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

Mineral Exploration Tax Credits

Guest Blogger: Kevin Chan

The 2012 Federal Budget extended the flow-through share tax credit for another year to flow-through share agreements entered into before April 1, 2013.  In order to qualify for the tax credit, the investor and the corporation must enter into a flow-through share agreement and the qualifying exploration expenditures must be renounced to the investor by March 31, 2013.

The flow-through share tax credit provides individuals with a 15% non-refundable tax credit for investors who invest in flow-through shares. Some provinces also provide additional incentives to flow-through share investors.  For example, Ontario provides an additional 5% refundable tax credit for eligible individual taxpayers who invest in flow-through shares of mining companies who incur eligible Ontario exploration expenses.

As the flow-through share tax credit is officially a temporary measure, the Federal Government is required to renew this tax credit every year in its Federal Budget.

 

What if...you were stuck with the CRA?

Listen to  this episode of Tax Tracks where Rick Biscaro, a former CRA Director, walks through a few “sticky situations” with the CRA.

 

What have you encountered in dealing with the CRA? Have you been in a sticky situation?

Sneak peak:
In the next episode, Sharon Gulliver – a former CRA officer – discusses what to do and what not to do when being audited by the CRA.

What would you like us to talk about next? Leave your thoughts and comments below.

Enhancing the Competitiveness of Canada’s International Tax System (Part 9)

By: Wally Conway

A New Approach to Tax Base Protection

The Canadian Income Tax Act includes certain provisions commonly referred to as the base erosion rules. These are rules are intended to prevent the shift of Canadian income to foreign jurisdictions by having a Canadian company establish a foreign affiliate. The foreign affiliate is to serve as a captive property procurement, insurance, financing or services company in a manner whereby a Canadian resident (usually the Canadian company or non-arm’s length person) incurs deductible charges from the affiliate and the resulting income is taxed in a foreign jurisdiction, often at a lower tax rate.

The Advisory Panel on Canada’s System of International Taxation in its December 2008 final report noted that Canada’s current base erosion rules are considered by many Canadian businesses as being too broad and prevent them from taking full advantage of global supply chains they have built up to support their global operations.

As Canadian companies expand globally, they acquire intellectual know-how, service and manufacturing capabilities in foreign jurisdictions, that they want use globally, in the most productive and cost-efficient manner possible. Providing their Canadian operations with access to such acquired capabilities, even in a manner that meets accepted transfer pricing guidelines, can run afoul of Canada’s base erosion rules.

Conceptually, base erosion rules should not apply to income that is derived by a foreign affiliate from active business operations carried on in a permanent establishment in a foreign country. Otherwise, the result is that such foreign active business income is inappropriately included in foreign accrual property income (FAPI) of the affiliate. This is contrary to the tax policy underlying the foreign affiliate rules. It also precludes such foreign affiliates from competing in the Canadian market place and the Canadian market place from benefiting from that competition.

The Advisory Panel recommended that the scope of Canada’s base erosion rules be reviewed to ensure they do not impede bona fide business transactions and the competitiveness of Canadian businesses.

A number of countries, including Australia and even the U.S., have or are considering the scope and necessity of their base erosion rules.  More recently, the UK has stated that its CFC rules will only include profits that have been artificially diverted from the UK.

In the March 29th federal budget, the government promised that amendments would be made to the base erosion rules to alleviate the tax cost to Canadian banks of using excess liquidity of their foreign affiliates in their Canadian operations as well as ensuring certain securities transactions undertaken in the course of a bank’s business are not inappropriately caught by these rules.

This is a very positive development for foreign operations of Canadian banks and a step in the right direction in re-evaluating Canada’s base erosion rules. But more work is needed to ensure that the global operations of Canadian companies in other industries are also not adversely affected by Canada’s base erosion rules.

Up a CRIC without a ...

By Eric Lockwood

On May 10, 2012 we hosted a webcast on the Foreign Affiliate Dumping (FAD) proposals (if you missed the webcast see our Tax Memo “Canadian federal budget targets Canadian subsidiaries of foreign multinationals” for background on these proposals).  Clearly, the proposals are targeted at new investments made by foreign-controlled Canadian corporations in foreign affiliates.  However, they are very broadly worded. There is another aspect of the proposals touched on during the webcast that I would like to comment on in this note; namely the extent to which the proposals, as drafted, appear to prevent a Canadian corporation from managing its current foreign affiliate structure.

Is the Elephant Finally Out of the Room?

By: Nick Pantaleo

The comments started coming in not long after the Minister stood up in the House of Commons and the budget papers became available. 

“Happy now?” someone emailed.  “Looks like you guys got what you wanted,” another observed. Others asked, “Is this really what the Panel recommended?”

Loan from FA and Thin Cap – Budget Proposal

By: Melanie Huynh

Currently, interest paid by a Canco to a controlled foreign affiliate (CFA) could be subject to the thin capitalization rule in 18(4).  This may result in a denial of some or all of Canco’s interest expense, while the interest income earned by the CFA is taxed in Canada as FAPI, giving rise to double taxation.

Under the March 2012 budget proposal, Canco’s interest deduction is not denied, but only to the extent that the FAPI, net of related deduction under 91(4), is included in Canco’s income. Although the proposal is welcome, further fine tuning is needed to properly address the double taxation issue.

Budget 2012 – Jobs, Growth and Long-term Prosperity

By: Wally Conway

The Honourable Jim Flaherty has finally tabled the Harper Government’s budget. As expected, the budget focus was on creating Canadian jobs, economic growth, and returning to balanced budgets. To meet its medium term goal of eliminating budgetary deficits, the federal government is relying on measures such as growing its revenue, protecting its tax base and reducing government operating expenditures.

By promoting Canadian economic growth, some of the budget measures would grow Canadian jobs and government revenues. The Harper government expects to grow jobs and government revenues by creating a Canadian business operating environment which would be globally competitive and attract new business investment to Canada. The proposed measures are designed to improve business operating conditions by supporting research, education and training, reducing investment inhibiting regulations and expanding access to foreign markets through expanding international trade and tax agreement networks.