Finance Committee on May 15th, 2007

[The Chair, Conservative, Brian Pallister]

Okay, it's just that Barbados' popularity has grown.

The second thing, if I get the gist of this, is that the U.S. has an approach that essentially takes into account the foreign taxes that have been paid, but then it taxes, in some manner, the repatriated money from earned income; whereas in Canada, we assume the money has been taxed in the foreign jurisdiction and we allow the repatriation of the money tax-free. Is that correct? Is that essentially the difference between the two countries' approach in terms of the repatriation of eligible earned income back to Canada versus the U.S.?

[Brian Ernewein]

You've accurately described the difference between the two in result, in that we don't tax and the U.S. will tax with a credit. My hesitation to confirm all of what you have said is that you included an assumption that the income bore underlying foreign tax roughly equal to Canadian tax rates. There has been an ongoing debate on that. It's not clear to me, frankly, that this was the intention in all cases. We have tax treaties we've negotiated with countries, with a range of tax rates among them, so it seems to me there's at least an argument, on the evidence of it, that our tax treaty network is not built exclusively on having treaties only with countries with rates equal to our own, but possibly just with important countries.

[The Chair, Conservative, Brian Pallister]

Very good.

Finally, some of these supposed loopholes were supposedly addressed a decade ago, in the mid-nineties, but then some of them were reopened for Barbados. Can you explain what the exceptions were in the mid-nineties and what effect they have had on interest in foreign investment, specifically in Barbados?

[Brian Ernewein]

I want to be careful not to characterize them as loopholes or having been opened or closed—

[The Chair, Conservative, Brian Pallister]

Fair enough; we'll call them rule changes.

[Brian Ernewein]

Yes, I believe you're referring to some changes that were made in 1994 to our listing rules for tax treaties to make sure there was a treaty in effect for exempt surplus treatment to apply, corresponding with the actual treaties we had in place. There was not an intention to affect any of our current treaties then in place. To make sure that was the case, the regulation that went out said that any treaties in place, and any provision in those treaties that was not subsequently modified, would be respected. The effect of that was to leave unchanged the application of our exempt surplus regime for Barbados and other countries with which we had tax treaties.

[The Chair, Conservative, Brian Pallister]

Thank you.

Madam Wasylycia-Leis, for just five minutes.

[Judy Wasylycia-Leis, NDP, Winnipeg North, MB]

Thank you, Mr. Chairperson.

Pardon me if any of this is repetitive; I'm sorry, but I had to leave for a short period of time. Somehow I doubt that my questions will have been asked already.

I saw yesterday's announcement as quite a shift away from the budget. The budget actually states that

Canada’s New Government has chosen to act, to ensure that everyone pays their fair share of tax. Budget 2007 proposes that interest expense on indebtedness incurred to acquire the shares of a foreign affiliate no longer be deductible, unless and until the shares generate income that Canada actually taxes.

It seems to me that except for double-dipping—and we're not quite sure how that will work now—there's been a complete restoration of interest tax deductibility on foreign investments. So I'm assuming that's the case and I'm asking you what will we do now? Businesses said this was going to cost them a billion dollars if the government had proceeded. Now that the government's backtracked, who's going to pick up the billion dollars? How do we make up for this lost revenue that was going to come from the government finally closing this corporate tax loophole?

You maybe can't answer that, but—

[Brian Ernewein]

I think the summation of my answer is that I can't, that is true.

There have been a lot of numbers thrown around on the effects of the budget proposal. It is not clear to us that those estimates are entirely accurate. Indeed, it's a difficult thing to measure. While the Canada Revenue Agency might determine, on audit of corporations' tax returns, what proportion of their debt relates to foreign investment and, as a subtotal, what proportion relates to double-dipping on foreign investments, that's not something we know with precision at this stage.

What the minister has represented in the material is that the tax revenues generated from this proposal will be returned to the corporate sector in forms that will further enhance the competitiveness of the Canadian tax system.

[Judy Wasylycia-Leis, NDP, Winnipeg North, MB]

Well, that in itself was also a shock, and an indication of the government flip-flopping or bowing to corporate pressure. Normally when a tax change generates revenue, it goes into general revenue to better all Canadians. It's not targeted or directed at a specific area, in this case in terms of corporate taxes, already, as we heard earlier, among the lowest in the world.

It was clearly stated by others, and even in the minister's own briefing, that in at least three countries where this issue is allowed there's also commensurate taxation of the income of the affiliate. Is there any attempt by the Department of Finance to move in this direction, to move to worldwide taxation, or global taxation, or some way to address this proposal, as previously done in those three countries?

[Brian Ernewein]

No, that's not the policy proposal.

[Judy Wasylycia-Leis, NDP, Winnipeg North, MB]

And why not?

[Brian Ernewein]

The policy proposal is built on the existing system. It reflects an exemption regime for foreign business profits that are brought home to Canada. I've already mentioned a couple of times today that there can be some perhaps perverse effects of imposing a system of taxation only on repatriation. It ends up providing the same deferral we do, but then preventing, essentially, the income from being brought home to possibly do good things, in our case in Canada. Other countries are struggling with that, sometimes actually imposing, as I mentioned, an amnesty, as in the U.S.

[Judy Wasylycia-Leis, NDP, Winnipeg North, MB]

But if it's in the minister's own documents from the finance department.... You mention that the United States, Great Britain, and Japan have the reasonable policy of both allowing for the deductions and taxing the income of the affiliates. So why isn't Canada looking at that as a proposal? Doesn't that make sense?

[Brian Ernewein]

I assume that there are people from the U.S, the U.K., and Japan who would argue that it does make sense. The observation we have, in addition to the one I've made, is that in our regime, by providing an exemption for foreign business profits, we help the competitiveness of our firms.

It's a balancing exercise. Parliament could choose that it wants to tax this income. It could choose that it wants to tax this income on a current basis. I think it might be alone in the world, but that's sort of the range of options it would have.

Not taxing it on a current basis, respecting essentially the international norms on it, the question is what you do with it at the end--tax it or allow it to be brought home exempt. The system is built on an exemption, and the interest deduction rules are built in part on that exemption as well.

[The Chair, Conservative, Brian Pallister]

Thank you, sir.

We continue with Mr. Del Mastro now.

[Dean Del Mastro, Conservative, Peterborough, ON]

Thank you, Mr. Chair.

Mr. Ernewein, a few moments ago one of my colleagues from the Liberal Party indicated that double-dipping is currently not allowed. In a presentation the other day by the Canada Revenue Agency, we had a very specific example of where they went to court and lost on a double-dipping case--or double exemption, if you prefer.

I want to go over this a little bit with you, explain to you what they presented to us, and then ask you a couple of questions on it.

They began with tax haven A, where company A borrowed $200 million at 10%, incurring a $20 million interest expense that they then deducted from Canadian taxes. They then loaned--

[The Chair, Conservative, Brian Pallister]

I'm sorry to interrupt, Mr. Del Mastro, and I don't want to get in the way of your flow, but I think Mr. Ernewein knows the double-dipping issue pretty well. You may want to move ahead to the question, on the assumption that he's familiar with this.

[Dean Del Mastro, Conservative, Peterborough, ON]

I'm just making sure the viewers at home understand the situation.

[The Chair, Conservative, Brian Pallister]

Oh, I see.

[Dean Del Mastro, Conservative, Peterborough, ON]

If the chair would be patient, I would appreciate that.

[The Chair, Conservative, Brian Pallister]

Absolutely. It's your time; use it as you will.

[Dean Del Mastro, Conservative, Peterborough, ON]

The residents in Peterborough thank you for your understanding.

They then loan the $200 million to another tax haven, which subsequently loans the money at 10% to company B in the United States. What happened was they got back most of the proceeds of the $20 million that they had deducted from their income for loaning the money back to a second tax haven, claimed the expense, and brought the $20 million back to Canada tax-free. Inherently it is wrong. They never incurred an expense, but they were allowed to claim the expense against Canadian taxes, and despite the fact that the CRA could prove that they did this, it was ruled that it was perfectly legal and legitimate.

Isn't this exactly what the finance minister is talking about cracking down on? It's not legitimate investment expenses abroad that will assist Canadian companies to expand. Rather, it's abuse of the system.

[The Chair, Conservative, Brian Pallister]

Mr. Pacetti, on a point of order.

[Massimo Pacetti, Liberal, Saint-Léonard—Saint-Michel, QC]

Mr. Chairman, the graph that he used.... He tried to correct me while I was asking my questions, but there is the same picture or diagram in the finance department's brief on page 3 that he just translated, but the CRA is--