears to have been made unilaterally by Ontario without the agreement or knowledge of the other provinces. Inconsistencies in the method of calculation will likely cause allocations among the provinces to exceed 100 percent of a corporate group's taxable income, resulting in double taxation. The proposal also fails to provide an administrative mechanism through which multiple allocations can be eliminated. Consequently, taxpayers would be compelled to negotiate separately with other provinces to obtain relief from multiple allocations.

TEl recommends that the Central Paymaster proposal be clarified to eliminate any potential double counting of wages and salaries for purposes of allocating the total taxable income of a corporate group to Ontario. We also recommend that implementation of the proposal be deferred until all Canadian taxing jurisdictions are of one mind concerning the proper allocation of the corporate group's income.

C. Distribution of Assets

Prior to Year-End

The budget proposal would give the Minister authority to compute a corporation's capital tax liability for a period based upon the net capital figures as of a date immediately preceding a significant non-arm's-length transfer of assets, rather than the date on which the fiscal period ends. The Minister proposes that this measure apply to taxation years ending after the budget date. Consequently, the proposed effective date could sweep in transactions occurring up to one year preceding the budget date.

The budget proposal is unacceptably vague and leaves many questions unanswered. For instance, will the paid-up capital of the acquiror be likewise adjusted in a contrary, mirrorimage fashion? How is the paid-up capital of the distributing corporation to be calculated in subsequent years? Under what conditions or in what factual circumstances will the Minister exercise this authority? Will the adjustment be made automatically in all cases or is the adjustment to be made solely where transactions are deemed to be undertaken primarily for tax avoidance purposes?

Even if the policy underlying this initiative is proper, TEl does not believe that the proposal should apply to transactions completed before the budget date. Retroactive application of tax law changes is generally to be eschewed because taxpayers should be permitted to rely upon existing tax legislation in evaluating, planning, and executing their business affairs. In the interest of fairness to taxpayers and of consistency in tax policy, we recommend that this measure apply solely to transactions completed after the budget date rather than to taxation years ending after the budget date.

D. Instalment Recalculation

In the area of Administrative Changes, a proposal was made to require the recalculation of the amounts of corporate instalment payments where the tax liability for the year upon which they were based is reassessed. The Ontario Mining Tax Act will be amended to reflect a comparable provision. This change will expose corporate taxpayers to an additional risk of non-deductible interest charges on instalments eventually determined to have been deficient.

In a letter dated May 25, 1993, to the Federal Minister of Finance and to the Minister, Revenue Canada, TEI recommended that the Federal Government institute a program of issuing Tax Certificates of Deposit. The program would permit taxpayers to place on deposit amounts that would eventually be applied against tax liabilities. The amounts on deposit would be applied against a tax liability on the later of the dates the amount was placed on deposit or the payment was required to have been made. For amounts applied against liabilities arising subsequent to the date of deposit (i.e., advance deposits or estimated instalments), the Certificates would bear interest at a rate slightly lower than that payable on deficient instalments or late payments of tax.

We recommend that the Ministry of Finance for the Province of Ontario implement a comparable program. Copies of TEI's submission to the Federal Government and the response of the Ministry of Finance are attached for your consideration.

Retail Sales Tax

A. Lead Time to Implement

Budget Changes

The lead time permitted to implement administratively a number of the changes was either non-existent or too short to enable taxpayers to properly comply. For example, the imposition of the Ontario Retail Sales Tax on warranty parts and labour effective on the day following the budget announcement gave vendors absolutely no time to analyze and comprehend the provision, let alone make the necessary changes to their information and accounting systems to bill and collect the tax from customers. In other areas, precious little information was made available in the budget documents or supplemental sources from which to gain an understanding of the scope of some of the changes. Indeed, what little information there was, was somewhat contradictory and occasionally incorrect. We recommend that substantially more time be allotted before major tax changes become effective so that industry and government alike may address the practical administrative difficulties arising from the measures.

B. Warranty Repairs, Parts

and Labour

The budget proposal would subject warranty parts and service to the eight percent Ontario Retail Sales Tax (ORST), effective May 20, 1993. The proposal would have the effect of creating a separately taxable transaction on the performance of warranty repairs where the cost of the warranty was simply part of the original purchase transaction--whether explicitly in a separate maintenance agreement or as part of the price of the goods purchased. We recommend that the introduction of this proposal be reconsidered because it will result double taxation of warranty parts and labour.

The ORST is designed to be a tax of single incidence levied on the consumer of a product. Parts used to repair defective goods under warranty are similar to goods consumed in the original production of a product. Component parts incorporated within another product have long enjoyed an exemption from tax under the Retail Sales Tax Act. We fail to see why the replacement or repair of defective portions of the goods should be subject to an additional level of tax.

Where a separate charge is explicitly added to an invoice and collected by a vendor for a warranty or extended service agreement, the ORST is applicable and collected by the vendor. By extending the ORST to materials or labour consumed by the warranty service provider, a second level of retail sales tax would be imposed upon the same fee already charged and collected for the warranty contract.

In most cases, however, the selling price of a warranted product will include an implicit markup to cover the cost of the warranty obligation. By taxing warranty repairs when they are made, manufacturers' costs will be increased in a fashion that does permit the tax to be recovered from the purchaser. In our view, this is tantamount to a second level of indirectly imposed retail tax borne by the manufacturer rather than the consumer of the goods. This is improper as a matter of tax policy because the Government should openly disclose to consumers the taxes they pay upon purchases, rather than hide tax increases through increases in manufacturers' prices.

TEI opposes adoption of the proposal to subject to ORST warranty parts and services that are not explicitly stated on an invoice. At a minimum, the extension of the ORST should not apply to warranty and maintenance services performed under contracts entered into prior to May 20, 1993. Should this proposal be enacted, we recommend that it apply solely to contracts entered into subsequent to May 20, 1993.

C. Tax on Insurance Premiums

The budget proposal would extend the ORST to insurance premiums and to an employer's self-insured employee welfare benefit programs, significantly increasing the cost of both. In our view, subjecting the premiums for benefit plans and the costs of self-insured benefit plans to the sales tax seriously undermines the incentive for employers to provide these types of benefits for their employees. TEl urges the government to withdraw its proposal.

In the event that the proposal is not withdrawn, a number of technical and administrative issues should be clarified. In an employer-sponsored plan, the cost of which is borne by employees through payroll deductions, the draft legislation appears to place the obligation to remit the tax on the employer and the insurance company. Without clarification, this will cause widespread confusion and possibly duplication of effort among insurers and employers. TEI recommends that the government state which party is primarily (and which is secondarily) liable to remit the tax (i.e., the insurance company or the employer), and furthermore clarify whether the insurer and employer may, through contractual terms, shift the remittance obligation thereby permitting either party to remit the ORST on employer-paid premiums.

In a benefit program where the full cost of optional insurance is paid by the employee, the amount of ORST payable is easily calculated and passed on to the employee through additional payroll deduction. In some plans, however, the optional insurance coverage is shared by the employer and employee. In such cases, the burden of calculating the ORST liabilities of the employer and employees respectively would be reduced by requiring the insurer to collect and remit the tax.


The Toronto Chapter of Tax Executives Institute appreciates this opportunity to provide its comments concerning the 1993 Ontario Budget to the Ministry of Finance. If you should have any questions about this submission, please do not hesitate to call either Paul J. de Winter, Chair of the Institute's Canadian Commodity Tax Committee at (416) 968-4506, or me, at (416) 733-6762.


1. Before embarking on a new CMT, the Ministry should give consideration to the fact that the tax will likely be incurred and paid during recessionary contractions when companies are most in need of cash to make additional investments or pay its other liabilities. A minimum tax tends to exacerbate rather than diminish the recessionary leg of a business cycle. Indeed, the United States recently liberalized its alternative minimum tax provisions in response to adverse economic effects during the most recent business downturn.

2. Under generally accepted accounting principles (GAAP), parent companies of a corporate group are required to account for subsidiaries on a consolidated basis. In auditing the operations of a consolidated group, independent accountants generally express an opinion on the financial statements of a consolidated group taken as a whole. Indeed, the operations of each entity are seldom audited to a degree that would permit the expression of an audit opinion with respect to each and every entity because the materiality of reported items is assessed at the consolidated reporting level.

The principal difference between separate and consolidated financial statements is that intercompany account balances and transactions are excluded from the consolidated statements. The preparation of consolidated statements, however, generally begins with the preparation of separate company statements prepared in accordance with GAAP. The unaudited financial statements of a corporation included within a group for which audited consolidated financial statements have been prepared will generally be an accurate and reliable source of data--particularly where the statements conform in all material respects with GAAP. In preparing their audit opinion, the independent accountants must be satisfied that material intercompany balances and transactions have been eliminated from the reported results for the group as a whole. As a result, an audit opinion with respect to consolidated financial statements provides a form of back-handed assurance that the separate statements are accurate.
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Author:Weiland, Ralph J.
Publication:Tax Executive
Date:Nov 1, 1993
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