2013 Federal and Provincial Budgets - Opportunities Lost or Deferred?

By: Nick Pantaleo

We are almost through the late winter / early spring ritual of federal and provincial governments bringing down their annual budgets – actually, Quebec’s budget was in November following the election of the PQ minority government – except for Ontario, which will be releasing their budget on May 2nd.

With the governments contending with a still fragile global economy, slow economic growth and generally high deficits, many weren’t expecting to receive a lot of goodies – and they weren’t disappointed.

What PwC said and what governments did

PwC’s federal budget submission cautioned about relying on measures governments have typically relied on in the past to raise revenue; namely, increasing corporate and personal income, capital and payroll-type taxes, all of which have a negative impact on economic growth and job creation. The federal government listened to that message and did not raise income tax rates.

We also recommended that the government work with the provinces to re-evaluate the efficiency and sustainability of the current mix of revenue generating measures, including conducting a review of the personal income tax and GST/HST systems (in particular, the inefficiency of the myriad of tax expenditures embedded in the system), to improve the way Canada raises tax revenue while protecting those who are most vulnerable. Unfortunately, they have not heard that message – at least not yet.

As for the provincial budgets, most continue to break ranks around rates.

Personal tax rates were raised for high income earners in B.C. - the NDP promises to impose a further increase if they win next month’s election - and Quebec and across all tax brackets in New Brunswick.

As for corporate tax rates, New Brunswick raised the main rate by 2 percent to 12 percent – disheartening because they have been one of the provincial champions of low corporate tax rates. New Brunswick made no mention of its 2011 promise to lower the small business (SB) rate to 2.5% by 2015, while Nova Scotia decreased its SB rate to 3% and PEI increased its rate to 4.5%. Meanwhile, B.C. stepped up its 1% corporate tax increase by one year with the NDP promising another 1 percent increase and the reinstatement of a capital tax on financial institutions if they win the next provincial election. Saskatchewan has deferred further corporate tax decreases, no longer committing to a 2015 implementation date and Manitoba will raise the capital tax rate on financial institutions from 4 to 5 percent. Ontario is the last big province to be heard from but its fiscal situation remains dire – it has a new Premier and a minority government that has already promised to defer further reductions, so all bets are off.

The upshot of all this, as shown in the table below, is that we are not close to seeing that uniform, across-the-country general corporate tax rate drop to 25%, something federal Finance Minister Jim Flaherty was seeking. If anything, the gap will widen. 

Of course, not shown in the table are the many tax credits provinces have to entice businesses to set up shop in their province. It all makes for a confusing and pretty inefficient corporate tax structure for Canada with each of the provinces doing what they think they must and because they can. On the other hand, it also means continued opportunities for provincial tax planning.

More disappointment

Many businesses were hoping that the government’s initiative to consider a formal system of group taxation would help make the tax system more efficient for corporate groups. However, the federal government announced in their budget that “feedback from the consultation exercise and discussions with provincial and territorial officials have not produced a consensus regarding how the Government could move forward in a way that would improve the tax system………[hence t]he Government has determined that moving to a formal system of corporate group taxation is not a priority at this time.”

Cynics will see this as another example of the federal and provincial governments’ failure to steer the boat in a single direction for the good of the country. Regardless, businesses have a right to be disappointed with this decision.

Two years have passed since a number of companies and business organizations made submissions to the government (see PwC’s submission), all mostly in favour of a formal system. Moreover, while the budget papers noted the provincial and territories’ concerns over the potential of reduced revenues and the likely upfront costs for all governments, as PwC noted in our budget submission, this was something that many businesses were sensitive to and were prepared to help the government resolve.  

One of the lessons learned from the consultation process is that the provinces and territories are not happy with the current “informal” system of group taxation because they do not know what it is costing them. The government promises to work with them on that – hopefully with the input from businesses. Hopefully, as well, provinces will not take unilateral action in the meantime.

Now what?

No easy answer. Corporate tax is an enigma.

It has the highest marginal cost in terms of raising government funds and its burden for the most part fall ultimately on labour. It isn’t an insignificant part of a province’s total tax revenue stream, but it is the most volatile, other than perhaps resource royalties. For example, Ontario’s corporate tax revenue prior to the financial crisis in 2007-8 was about $13 billion (19% of total tax revenue) and immediately dropped to under $6.7 billion the year after. What government can tolerate such a decrease in one year?

In many respects, the corporate tax challenge we face in Canada is similar to that being experienced globally, most recently manifested in the OECD’s report on Base Erosion and Profit Shifting, except ours is self-inflicted.

Makes one wonder why the provinces are in the corporate tax game. Wouldn’t they be better off leaving that to feds in exchange for a greater share of GST/HST revenue? It would also make life easier for corporations carrying on business in different provinces.

Maybe in a perfect world that would happen, but as a former colleague told me early in my career, “it’s not a perfect world”.

PwC Canada's Budget Memo

On March 21, 2013, the Federal Minister of Finance, Jim Flaherty, presented the majority government’s budget. This Tax memo discusses the tax initiatives proposed in the budget.

Giving Canadians Their Say

By: Nick Pantaleo

The Harper Government has made much of its pre-budget consultations sessions in prior years and 2013 is no exception.

Having not participated in one before, I have been curious as to how productive the sessions are. Not so much from the perspective of how many actual budget measures have come from such sessions – after all, the government is inundated with all sorts of proposals from all sorts of groups. Rather, I just wondered about the nature of the discussions.

So, when I was invited to attend a recent session I happily accepted. And I am glad I did.

It was good group of participants with different backgrounds. There was a social/community worker, a stay-at-home mom, an educator, a local politician and representatives from large and small businesses and the local chambers of commerce.

Each individual was impressive. Each showed an obvious passion for what they do, their community and the country. Their ideas were grounded and focused; aimed at improving conditions for businesses and for those less fortunate. For example, there was excellent input from the educator and business representatives as to how to improve the skills of Canadian workers and to better match them to job market opportunities.

The government MPs in attendance, which included one cabinet minister, seemed genuinely engaged and impressed. Being politicians, I expected to have to endure some chest-thumping but they were generally restrained and receptive to new ideas.

I was the only (tax) accountant in the group – at least I was the only one to admit to being one. But, no one admitted to being a lawyer!

Below is my opening statement to the group, which focused on our tax system and the challenge I see Canada having in the future to raise revenue. I thought my comment on relying more on consumption taxes would go over like a lead balloon....but, I was surprised that there were strong proponents of the idea in the group. However, it was also clear that there would have to be a lot more work on this – particularly in convincing the politicians.

All in all, it was a worthwhile session and one that you should participate in if you get the chance. If nothing else, having the chance to hear and speak to different people will give you a fresh perspective.

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Opening Statement – 2013 Pre-Budget Consultation

Good morning.

Thank you for inviting me to this pre-budget consultation.

My name is Nick Pantaleo. I am a chartered accountant and for over 25 years I have served as a corporate tax advisor.

From December 2007 to December 2008, I served as a member of Finance Minister Jim Flatherty’s Advisory Panel on Canada’s System of International Taxation.

I will speak briefly to suggested changes to Canada’s corporate and personal income tax and GST/HST systems, which I believe will help strengthen and grow Canada’s economy while protecting those who are most vulnerable.

Corporate income tax

Competitive corporate tax rates are fundamental to creating a globally competitive business environment. The government is to be congratulated for reducing the federal corporate tax rate to its current level and for encouraging the provinces to do the same.

Corporate income, capital and payroll-type taxes have a negative impact on business investment and hence, economic growth and job creation, and therefore should not be increased.

I support the recommendation made by the Canadian Institute of Chartered Accountants, to adjust the capital cost allowance rates of depreciation for all business assets to reflect their true economic life. This will encourage additional investment and increase productivity.

Some organizations recommend extending the temporary accelerated depreciation rates for manufacturing and processing beyond 2013, or making it permanent. In the current economic environment and in light of similar measures being taken in the U.S., this measure should be extended into 2014.  However, other industries (for example, retail, telecommunications, etc.) should be considered for this as well.

In addition, depreciation classes should be updated to ensure they are properly capturing assets used in high value-added service sectors such as telecommunications.

The government has made a number of improvements to the corporate tax system, including introducing measures to broaden the corporate tax base.

Additional measures should be adopted to further enhance the competitiveness of the corporate tax system, simplify it to minimize compliance costs for large and small businesses and to facilitate the administration and enforcement by the Canada Revenue Agency.

For example, the government should:

• adopt the remaining recommendations of the Advisory Panel on Canada’s System of International Taxation; and
• work with the provinces to enact a formal system of group taxation.

Personal income tax

A comprehensive review of our personal income tax system is long overdue.

High personal tax rates have a negative impact on savings by Canadians - savings they will need in the future to offset the impact of reduced government spending in areas such as pensions and health care – and investment. It is also a disincentive to work and to upgrade job skills. Combined, these factors negatively impact productivity and growth.

Some, including Roger Martin and James Milway in their recent book, Canada: What it is, What it Can Be, also point out that low income families and retirees incur high marginal tax rates because financial assistance they receive under various government programs are “clawed back” as their income increases.  Addressing this problem – by smoothing out the claw-back effect as well as looking at the design of the various programs, as Messrs Martin and Milway suggest – would help reduce poverty and reduce income inequality.

The current number of personal tax expenditures (i.e., deductions, rebates, tax credits, etc.) is in need of a review.

In a perfect world many would be eliminated and tax rates reduced accordingly. This would greatly simplify the tax system.  While this may be too daunting a task, nonetheless, individual expenditures should be reviewed to ensure they are cost effective and properly targeted to those that need them the most.

For example, the Canada employment credit cost $2.0 billion in 2011. It is available to all employees regardless of their income level. Is it appropriate or affordable that this credit, and credits such as the fitness and public transit tax credit (costing $115M and $150M, respectively), be available to high income earners?

The savings in eliminating or reducing the cost of various expenditures could support lower personal tax rates, particularly for low-middle income families. It could also simplify the personal tax system.

Lower personal tax rates can be achieved by actually reducing rates or broadening the current income tax brackets (i.e., raising the threshold levels).

GST/HST

In today’s economic environment, including its changing demographics (for example, the decrease in the number of workers relative to retired individuals), the traditional response of increasing income tax to fund government spending is due for a re-evaluation. 

Many countries place greater reliance on consumption taxes while Canada still relies more on income taxes – in 2010, about 47% of Canada’s total tax revenue came from corporate and personal taxes v. an average of 33% for all OECD countries.  

A recent C.D. Howe Institute paper reveals that the marginal cost of raising revenue by increasing federal (and provincial) corporate and personal tax rates is very high in comparison to consumption taxes. This means that large economic gains could be obtained by changing Canada’s tax revenue mix to put a greater reliance on consumption taxes.

Greater reliance on consumption taxes would result in a more sustainable and less volatile revenue stream and would potentially be more robust in terms of being less susceptible to tax avoidance.

This does not mean that GST rates should or would have to be increased. The GST system also includes numerous tax expenditures. These expenditures are in the form of goods and services that are exempt from GST.

Many exemptions exist for a very good reason: to mitigate the burden on low-middle income families.

But, as the University of Toronto economist, Michael Smart, noted in a recent paper, there is a significant cost to such a policy, which is that most of the benefit of these expenditures accrues disproportionately to high income families because they spend a larger absolute amount on tax exempt items, such as food, than low income families.

Reducing some of these exemptions, while providing low-middle income families with enhanced GST income tax credits or rebates, would be a more effective alternative than increasing income tax rates to raise revenue.

Reducing such exemptions could also help reduce personal income tax rates.

Thank you for your attention.

I look forward to our discussion.


Nick Pantaleo, FCA

January 19, 2013

Aggressive Tax Planning on a global scale

While corporations face increasing pressure to be more profitable and move risk, functions and assets to different locations around the world in order to gain tax efficiencies and be more competitive, tax administrations are looking to raise revenues. As a result, governments around the world are becoming more aggressive with respect to tax avoidance, risk assessments and auditing. International norms of tax behaviours are beginning to be challenged.

In this panel discussion at the PwC / Tax Executives Institutes International Tax Day opening plenary session on November 21, 2012, John Preston, PwC’s global Tax Policy leader, David Swenson, PwC’s global leader of Tax Controversy and Dispute Resolution (TCDR) and Marc Vanasse, leader of PwC Canada’s TCDR team discuss global tax controversy and tax policies.

The risks of cross-border travel

Why not listen to the third episode of our Tax Tracks series looking at “Frequent Business Traveller Issues”. 

In this episode Brandi Scales gives employers and employees insight into what risks they may face through frequent cross-border travel, how these risks can be reduced through procedure and policies and what can be done to manage and monitor the business traveller population.

Compliance Issues Facing your International Workforce

Check out the second episode in our Tax Tracks series looking at “Frequent Business Traveller Issues”.

Shabnam Malik looks more deeply into the compliance issues which surround frequent business travellers and what that means for employers and employees alike.

Looking at Frequent Business Traveller Issues

Have a listen to the first episode in our new Tax Tracks series which examines “Frequent Business Traveller Issues”.

Chris Chan, part of our HRS Tax team, outlines the tax obligations of employers and employees regarding non-permanent residents providing services in Canada.

Tax Policy and Carpentry Have much in Common

By: Nick Pantaleo

In October, the Department of Finance released almost 2000 pages of draft legislation and technical notes affecting many areas of the Income Tax Act, but principally the foreign affiliate area. Most reflect technical changes – some are relieving and simplifying but many tighten existing provisions. Others, most notably the foreign affiliate dumping (FAD) rules, reflect policy changes.

Going through this stuff, I found myself thinking about a former Deputy Minister of Finance who once compared setting tax policy to screwing together two or more pieces of wood: if you use too few screws or do not tighten the screws enough, the structure will be weak and unsteady and will ultimately collapse. On the other hand, if you use too many screws or tighten them too much, the wood will crack and you will get the same result.

There is no doubt that setting tax policy and drafting legislation to deal with deficiencies in the law is an inexact science. It’s never easy to know “how far to go”.

Using more “screws” than needed or screwing them in too tightly can result in overly broad, complex legislation that makes it difficult for taxpayers to understand and comply with and for the CRA to administer, ultimately compromising the integrity of the system. It can also compromise the competitiveness of the system and have a negative impact on how and where business transactions are carried out.  

Take the FAD rules – please!!

As a member of Finance Minister Flaherty’s Advisory Panel on Canada’s System of International Taxation, I am constantly asked whether the FAD rules go farther than what the Panel recommended (see PwC’s recent summary).

As I have written previously, under the terms of its mandate, the Panel focused on foreign affiliate debt dumping. The phrase foreign affiliate dumping clearly indicates that the FAD rules are intended to go farther than the Panel’s recommendation; no doubt to ensure the rules are not susceptible to planning that would defeat their purpose.

I don’t have a problem with this. After all, the Panel did recommend that any change be “robust”. 

What’s more, the FAD rules are also intended to deal with inappropriate surplus stripping transactions, something the Panel did not specifically address - although if we did, I doubt we would have been fussed by planning to defer Canadian withholding tax, unless it facilitated debt dumping.

Critics, though, argue that the “more closely connected” exception is too restrictive and will give rise to considerable uncertainty as to how it can and will be administered and complied with – an example, if you wish, of using more screws or tightening the screws more than needed.

In Finance’s defense, they had the difficult challenge of determining the circumstances of when the Canadian tax system should not subsidize foreign investments by a foreign controlled Canadian company because of the perceived lack of significant economic benefit to Canada. The test is not perfect, but it should capture the abusive type of planning the Panel believed should be stopped, while the paid-up-capital offset and re-instatement rules and the new elective 17.1 regime should provide taxpayers with alternatives for many situations that are not abusive or that are not intended to erode the Canadian tax base.

Going too far

Still, the critics have a point – the FAD rules are far reaching. Two areas in particular come to mind.

The first is the indirect acquisition rule, which applies when a non-resident corporation acquires a Canadian company, directly or indirectly, if the latter has investments in foreign affiliates that exceed 75% of the value of the Canadian company.

Increasing the threshold from 50%, as initially proposed just two months earlier in August, is a big change and suggests that the rule is arbitrary and the targeted abuse unclear. More importantly, while the resulting structure following such acquisitions looks similar to the structures that the FAD rules are intended to catch, it should be relevant that in these circumstances the structure is not the result of abusive tax planning.

Other government policies and legislation encourages inbound foreign investment, including the acquisition of Canadian companies where there is a net benefit to Canada. Invariably, such targets will have foreign affiliates because, as the Panel noted, business expansion into foreign jurisdictions is something that Canadian companies do sooner than most of their global competitors because of the smaller Canadian market. It seems inappropriate for the tax rules to impose a penalty on such acquisitions just because foreign affiliates account for 76% instead of 74%, or 80% instead of 10% of the value of the Canadian target.

I am not convinced these acquisitions need to be targeted, absent some clear abuse post acquisition.  At the very least, the rules should provide for generous grandfathering, especially where an acquisition occurred prior to the FAD rules coming into force.

The second area involves the impact the FAD rules have on companies listed on Canada’s stock exchanges ostensibly to raise capital to invest in foreign businesses. This is particularly prevalent in the mining industry, where hundreds of mining companies seek to be listed in Canada even though many do not have Canadian operations. There are clearly non-tax reasons for these structures because Canada is not the poster boy holding company jurisdiction for tax purposes, except where there’s the ability to leverage Canadian operations.

It seems unnecessary for the FAD rules to go this far, especially if there is a risk of jeopardizing Canada’s well deserved reputation of being a good place to raise capital, not to mention the economic benefits such activity brings to Canada’s banking and investment community, Canadian stock exchanges, professional advisors, etc. Raising capital, public listings…these are mobile activities. It is reasonable to ask if it is necessary to give mining executives and others a reason to take their business elsewhere.

If there is concern about possible abuse in the future, by facilitating inappropriate leveraging if Canadian operations are acquired, then the focus should be to deal with that issue by allowing some safe harbor level of Canadian investment or even to restrict borrowings to something that is tied to the level of Canadian assets. Having said that, if such structures do result in Canadian investment, isn’t that a good thing, consistent with what the government says it wants?

Final thoughts

By including the indirect acquisition rule and public companies, the FAD rules seem to go farther than they need to. To extend the carpentry analogy, the rule is “measure twice, cut once”; Finance may have been too hasty in reaching for the saw.   

Bringing back the income trust with PwC's Foreign Asset Investment Trust (PwC FAIT)

The number of Initial Public Offerings (or IPOs) in the last while has been quite low. And, as such, there might be some capital in the public market just waiting to be tapped into.

In the video below, I talk about how the original income trust structure that was used to tap into those public markets was killed in 2006 but has been brought back to life through PwC FAIT. I also talk about how the structure takes into consideration cross-border issues, how it's worked so far, and other issues to consider when going through an IPO. 

 

What do you think? Could this be something that might apply to you and your organization? Leave your thoughts and comments below.

 For those attending the Canadian Tax Foundation's Annual Conference in Calgary on November 26th, I look forward to seeing you there (and to talking more about this in detail)! 

 

About Murray Lee:

Murray Lee is a Tax Services partner in the firm’s Calgary office. He has assisted both large and small clients in all aspects of Canada-U.S. taxation including reorganizations, mergers and acquisitions and cross-border financings. Murray has written several articles and made numerous presentations on various U.S. and cross border issues.

Dispelling Myths and Moving Forward

By: Nick Pantaleo

In August, the federal government launched consultations on the impact of contingency fees on the effectiveness of Canada’s scientific research and experimental development (SR&ED) tax incentive program.

For those unfamiliar with the practice, a contingency fee is a charge, in this case, for services to help companies identify and file claims for tax benefits under the SR&ED program, which is only payable if the claims are approved by the government.

This type of service arrangement has existed for years. Why is the government so concerned now?

What’s the fuss?

The SR&ED program has been under scrutiny in recent years. It is the largest federal program supporting business R&D in Canada, providing more than $3.6 billion in tax assistance in 2011. Still, recent studies show that Canada continues to lag many countries in business R&D spending, rates of commercialization of new products and services, and productivity growth.  

The 2011 report of the Independent Panel on Federal Support to Research and Development (the Jenkins Report) made recommendations to improve the program. It also observed that the SR&ED program is criticized for its complexity and high compliance costs, which forces companies to retain consultants on contingency fee arrangements.

The government, in announcing the consultations, stated that it has heard concerns about the prevalence and magnitude of contingency fee arrangements – it has been reported that such fees might be as high as 30% of total SR&ED benefits – and it is worried contingency fees may be diminishing the benefits of the SR&ED program to Canadian businesses and the economy.

What is the government looking for?

The consultation sought input to better understand:

• Why third-party preparers are hired on a contingency-fee basis;
• Why these preparers charge contingency fees;
• The prevalence of this practice and the amounts charged; and
• The impact of this practice on the effectiveness of the SR&ED program.

Submissions from stakeholders were due October 1st.

What has the government heard?

A number of professional firms and associations, including PwC, the Canadian Institute of Chartered Accountants and the Tax Executive Institute, have made submissions. Although the Department of Finance has not yet made any public, the consensus seems to be that contingency fee arrangements enhance the effectiveness and efficiency of the SR&ED program.

PwC notes that limiting such arrangements would not reduce compliance costs and that “Canadian businesses use contingency arrangements to reduce actual and perceived risks associated with claiming SR&ED benefits.”

The CICA agrees, arguing that “[a]ny action to target contingent based fees directly would only serve to eliminate a valuable avenue for obtaining claims assistance and potential financing for small and medium sized businesses.” Its conclusion is based on a survey it conducted within its membership. Among the other survey results:

• Fees paid under all types of arrangements are nominal, less than 4% of the total program costs.
• Contingency fees are comparable to fixed or hourly rate fee engagements suggesting that contingency fees do not increase compliance costs.
• Almost 50% of respondents who paid contingency fees would not likely to have made SR&ED claims under some other fee arrangement.

TEI maintains that contingency arrangements are important to taxpayers who desire to have SR&ED benefits identified at the lowest cost and properly structured contingency fee arrangements result in no higher costs than per hour or per diem fee billing methods. In fact, TEI contends that a per hour fee arrangement can be very inefficient. Moreover, there is generally no immediate “hit” or expense for the incremental cost of performing the study because the cost and tax benefit will be accounted for at the same time.

TEI also disagrees that claims filed on a contingency fees basis are less reliable or more aggressive than claims filed using traditional billing methods.

Was the consultation a wasted effort?

I don’t think so.

Sometimes you have to take a half step backward in order to take one step forward. The government wanted to find out how contingency fees impact the SR&ED program and they received some great insight.

The consultation provided an opportunity for tax preparers and SR&ED performers to be transparent and build trust with the government and to dispel some of the myths. That is important, particularly when the integrity of the program and its players are essentially being questioned.

Let’s now take that one step forward and re-focus on reducing complexity within the program, improve its administration and think about how other initiatives (for example, a patent or innovation box) might help to reduce Canada’s innovation deficit.