Tax professionals and business groups are hoping that a comprehensive review of Canada’s system of taxing international income will help Canadian companies compete abroad more successfully. These groups are also looking for a level playing field at home for both foreign and domestic businesses.

“We want to ensure that all Canadian companies can compete on an equal footing, both in Canada and abroad,” says Barbara Amsden, director of research and strategy with the Investment Funds Institute of Canada in Toronto.

IFIC is one of more than 30 groups that have made submissions to the federally appointed advisory panel on Canada’s system of international taxation.

The panel of tax experts, headed by Peter Godsoe, the retired past president of Bank of Nova Scotia, is due to make recommendations to the federal minister of finance on Dec. 1. The panel’s mandate is to examine the tax policy framework with respect to Canadian businesses’ investments abroad, as well as foreign businesses’ investments in Canada.

The panel is aiming to improve the competitiveness and fairness of Canada’s tax system, including minimizing businesses’ compliance costs. The panel is also focusing on measures that will be practical to implement, as well as providing greater certainty and simplicity for taxpayers.

“The fact that the panel is looking at this in a sophisticated way is really welcome,” says Andrew Dunn, Canadian managing partner for tax with Toronto-based Deloitte & Touche LLP. “Some of the tax policy that Canada has stumbled through in the past couple of years seemed to be driven by the urgency of the moment and a fundamentally short-term agenda. But it’s an area of policy in which we need to be thoughtful more than we need to be quick.”

The panel is faced what Firoz Talakshi, national practice leader for international corporate tax with KPMG LLP in Toronto, calls “a Herculean task.” He maintains that Canada’s system for taxing international income has become “far too complex” and that this problem is compounded by the enormous volume of proposed tax legislation awaiting enactment. “This complexity and uncertainty,” he adds, “frustrates Canadian businesses’ efforts to comply with the law and plan for the future.”

One new tax regulation, criticized in many submissions received by the panel, involves the legislated — but not yet enforced — interest-deductibility rules, commonly known as the “double-dip financing rules.”

“They should be ripped out,” says Dunn. He notes that the purpose of the rules is to prevent companies from claiming tax deductions in Canada on interest and borrowing costs for investments in foreign countries if these deductions are also allowable under the tax laws of the foreign country. The concept may seem fair, he says, but the foreign tax deduction has no impact on Canada’s tax base and, as long as other countries allow double-dipping, the rules “put Canadian companies wanting to expand in foreign jurisdictions at a disadvantage relative to other countries’ companies.”

DOUBLE-DIP RULES

Adds Rod Bergen, chairman of the Tax Executive Institute Inc. ’s Canadian income tax committee: “Canada is weighing in with respect to Canadian multinationals as the world tax police.”

He also maintains that the double-dip rules affect the ability of Canadian multinationals to compete. However, since the provisions do not come into effect until 2011, he adds: “The hope is that the government will see the light of reason and change its tack.”

Another key concern raised by interested parties involves the tax exemption rules for income earned by foreign affiliates of Canadian companies. This income is not subject to Canadian taxes unless it is brought back into this country in the form of dividends — for example, if it is paid to Canadian shareholders. Under existing regulations, this income, which is normally subject to taxes in the foreign jurisdiction, is considered exempt from Canadian taxes provided there is a tax treaty between the two countries or if the other country has indicated that it is willing to enter into a tax information exchange agreement with Canada in the future.

That last provision covers most parts of the world, but there are some jurisdictions that have no tax treaty with Canada and no intention of entering into an information-sharing agreement.

Hong Kong is one example cited by the Canadian Life and Health Insurance Association Inc., which notes in its submission to the panel that its members have significant active businesses in Hong Kong and are unable to benefit from exemptions: “It seems unfair to us that the treatment of a Canadian taxpayer’s foreign active business income depends upon a foreign government’s decision whether to enter into a TIEA with Canada.”

@page_break@The Toronto-based Canadian Bankers Association maintains that moving to a full exemption system will not only improve the competitiveness of Canadian firms and allow for the more efficient allocation of capital, but also simplify tax rules, for the benefit of both Canadian taxpayers and the Canada Revenue Agency, which is responsible for enforcing the rules.

The CBA cites the findings of a recent World Bank/Price-water-houseCoopers study that found Canada ranks eighth in the Organization for Economic Co-operation and Development in terms of the ease of tax compliance, behind key competing jurisdictions such as Britain. “The bur-den of complying with Canada’s ever more complex tax system is becoming an increasing part of the overall tax burden on corporations in Canada,” the CBA submission states. “Canada should aim to have the simplest and most efficient tax system in the world.”

There are also huge compliance problems arising from the complexity of regulations relating to non-resident trusts and foreign investment entities. The regulations were designed to prevent Canadian taxpayers from diverting income offshore, according to the CLHIA’s submission to the panel: “We believe that any benefits from these rules are outweighed by the compliance burdens imposed by them, and by the lost opportunity costs associated with their overly broad and extraordinary complexity.”

Tax lawyer Michael Cadesky of Cadesky and Associates LLP is urging the panel to study these rules as the centrepiece of its report: “These rules, as presently drafted, are overly complex and provide a disincentive to Canadians to commit funds to international business.”

Cadesky maintains that the CRA sometimes unfairly targets smaller businesses that have international operations, on the grounds that these enterprises have “no business substance” because they are thinly staffed and frugally financed. However, while noting that these businesses often grow to become sizable, he adds: “There is generally a view that the CRA discourages the setting up of international operations by smaller Canadian corporations, perhaps because they are ‘easy targets.’ This leaves the international area to the domain of larger enterprises, which is unfair.”

FOREIGN MONEY MANAGERS

IFIC raises two issues of specific concern to investment advisors, one relating to imported financial services and the other involving exported financial services.

The concern with regard to imported financial services arises in situations in which a Canadian investment fund manager acquires or establishes operations outside Canada and engages this affiliate to provide investment advi-sory services to its Canadian mutual funds. The service fees paid to the offshore affiliates will be foreign accrual property income, with potentially adverse results. In contrast, the IFIC submission states, if the Canadian investment fund manager engages an unrelated foreign person to provide the investment advisory services, that is not the case.

In addition, a foreign investment fund manager with a Canadian mutual fund business is able to provide investment advisory services to its Canadian mutual funds without such potentially adverse results. “The result,” states the IFIC brief, “is that Canadian investment fund managers are at a competitive disadvantage and are discouraged from expanding offshore.”

A similar issue arises when Canadian investment fund managers provide investment advi-sory services to foreign investment funds. The volume of trading and other facts may be sufficient to cause the foreign investment funds to be viewed as carrying on a business in Canada, thus making them subject to Canadian income tax rules. On the other hand, this problem does not arise if a foreign fund hires a foreign investment advisor.

“This result places Canadian investment fund managers at a competitive disadvantage in advising on Canadian investments relative to foreign investment fund managers,” states the IFIC brief, which proposes legislative amendments to address both these issues.

Another issue that the panel is expected to examine in detail involves the so-called “thin capitalization rules” that govern the amount of debt in relation to equity held by Canadian subsidiaries of foreign companies. On this matter, various submissions have called upon the panel to find a balance between the complex requirements of multinationals, including financial institutions, and the need to prevent “debt dumping,” whereby foreign companies use debt to avoid Canadian tax liabilities.

The Canadian Chamber of Commerce is one of many organizations calling for broader exemptions with respect to withholding taxes that non-residents must pay in certain circumstances on interest, dividends, royalties, rents and other payments derived from Canada. When exemptions currently do not apply, the CCC brief maintains, “[The imposition of these taxes] has a negative effect on the economy, since it can impede cross-border capital flows and act as a tariff on the importation of capital and/or knowledge.” Withholding taxes on royalties, it adds, can also raise the cost to Canadian businesses of accessing foreign technology.

As the panel deliberates over these and numerous other issues, IFIC’s Amsden is concerned that the process could become derailed by the federal election: “We hope that the expert panel will be able to conclude its deliberations, and that the new government will act upon its recommendations.” IE