Pending Canadian income tax issues.

• Position: Includes response from Canadian Department of Finance

On December 3, 1992, Tax Executives Institute held its annual liaison meeting with officials of the Canadian Department of Finance. In connection with the meeting, the Institute submitted the following comments, which were prepared under the aegis of the Institute's Canadian Income Tax Committee. The chair of the committee is Vincent Alicandri of INCO Ltd. Also participating in the development of the comments was J. Lawrence Martin of Mobil Oil Canada, is the Institute's Vice President. Region I, and other members of the Canadian Income Tax Committee.

Tax Executives Institute welcomes the opportunity to present the following comments on several pending tax issues, which will be discussed with representatives of the Department of Finance during TEI's December 3, 1992, liaison meeting. In the meantime, if you have any questions about these comments, please do not hesitate to call either J. Lawrence Martin, TEI's Vice President for Canadian Affairs, at (403) 260-7991 or Vincent Alicandri, chair of the Institute's Canadian Income Tax Committee, at (416) 361-7853.

1. Background

   Tax Executives Institute is an international organization of approximately 4,700 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 more than 2,400 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.

2. Tax Competitiveness

   In the past, TEI has focused during its liaison meetings primarily on the policy and administration implications of specific tax proposals. Given the growing interdependence between tax, trade, and economic policies -- together with the burgeoning importance of international competitiveness (highlighted most recently by the North American Free Trade Agreement (NAFTA)) -- the Institute believes it is prudent to address the competitiveness and efficiency of the Canadian tax system on a so-called macro basis. This new approach is manifested in this section of the submission, which analyzes recent developments in Canada and in other parts of the world.

   1. Background

      In the last six months, two research organizations have addressed the competitiveness of Canada's income taxation system vis-a-vis the United States and expressed concerns about Canada's ability to compete in the global market. These organizations are the Conference Board of Canada Business Centre for Tax Research and the Prosperity Secretariat Initiative Steering Group, which was established by the Minister of Industry, Trade, and Technology.

      The Conference Board's conclusions are contained in the Board's interim report entitled Canada-U.S. Tax Competitiveness in Manufacturing Industries, which will be published later this year. In 1990, the Conference Board expressed the view that Canada's relative tax competitiveness vis-a-vis the United States had slipped in recent years. That study reviewed four specific industries -- Petrochemicals, Steel, Forest Products, and Telecommunications.(1)

      The Prosperity Secretariat's findings are contained in its publication, Prosperity Through Competitiveness, which was published in June. The report analyzes the role the financing of investment plays in the global competitive scene. At the request of the Steering Group on Prosperity, the Prosperity Secretariat undertook a cross-country consultative process, commencing in April of this year. According to the Steering Group, the study was needed because Canada's economic prosperity was at stake: "Unless we adopt a new approach to the challenges of competing in the New World Order, we run the risk of falling even further behind the leading players." In this regard, the Prosperity Secretariat reported that the message from across the country was clear and concise; there was an exceptionally high level of consensus among "stakeholders" on the important issues and recommendations and on the immediate need for action.

      The study focused on the cost of capital, availability of capital, and the efficiency of the markets. One of the key areas was taxation. The stakeholders canvassed included executives in High Technology Businesses, Small and Medium-sized Enterprises, Multinationals, Institutional Investors, Banks, Venture Capital Firms, Investment Dealers, and other professionals, including accountants and lawyers. In all, the Prosperity Secretariat interviewed 280 senior business and financial industry leaders.

      The principal themes regarding tax policy were, as follows:

      * The importance of international

      tax harmonization and coordination.

      * Ensuring that the United

      States remains the focus of our

      competitive tax regime comparison.

      * Concern that the country's relative

      tax competitiveness vis-a-vis

      the United States has

      slipped since 1984.

      * Consternation over the complexity

      and inefficiency of the

      tax system.

      * Bitterness at the way tax dollars

      are spent.

      * Irritation over the multi-jurisdictional

      lack of tax coordination

      among Governments in

      Canada.

      Against this background -- together with the Canada-U.S. Free Trade Agreement and the recent progress on NAFTA between Canada, the United States, and Mexico -- TEI recommends that the Department of Finance review the recent developments in the European Economic Community (EEC) with respect to direct taxation and corporate income taxes. In particular, the Department should focus on those changes designed to strengthen the EEC's competitiveness in world markets and to help eliminate distortions within the internal market, created by the existence of differing taxation systems. These developments are summarized below.

   2. European Economic Community Experience

      Although most of the emphasis in the EEC initially was to harmonize the value-added tax (VAT) system, in recent years more attention has been given to the subject of direct taxation and to corporate taxation in particular. This is especially the case with the expected completion of the VAT initiative by the end of 1992.(3)

      In 1960, the Neumark Committee, a group of tax experts, was established by the EEC to examine tax competitiveness. Although primarily concerned with indirect taxation and border transactions, the committee also addressed the impact of direct taxation on competition. In 1962, it recommended that the first phase of tax harmony deal with the taxation of dividends and interest as well as the avoidance of double taxation.

      In 1966, the Segre Report on "the establishment of an integrated capital market within the Community" was issued. Dealing extensively with the fiscal obstacles to the free movement of capital, the committee concluded that tax considerations should not influence the choice of location of investments or transactions. The chief obstacles to competitiveness within the Community were found to be the international double taxation of investment income, the existence of tax advantages or disadvantages affecting investment in certain countries, and the different treatment of investment income payable to non-resident and corporate investors.

      A number of the recommendations of the Neumark Committee and Segre Report were adopted by the Commission of European Communities in 1967. Taxation was seen by the Commission as a major obstacle to the free flow of capital. In the long term, the alignment of national tax systems would be required in order to create conditions of fiscal neutrality. Among the first matters that should be dealt with, the Commission agreed, were withholding tax on dividends and interest; the elimination or reduction of double taxation of dividends; tax arrangements applicable to holding companies; and the tax treatment of investments through financial intermediaries. The Commission also recommended the removal of obstacles to industrial combinations and the harmonization of certain taxation rules.

      In 1985, a White Paper on "Completion of the Internal Market" was issued. The paper, which was commissioned by the EEC, urged the adoption of three incentives aimed at removing obstacles to cooperation between European entities: the tax treatment of dividends flowing between subsidiary and parent; the taxation of mergers within the EEC; and the avoidance of double taxation.

      These three initiatives were the subject of Community Directives, which were released in 1990. The Parent-subsidiary Directive has been implemented or is in the process of being considered by all 12 Member States. The Tax Merger Directive has been implemented or is in the process of being considered by ten Member States (excluding Germany and Greece). And to date, the Arbitration Directive -- for the avoidance of double taxation -- has been implemented or is being considered by five Member States -- the United Kingdom, the Netherlands, Germany, France and Denmark.(4)

      1. The Parent-subsidiary Directive. This Directive requires parent companies to hold at least 25 percent of the capital of the subsidiary, although Member States may stipulate a less onerous burden in their domestic legislation.(5) The Commission has since recommended this holding requirement be reduced to 10 percent.

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