Canadian legislation on foreign investment entities: October 31, 2001.

On October 31, 2001, TEI submitted the following letter to the Canadian Minister of Finance, Paul Martin, commenting on draft legislation relating to Foreign Investment Entities (FIE). For TEI's comments on the latest draft of the NRT provisions, which are part of the same legislative package from the Department of Finance, see the related comments in this issue. The comments on the FIE provisions follow up on a submission sent by TEI in February 2001 relating to an earlier version of the draft legislation. TEI members also met with representatives of the Department of Finance in May to discuss the draft legislation. (For TEI's earlier comments, which address the FIE and NRT provisions in a single package, see the March-April 2001 issue of The Tax Executive.) The comments below were prepared under the aegis of TEI's Canadian Income Tax Committee, whose chair is David M. Penney of General Motors of Canada Limited. Contributing substantially to the development of TEI's comments were Vince Alicandri of Hydro One Networks, Inc. and Alan Wheable of Toronto Dominion Bank.

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On June 22, 2000, the Department of Finance released draft legislation relating to Foreign Investment Entities (FIE) and Non-Resident Trusts (NRT). In response to public comments and consultations on the draft proposals, the Department on September 7, 2000, announced modifications to the proposals, delayed the implementation date, and extended the consultation period. Tax Executives Institute submitted comments on the modified draft in February 2001 and met with representatives from the Department of Finance in May. TEI is pleased that the Department afforded us the opportunity to discuss the draft legislation and to elaborate on our written comments. Subsequently, another draft of the legislation was released on August 2, 2001. While the draft legislation has been improved, TEI remains concerned about the draft legislation relating to Foreign Investment Entities. On October 25, we submitted separate comments on the latest draft of the Non-Resident Trust provisions.

Background

Tax Executives Institute is the preeminent association of business tax executives. The Institute's 5,300 professionals manage the tax affairs of the leading 2,800 companies in Canada, the United States, and Europe and must contend daily with the planning and compliance aspects of Canada's business tax laws. Canadians constitute 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 eight geographic regions. Our non-Canadian members (including those in Europe) work for companies with substantial activities in Canada. In sum, TEI's membership includes representatives from most major industries including manufacturing, distributing, wholesaling, and retailing; real estate; transportation; financial services; Telecommunications; and natural resources (including timber and integrated oil companies). The comments set forth in this letter reflect the views of the Institute as a whole, but more particularly those of our Canadian constituency.

TEI is concerned with issues of tax policy and administration and is dedicated t9 working with government agencies in Ottawa (and Washington), as well as in the provinces (and the states), to reduce the costs and burdens of tax compliance and administration to our common benefit. We are convinced that the administration of the tax laws in accordance with the highest standards of professional competence and integrity, as well as an atmosphere of mutual trust and confidence between business and government, will promote the efficient and equitable operation of the tax system. In furtherance of this principle, TEI supports efforts to improve the tax laws and their administration at all levels of government.

Overview of Draft Legislation and TEI Comments

The draft Non-Resident Trust (NRT) and Foreign Investment Entity (FIE) legislation released by the Department of Finance on August 2, 2001, is intended to replace the current rules in respect of foreign trusts in section 94 of the Income Tax Act (hereinafter "the Act") and the "offshore investment fund" rules found in section 94.1 of the Act. The draft legislation replaces the draft originally released on June 22, 2000.

The current rules in sections 94 and 94.1 are anti-avoidance provisions that are intended to prevent taxpayers from inappropriately deferring or avoiding tax (including conversion of income gains to capital in specific situations). Current section 94 applies where a person resident in Canada transfers or loans property to a foreign trust that has one or more beneficiaries resident in Canada. Current section 94.1 applies where a taxpayer has invested in an offshore investment fund and one of the main reasons for the investment is to reduce or defer the tax liability that would have applied to the income generated by the underlying assets of the fund if such income had been earned directly by the taxpayer.

In announcing the June 2000 draft legislation, the Department's press release explained the general purpose of the provisions to expand the scope of the anti-avoidance rules, as follows:

It is important that the income tax system not provide a means for Canadians to avoid Canadian income tax by transferring funds to offshore trusts or accounts. The proposed rules intend to provide a fair and workable approach to dealing with this complex area. While the August 2001 draft legislation includes important and substantial revisions, the latest rules remain overbroad, extraordinarily complex, confusing, and, in the case of the FIE provisions, continue to overlap and conflict with the entire foreign affiliate regime, including section 17 as it applies to loans to non-residents. As a result, the provisions will interfere with legitimate business operations. In addition, the FIE rules do not integrate well with the new rules governing non-resident trusts. Although the latest version of the draft legislation helpfully reduces the number of instances where a non-resident corporation operating an active business could qualify as a FIE, TEI continues to believe that, once an entity is trapped in the labyrinth of the FIE rules, taxpayers will be unable to comply. We also continue to question whether auditors from Canada Customs and Revenue Agency (CCRA) will, anymore than taxpayers, have the requisite resources to be able to properly administer these rules. From both compliance and administrative perspectives, these rules would be vastly improved if they were more limited in scope and focused solely on remedying perceived abuses. To the extent that the government can identify specific abuses, it should propose narrower, targeted solutions. These draft proposals, however, remain unworkable and we again urge the government to withdraw it.

The preamble before the table of contents for the explanatory notes states that the notes are for information purposes only and should not be construed as an official interpretation of the provisions described. Given the complexity of...