TEI-Department of Finance liaison meeting agenda: income tax issues.

• Position: Canada

December 8, 1999

On December 8, 1999, Tax Executives Institute held its annual liaison meeting with Department of Finance on pending income tax issues. The Institute's agenda for the meeting was prepared under the aegis of TEI's Canadian Income Tax Committee, whose chair is John M. Allinotte of Dofaseo, Inc. Marlie R.M. Burtt, the Institute's Vice President-Region I, coordinated preparations for the liaison meeting.

Tax Executives Institute, Inc. welcomes the opportunity to present the following comments on pending income tax issues, which will be discussed with representatives of the Department of Finance during TEI's December 8, 1999, liaison meeting. If you have any questions about these comments, please do not hesitate to call either Marlie R.M. Burtt, TEI's Vice President for Canadian Affairs, at (403) 269-8736, or John M. Allinotte, chair of the Institute's Canadian Income Tax Committee, at (905) 548-7200, extension 6821.

1. Background

   Tax Executives Institute is an international organization of approximately 5,000 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 2,800 of the leading corporations in Canada, the United States, and Europe.

   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 eight geographic regions. In addition, a substantial number of our U.S. and European 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; telecommunications; and natural resources (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. Foreign Affiliates -- Definition of Investment Business

   1. Pursuant to subsection 95(1), to be considered "active" an "investment" business conducted by a foreign affiliate must, among other requirements, employ more than five persons full time in the conduct of its business. The definition of an investment business encompasses a number of different commercial activities, including banks, trust companies, securities brokerage, etc., each of which has fundamentally different operations and staffing requirements. Hence, the five-employee rule is arbitrary because it fails to reflect the commercial reality of what is required to operate the business. Where an "investment business" can be conducted by fewer than six employees, Canadian-owned foreign affiliates may likely be uncompetitive with local businesses in a foreign country. Moreover, the arbitrary rule could lead to the loss of Canadian-based jobs. As a result, TEI recommends that subsection 95(1) be revised. Specifically, we recommend that the "more than five employees" test be recast as a safe harbour. Taxpayers with foreign affiliates that conduct investment businesses should be accorded the opportunity to demonstrate that their commercial activities are substantive enough to be deemed active without regard to an arbitrary five-employee rule. We invite the Department's views on our proposal.

   2. Increasingly, businesses must consider alternative, flexible work arrangements to meet their staffing requirements, including contracting out for essential administrative functions. In view of this trend, TEI recommends that services provided to a foreign affiliate by non-residents of Canada on a contract basis that are equivalent to a full-time position be counted as a full-time position regardless of whether those services are provided by a corporation related to the affiliate. We invite the Department's views on this proposal as well.

3. Non-Residents Carrying On Business In Canada

   As the world economy becomes increasingly integrated, Canadian industries are required to adapt quickly to global competition for customers, employees, and suppliers. Inefficient businesses that do not streamline on a global scale quickly lose competitive advantages. To meet the challenges, successful Canadian businesses are reorganizing their international operations and in some cases centralizing functions in Canada to eliminate duplicative expenditures. Where services are provided from Canada for related parties outside Canada, section 247 requires that arm's-length service fees be charged and included in income thereby increasing the Canadian income tax base. An additional benefit to the Canadian economy and tax base that arises from providing centralized services in Canada is the employment of highly skilled, higher-paid, professionals exporting services from Canada.

   Operations carried on by a foreign affiliate of a Canadian taxpayer sometimes require that limited authority be delegated to a related-party Canadian service provider. For example, when the foreign affiliate is located in Central Europe, Asia, or similarly distant regions, the nonresident may not be able to act on the advice of the Canadian service provider on a real-time basis. One pragmatic solution is for the non-resident to grant limited authority to the Canadian service provider to contract on behalf of the foreign affiliate. If that authority is exercised on a regular basis, however, the non-resident would likely be considered to have a permanent establishment (PE) in Canada or be considered carrying on a business in Canada. As a result, the non-resident would be required to file a Canadian income tax return and allocate profits to the business carried on in Canada. Generally, the income attributable to the Canadian activity of the non-resident will be equivalent to the value of the services provided and charged to the foreign affiliate by the Canadian service provider. Consequently, the net income of the PE will likely be nil, yielding no net tax benefit to Canada, whereas the foreign affiliate will be required to bear significant administrative costs to comply with the tax laws. As a result, TEI recommends that the rules be clarified to provide that the provision of services by a Canadian to a nonresident related party will not lead to the non-resident being considered as carrying on business in Canada so long as the charges for services provided by the Canadian resident comply with section 247. We invite the Department's views on our proposal.

4. Barbados Exempt Insurance Companies

   Will the Department please provide an update on current developments on discussions with the Government of Barbados concerning the Canadian taxation of dividends distributed by a Barbados resident insurance company?

5. "Foreign Content" Rules

   Registered plans are currently permitted to invest no more than 20 percent of total assets in non-Canadian companies. Recommendations have been made that the limit on the percentage of so-called foreign content be increased or, even better, abandoned. Will the Department comment on whether it is considering raising or eliminating the foreign-content limit?

6. Arbitration Procedures

   In a report...