TEI testimony on pre-budget consultations before House of Commons Standing Committee on Finance: September 10, 2004.

• Position: Tax Executives Institute

On September 10, 2004, TEI filed a written statement with the House of Commons Standing Committee on Finance on the topics that it intends to testify about in connection with the Standing Committee's not-yet scheduled 2004 Pre-Budget Consultations. TEI will be represented at the hearing by its 2004-2005 Vice President for Canadian Affairs, David M. Penney of General Motors of Canada Limited, and by its 2004-2005 Chair of the Canadian Income Tax Committee, David V. Daubaras of General Electric Canada. Various members of TEI's Canadian Income Tax Committee contributed to the development of the written statement.

Tax Executives Institute (TEI) commends the Standing Committee for holding pre-budget consultations again this year. The hearings provide an important avenue for the Committee to gather input from Canadians across the country and TEI is pleased to have the opportunity to participate. TEI has a number of recommendations in respect of taxation measures that we believe will foster economic growth and job creation, promote a favourable business environment for investments in Canada, and ensure a high level of innovation and productivity. Implementation of our tax policy and administrative recommendations will spur economic efficiency and improve tax administration.

Background

Tax Executives Institute is the preeminent association of business tax professionals. TEI's 5,400 members work for 2,800 of the largest companies in Canada, the United States, and Europe. TEI's membership includes representatives from a broad cross-section of the business community, with members employed in all major industries and sectors of the economy. In that sense TEI is unique--we do not represent a particular group or industry. Canadians make up approximately 10 percent of TEI's membership, with our Canadian members belonging to chapters in Calgary, Montreal, Toronto, and Vancouver. In addition, many U.S. and European members work for companies with substantial Canadian operations.

Summary of Recommendations

The Institute urges the Standing Committee to incorporate the following recommendations in its report on the pre-budget consultations.

* Substantially narrow the scope of the Reasonable Expectation of Profit (REOP) test included in draft legislation clarifying the deductibility of interest and other expenses.

* Abandon the draft legislation in respect of Foreign Investment Entities and Non-Resident Trusts; if perceived abuses of the Income Tax Act cannot be addressed by Canada Revenue Agency (CRA) under the current provisions of the Income Tax Act, adopt narrower, more targeted remedies than this draconian legislation.

* Recommend that the Department of Finance expeditiously negotiate and implement a new provision in the Income Tax Convention with the United States eliminating withholding on all dividends and interest for payments to both related and unrelated parties.

Draft Legislation Relating to Interest Deductibility and Other Expenses--Abandon the Statutory Reasonable Expectation of Profit Test

On October 31, 2003, the Department of Finance released draft amendments to section 3.1 of the Act to clarify that (1) "income" for purposes of the Act is "net" income, in accordance with the generally accepted understanding of the Act prior to the Supreme Court of Canada's decision in Ludco Enterprises Ltd. v. Canada, (1) and (2) "net income" excludes "capital gains and losses." In addition, the Department of Finance said that draft subsection 3.1(1) should be introduced in order to institute a statutory "reasonable expectation of profit" (REOP) test, replacing the common law REOP test. TEI is pleased to have participated in consultations with the Department of Finance on this proposed legislation and will continue to respond to requests for information. A copy of TEI's comments and recommendations to the Department of Finance is attached as Appendix 1.

Although the Department's goals are clear and seemingly circumscribed, the proposed amendment to subsection 3.1(1), relating to limits on losses, is far broader than necessary to achieve those goals. The emphasis of the proposed legislation on establishing a "cumulative profit" and requiring taxpayers to trace expenditures to a "source" of business or property income in order to ensure their deductibility raises a number of administrative and policy concerns. Specifically, the proposed changes would modify the longstanding treatment of interest and other commercial expenses that taxpayers and Canada Revenue Agency (CRA) have long considered fully deductible. Indeed, the proposals go substantially beyond restoring the Act to the pre-Ludco status quo for the treatment of such expenses. As important, TEI believes the Supreme Court of Canada's decision in Stewart enunciates a clear and rational tax policy basis for distinguishing commercial activities from personal and hobby-related expenditures. (2) Moreover, the generally accepted understanding of the Act pre-Ludco was that income is "net" income and that "net income" is synonymous with "profit" for determining a "source of income." Thus, TEI believes the draft legislation poses a substantial risk of (1) creating confusion and ambiguity for taxpayers and CRA auditors alike, (2) imposing unwarranted restrictions on the ability of commercial enterprises, especially large-file taxpayers, to deduct the costs of producing their "net" income, and (3)...