Finance Committee on Feb. 28th, 2013

[Ted Cook]

Certainly within the tax legislation division, tax policy branch, we have strong connections with the OECD, and various people within the branch are members of various committees. Some of the committees are chaired by CRA representatives. So certainly we're tied in to the OECD, at minimum.

[The Chair, Conservative, James Rajotte]

Thank you, Mr. Van Kesteren.

Ms. McLeod, please.

[Cathy McLeod, Conservative, Kamloops—Thompson—Cariboo, BC]

Thank you, Mr. Chair.

I'm very, very pleased to see this technical tax act moving forward. I know at our pre-budget consultations that I've been part of for the last couple of years, it is a frequent request that we have, so I think it's going to be a welcome bill for many of our stakeholders.

In terms of our current study, you probably are aware that we're doing a study on tax evasion, and I wonder if you could talk about the areas in this bill that are very complementary to moving forward on tax evasion and the offshore tax havens and how they actually link very nicely with some of the work we're doing.

[Ted Cook]

Perhaps I'll just outline a few areas and then pass it to various colleagues who can speak to the specific parts.

Obviously I would say part 1 relates to non-resident trusts and foreign investment entities. Parts 2 and 3 relate to foreign affiliates, and certainly we've already talked about that. Part 5 does have measures that relate to international taxation. I guess the one that springs most readily to mind is the measure related to foreign tax credit generators, which is a budget 2010 measure designed to prevent taxpayers from entering into plans to artificially generate foreign tax credits in a way we feel is inappropriate, by way of taking advantage of differences in law between various jurisdictions.

I'll pass it first to my colleague Grant Nash, who might speak briefly about part 1.

[The Chair, Conservative, James Rajotte]

Mr. Nash.

[Grant Nash, Senior Tax Policy Officer, Business Income Tax, Department of Finance]

Good morning, members, Mr. Chair.

Thanks for your question, Ms. McLeod.

In the simplest of terms, it's possible to reduce Canadian tax by interposing a foreign intermediary between a source of income and a taxpayer. Since the 1970s, the Income Tax Act has contained rules that seek to respond to that to ensure that an appropriate amount of Canadian tax is paid.

Part 1 of Bill C-48 modifies those rules to ensure that they continue to apply appropriately, particularly in the context of circumstances involving a non-resident trust as the foreign intermediary.

[Cathy McLeod, Conservative, Kamloops—Thompson—Cariboo, BC]

Thank you. I think what I'm hearing is that certainly in the last number of years we are really taking some significant action towards closing some of those loopholes that did exist. Is that a fair comment to make?

[Grant Nash]

Certainly in the case of what part 1 is seeking to accomplish, it responds to concerns with respect to the ability of the existing rules to give full effect to their objectives.

[Cathy McLeod, Conservative, Kamloops—Thompson—Cariboo, BC]

Great. For my next question, we talked about the grey to white, but you indicated that there are a few areas that actually were not grey sections. Could you specifically talk about those sections that are new to this particular act?

[Ted Cook]

In terms of the income tax side, I think what you're talking about are the new measures where there has not been a consultation as yet, prior to introducing the bill. There are three areas where there are new measures that were not previously announced.

One relates to one I was personally responsible for in terms of preparing the legislation, departure tax and short-term residents of Canada. The Income Tax Act imposes a departure tax, if you will, a tax when people leave Canada and they are deemed to have disposed of most of their properties and to pay tax accordingly. There are rules that excuse certain people from this tax if they are just short-term residents of Canada. So if you've just come into Canada, you're perhaps an American who comes up to work in Canada and you leave Canada within five years, we don't feel it's appropriate to impose the departure tax at that point.

The rule requires that you own the same property. Some people were caught up in an issue where they came into Canada and during that five-year period, the company went through a reorganization and as a result they had a different share than they started out with. But economically they're the same. So a comfort letter was issued in the early 2000s that we thought that was an anomaly and that an amendment would be made to the act, and that's contained in Bill C-48.

The two other measures relate to the allocation of income to provinces by airlines and also some changes with respect to LSVCCs. I think my colleague Davine Roach can just provide a very brief summary of the airline measure.

[Davine Roach, Senior Chief, Domestic Corporations and Resource Income, Department of Finance]

Sure, thank you. With respect to the airline change, under the Income Tax Act there's a provision that allocates corporate taxable income amongst the provinces based on certain formula. In the case of airlines, it was on air miles flown.

Now the formula doesn't work in terms of allocating to the provinces airline miles flown over the territorial waters, which includes the Bay of Fundy and Hudson Bay. All this amendment is doing is ensuring that all the airline miles flown in Canada including over territorial waters are appropriately allocated to provinces.

[The Chair, Conservative, James Rajotte]

Thank you, Ms. McLeod.

We're going to Mr. Rankin, please.

[Murray Rankin, NDP, Victoria, BC]

Thank you, Mr. Chair.

And thank you, witnesses, for attending this morning.

I'd like to focus in on part 5 a little bit further, if I could, and pick on something that I think Mr. Cook referred to just recently in response to Ms. McLeod, and that is the issue of foreign tax credit generators for international tax avoidance.

My question is, how is it working? How is it intended to work? And what is the fiscal impact expected to be?

[Ted Cook]

Perhaps I'll provide just a bit of explanation.

Foreign tax credit generators seek to create foreign tax credits for Canadian taxpayers by taking advantages of differences in the way tax laws work in Canada and in other jurisdictions, for example, the United States. We tax on the legal substance in the form of what a taxpayer does. The U.S. generally taxes based on the economic form of what the taxpayer has done. What this does is it allows taxpayers to set up situations where, for example, for Canadian tax purposes, a Canadian taxpayer might own a partnership interest in the U.S., but because of the series of transactions that have been entered into under the U.S. economic substance approach, that property, that partnership interest, might be considered to be owned by someone else for U.S. tax purposes, with the result that, arguably for Canadian tax purposes, you have an interest in a partnership and you should get a foreign tax credit for the tax paid by that partnership.

But for U.S. tax purposes, what they see is an interest in a partnership that's owned by a U.S. resident, and a U.S. resident makes payment of interest, which is exempt from U.S. withholding, for U.S. purposes. The result is you can get results that you can't get in a straightforward way. You get a foreign tax credit in Canada and the U.S. company gets a deduction.

In terms of the impact, which I think is what you're asking, this is an integrity measure. Again, this is just something where the CRA identified these schemes and we took action to stop them. Individual transactions that were identified could run to the tens and maybe hundreds of millions of dollars with respect to the income at play. But in terms of what's actually booked for fiscal revenue, there is no fiscal cost associated with it.

And as to how it's working, we don't have any intelligence that it's not.

[Murray Rankin, NDP, Victoria, BC]

All right.

I understand that one of the concerns in part 5 is to provide greater information on tax avoidance, generate more information about what are called avoidance transactions, transactions designed to get a tax benefit. They all must now be reported, and I understand even if the transaction is not necessarily abusive, there has to be some sort of reporting mechanism for such transactions, if I have that right. And then a red flag might go up if this abuse...an additional reporting is required.

That sounds like a fairly intrusive type of arrangement, for very good reason, to get at tax avoidance. Can you comment on whether my summary is more or less accurate; and how they are working in practice, these additional reporting measures for tax avoidance?

[Ted Cook]

Again, I'll pass that to my colleague Ed Short, who's got carriage of that particular file.

One thing I will note, and Ed can correct me if I'm wrong, is that because this requires an actual reporting requirement, the CRA isn't able to require the reporting by taxpayers until this bill is actually passed. Is that correct, Mr. Short?

[Edward Short]

Yes, that's right.

Your description of the proposal is not exactly correct. It's about half correct. It is true that it requires the reporting of what we call an avoidance transaction. It's defined in the tax law. But it's only a reporting of that avoidance transaction if also there are two out of three hallmarks present—what we call hallmarks.

Just first, on what an avoidance transaction is, an avoidance transaction is not necessarily something that's abusive. An abusive avoidance transaction would be subject to the general anti-avoidance rule. That requires another step for the CRA to reassess, that is, the CRA would have to show that the transaction or series of transactions actually represents an abuse of the tax law. This rule for reporting applies just for simple avoidance, if you want to call it that.

What is an avoidance transaction? It is one where the purpose of the transaction is more for tax than for any other purpose, and it could involve a series of transactions where there may be a commercial purpose to the series of transactions. But if there is a transaction in the series and the purpose of that transaction in the series is not for a commercial purpose but it is for a tax purpose—that is, the purpose is to receive a tax benefit—then the whole series will be considered to be an avoidance transaction. So that's the first thing. To be an avoidance transaction, you didn't do this as much for commercial purposes as you did it to lower your taxes.

The second thing is the hallmarks—two out of three hallmarks. And what's a hallmark? It's a set of circumstances under which—

[The Chair, Conservative, James Rajotte]

Just briefly.

[Edward Short]

To put it briefly, where there's smoke, there's fire. There are factors that seem to exist, things like tax advisers who charge contingent fees. Who would do that? That is, it's contingent on the tax benefit. So that's one hallmark.

Contractual protection, that is a guarantee. “Even if this transaction doesn't work, the CRA challenges it, don't worry, we will guarantee you your tax benefit, we'll pay it for you.” That is the second one.

Another is confidential protection. “You're not allowed to disclose the details of this to anybody.”

Two out of three, and now you have to report.

[The Chair, Conservative, James Rajotte]

Thank you, Mr. Rankin.

I'm going to take the next round. I wanted to touch upon two issues in budget 2010 dealing with SIFTs and dealing with section 116, both of which were in the appendix to the budget.

My first question would be, why is the most interesting part of the budget always the appendix?

[Voices]

Oh, oh!

[The Chair, Conservative, James Rajotte]

First of all, I'd like to get an explanation—I don't know if it's you, Mr. Cook, or someone else dealing with these two sections—why the changes were made with respect to taxable Canadian property in section 116.

[Ted Cook]

In terms of how this relates to the budget 2010 measure, the actual main measure, if you will, with respect to budget 2010 and taxable Canadian property, has actually been implemented as part of one of the budget implementation acts. With respect to what's in this bill, it's sort of a tweak of an issue that has been identified to us.

With respect to budget 2010, in order to reduce reporting requirements for non-residents engaging in transactions that don't result in any Canadian tax, what we did was amend the definition of taxable Canadian property to accord with, essentially, our rights to tax under our tax treaties. As a general matter, if there's a tax treaty, if it assigns or denies Canada's right to tax, regardless of what the act says, you go with the treaty.

What was happening was people were having obligations to file paperwork with the CRA, even though there would be no tax. Our way of dealing with that was to amend the definition of taxable Canadian property.

The specific amendment in this bill simply deals with the situation where it's kind of whether or not we have a look-through rule. You have a corporation, you're trying to decide whether its got taxable Canadian property, well, if it owns another corporation, do you look through to the underlying property or do you just look at whether that corporation's shares are taxable Canadian property?

[The Chair, Conservative, James Rajotte]

The question as it relates to process is, would it be that the measures are implemented in a budget implementation act, and there's just something that's unforeseen at that time? Something pops up and therefore the department then responds to that. Is that the reason why this amendment is in this particular bill?

[Ted Cook]

That's exactly right with respect to that particular change. We were implementing the 2010 measure, and it was brought to our attention that there was this little inconsistency in terms of the operation of the rule.