Draft Canadian legislation on the tax treatment of interest expense.

On May 1, 1992, Tax Executives Institute filed the following comments with the Canadian Department of Finance relating to draft legislation on the tax treatment of interest expenses. The comments took the form of a letter from TEI President Reginald W. Kowalchuk to Ian Bennett, Senior Assistant Deputy Minister for Tax Policy and Legislation. The comments were prepared under the aegis of the Institute's Canadian Income Tax Committee whose chair is Hugh D. Berwick of Alcan Aluminium Limited; their submission was coordinated by Andrew G. Kenyon of the Canadian Imperial Bank of Commerce, who is the Institute's Vice President-region I.

On behalf of Tax Executives Institute, I am pleased to submit the following comments on the Department of Finance's Release 91-141, Draft Legislation on the Tax Treatment of Interest Expenses, which was released on December 20, 1991.

Background

Tax Executives Institute 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 almost 2,000 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. 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 resource (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.

General Comments

At the outset, TEI wishes to express its support for incorporating into written law the tax policies with respect to deductibility of interest that are embodied in the June 2, 1987, Notice of Ways and Means Notion and its periodic renewals. Regrettably, TEI believes that the December 20, 1991, draft legislation fails to do that. More fundamentally, we fear that the draft legislation will create serious problems to many corporations carrying on business in Canada. The problems include the following:

* higher financing costs,

* higher administrative costs,

* a relative disadvantage compared

with foreign businesses,

* uncertainty, and

* unnecessary complexity.

The proposed rules dealing with borrowings for the purpose of distribution are of primary concern. The shortcomings of the proposed rules are so pronounced that the policy underlying them should be fully reconsidered. In the comments that follow, we first review the key concepts underlying these rules and then proceed to more technical comments on the various proposals.

Money Borrowed

for Distribution

Financial administration in recent years has become more sophisticated. Companies are able to manage money to reduce unnecessary interest expense. The treasury function is frequently centralized, with funds accumulated in one place for use throughout the business. Borrowed monies can usually be traced to an eligible use for deductibility of interest purposes under current administrative policies of Revenue Canada. One of those uses, however, is the payment of dividends or other distributions. TEI believes that, under the proposed rules, many companies will be compelled to spend considerably more money and time to minimize non-deductibility of interest on money borrowed for distribution.

Proposed sections 20.1 and 20.2 of the Income Tax Act adopt a property measurement test for the purpose of determining the deductibility of interest on monies borrowed by corporations and partnerships to make distributions. TEI's principle concerns about the test relate to the measurement of assets at tax cost and the exclusion from "equity" of shares in companies owned 10 percent or more by the Canadian taxpayer. Indeed, we believe these two issues alone are more than enough reason to scrap section 20.1 in its entirety.

1. Use of Tax Cost. The borrowing of money for the purpose of making distributions is widely recognized as an appropriate method of doing business and the cost of such borrowing is...