Finance Committee on April 24th, 2007

[The Chair, Conservative, Brian Pallister]

Are there facts to support such a statement?

[Mark Carney]

The government believes the increases in the competitiveness of the Canadian tax system and the Canadian competitive environment through implementing Advantage Canada will help.

[The Chair, Conservative, Brian Pallister]

But surely if we didn't force Canadian corporations to pay any taxes they'd be more competitive.

Isn't it impossible to argue against that statement?

[Mark Carney]

Yes.

[The Chair, Conservative, Brian Pallister]

Yes. To be clear, if Canadian corporations did not have to pay taxes of any kind, they would be more competitive, would they not?

[Mark Carney]

Mr. Chair, you are correct that Canadian corporations would be more competitive. The changes in the other elements of the tax system that would be necessitated to make up for that shortfall might not make the country more competitive.

[The Chair, Conservative, Brian Pallister]

Good. Thank you, sir. Okay.

In other words, as the phrase has been coined by a number of commentators as well, if we were to continue to reduce corporate tax obligations ostensibly to be competitive with other jurisdictions that have done so, or in fact other jurisdictions that don't impose corporate taxation of any kind, that would be a race to the bottom.

In any case, I'm also interested in knowing what other taxes businesses care about. You have done some extensive work, I'm sure, on the competitiveness ramifications of tax changes in this country. What do Canadian corporations care about when it comes to taxation? What are some of the major taxes they would like to see addressed? Could you comment on that?

[Mark Carney]

Thank you for the question.

One of the most important taxes for corporations in terms of what we're told and what our analysis shows is getting the depreciation rates on new capital investment right, so matching depreciation rates to useful life. The department has undertaken an extensive work plan to try to update a number of these estimates. The government has taken a number of decisions that have aligned CCA rates, depreciation rates, with useful life, including in the course of the last couple of budgets.

The second tax probably that Canadian corporations most strongly wanted removed was the capital tax, which was just a dead-weight loss tax, if I may, on capital, a deficit-fighting measure. The times have changed. It was eliminated in budget 2006. There were a number of CCA measures, as I say, in budget 2007 and 2006 as well.

Also corporations are very focused on the marginal or statutory tax rate. The government enacted a two-point reduction in the statutory tax rate in budget 2006 and another 0.5% reduction in the corporate statutory tax rate in 2011 as part of the tax fairness plan. It's part of the legislation for this budget. It will establish a tax advantage over the United States in manufacturing of more than 5% once fully enacted.

So getting on the marginal or statutory tax rates, getting rid of the capital tax, getting the depreciation correct are some of the most important elements. I would say there is one other tax that corporations tell us is incredibly important, which is out of our hands. These are the provincial sales taxes. The government has been discussing the concept of tax harmonization and harmonizing these sales taxes with the GST. That would have a real impact on the incentives for new business investment.

The last point I'll make, Chair, is that there was one other measure in this budget that was important to help our manufacturing sector adjust to both unprecedented competition from emerging markets at a time of globalization and the recent strength of the Canadian dollar, and that was a temporary increase in depreciation--the CCA rate, if you will--for manufacturing equipment to 50%. So effectively it's an ability to write off new plant and equipment investment over two years, a very important shot of adrenalin, as I think the minister put it, for the manufacturing sector.

[The Chair, Conservative, Brian Pallister]

Thank you very much.

Madam Ablonczy, for five minutes.

[Diane Ablonczy, Conservative, Calgary Nose Hill, AB]

Thank you, Mr. Chairman.

I see at this committee the Liberals are dusting off some of their campaign rhetoric and doom and gloom scenarios. But it's pretty clear, I would think, Mr. Carney, that if someone, whether it's an individual or a company, is claiming a tax deduction, it should be against tax payable.

As I understand it, the loophole of interest deductibility has been plugged because there's no tax payable at the end of the day. That is why it makes sense financially that if you don't pay tax, you shouldn't have a deduction. Is that a correct analysis?

[Mark Carney]

That is correct.

[Diane Ablonczy, Conservative, Calgary Nose Hill, AB]

I don't know why the Liberals would want to give a tax deduction to someone who is not paying taxes, but I guess they'll have to explain that one.

Mr. McCallum mentioned the U.K and Japan. I understand, Mr. Carney, that if investors in those countries earn dividends from foreign investments, they in fact have to pay tax on those dividends, whereas if Canadians earn dividends on foreign investments they don't have to pay tax. Can you explain how that works?

[Mark Carney]

I'll ask Mr. Ernewein to go into detail, please.

[Diane Ablonczy, Conservative, Calgary Nose Hill, AB]

Sure.

[Brian Ernewein]

I think the question generally suggests the correct answer. With respect to the U.S. and Japan, and I'd add the U.K., which are probably the three largest countries that have a system whereby on foreign earnings--and we're talking all within the multinational group, not individual investors, but one corporation in one country investing in a subsidiary in another country--the dividends paid from the subsidiary to the head office in the U.K. or the U.S. or Japan are all subject to tax when remitted to head office or home office under those tax regimes.

Canada's system for the past 35 years has been actually to not tax or impose any sort of Canadian ownership charge on earnings remitted to Canadian owners, Canadian companies, from their foreign affiliates where it comes out of active business income and where it happens to be a country with which we have a tax treaty. That reflects our objective of having a competitive tax regime with respect to international income.

So the budget proposal that would restrict interest deductions claimed in Canada against investments in foreign affiliates reflects the prior decision, affirmed in this budget, to exempt foreign income of this type from Canadian tax. The income is exempt for competitiveness reasons. Following from that, with the exemption for the income, the expenses associated with it are not to be recognized for Canadian tax purposes.

[Diane Ablonczy, Conservative, Calgary Nose Hill, AB]

So what's the bottom line? Does all that make Canadian businesses with foreign affiliates more competitive or less competitive relative to other G-7 countries?

[Brian Ernewein]

I'd love to give you a single yes or no to that, but the answer is that the change will restrict interest deductions in the future for Canadian companies where they would have been allowed to take an interest deduction in the past. So just viewed in that narrow perspective, it's a tightening change under the Canadian tax system.

[Diane Ablonczy, Conservative, Calgary Nose Hill, AB]

That's with respect to the taxation of income earned from foreign affiliates.

[Brian Ernewein]

Yes.

Where it places Canada vis-à-vis other countries, such as the U.S., the U.K., and Japan, will depend on what happens. If the money is being brought home and there's more money being earned by the foreign affiliate than the interest expense associated with it, our regime is better, because there will be no net tax paid in Canada as a result of those profits. The U.S. system will impose a tax, and even though they gave a deduction for the interest up front, the tax result in our regime, at the end, will be a lower tax bill for the Canadian firm, all in.

But there are other factors. For example, while the income is left offshore, the U.S., the U.K., or Japan, in some cases—not in all cases—will have provided an interest deduction where we have not; and that, on a temporary basis, will be more favourable for them.

[Diane Ablonczy, Conservative, Calgary Nose Hill, AB]

So what I hear you saying is that you have to look at each country's tax system as a whole before you can make comparisons.

[Brian Ernewein]

I believe that's right, and to reference Mr. Carney's remarks, on the whole there have been some very dramatic changes trying to make Canada's system overall more competitive. Our corporate tax rates at the beginning of this millennium were 50% higher than they'll be a decade after that, and that has to be taken into account in terms of calculating overall competitiveness.

[The Chair, Conservative, Brian Pallister]

Thank you very much, Madam Ablonczy.

Mr. McKay, over to you.

[John McKay, Liberal, Scarborough—Guildwood, ON]

Thank you, Mr. Chair.

Mr. Carney, it's good to see you again. You seem to be looking a little thinner. I hope that has nothing to do with these budget policies.

You have three policies that are in this budget. The first is with respect to income trusts, the rather draconian imposition of a surprise tax; the second is the issue of interest deductibility, which you're familiar with; and the third is the scrapping of the border withholding tax.

Have you considered the combination of those policies? Surely to goodness a policy that makes Canadian trusts cheaper and more prone to be acquired by foreigners is not necessarily good for Canadian economic sovereignty.

Surely a policy that makes it more difficult for Canadian companies to acquire abroad—and it is somewhat disturbing to hear Mr. Ernewein say it may be on a case-by-case basis as to whether this works or doesn't work—is not good for economic sovereignty.

Surely to goodness it's not good to make foreign companies entitled to buy Canadian companies and be able to in effect get a tax discount because of the scrapping of the border withholding tax.

Surely to goodness that combination of policies has hung out on Canada a huge “For Sale” sign and more than offset any other things you might have done in the budget to have brought corporate taxation rates or depreciation rates or capital taxes more in line with competitive regions. I fail to understand whether in fact you have considered these three policies as making it far more difficult for Canadians to compete in the world.

[Mark Carney]

Thank you for the question, Mr. McKay.

Your question relates to competitiveness. The government, in conducting tax policy, looks at fairness and competitiveness in all these policies, particularly with respect to income trusts. You're familiar with the issues there. We've talked a bit about fairness, probably not as much as perhaps we should, on the interest deductibility.

But to go to the competitiveness element of your question, which is there in terms of the proposed elimination of the withholding tax through a new, updated tax treaty with the United States, this will lower the cost of capital for Canadian business. The existence of a withholding tax on borrowing less than five years has raised the cost of capital for Canadian business.

[John McKay, Liberal, Scarborough—Guildwood, ON]

Why would you lower the cost of Canadian capital while eliminating the withholding tax, and then raise the cost of Canadian capital by eliminating the deductions? It's a contradictory policy.