1. Introduction
1.1 Canada’s tax policy is important to the country’s ability to sustain and improve its competitiveness in the changing global environment. In particular, Canada’s international taxation system must keep pace with global trends to support business investment by Canadians abroad and to attract foreign investment into Canada. In the past few years, the Government of Canada has made changes that support a competitive international tax policy. Future changes are scheduled that enhance our competitiveness to the benefit of all Canadians. However, more changes to Canada’s tax system — and to its international tax system, in particular — may be needed.
1.2 In Budget 2007, the government announced it would strike an advisory panel to review Canada’s system of international taxation. On November 30, 2007, the Minister of Finance announced the formation of the Advisory Panel on Canada’s System of International Taxation (“the Panel”). The chair and vice-chair of the Panel are Peter C. Godsoe, OC, and Kevin J. Dancey, FCA. The other members of the Panel are James Barton Love, QC, Nick Pantaleo, FCA, Finn Poschmann, Guy Saint-Pierre, CC, and Cathy Williams.
Our Mandate: Enhancing Canada’s International Tax Advantage
1.3 The Panel’s mandate is to make recommendations to guide the government in establishing an international tax policy framework with respect to investment abroad by Canadian businesses as well as investment into Canada by foreign businesses.
1.4 Our recommendations will aim to improve the competitiveness, efficiency and fairness of Canada’s system of international taxation, minimize compliance costs for businesses, and facilitate administration and enforcement by the Canada Revenue Agency (CRA). We will attempt to make recommendations that can be practically implemented and that will increase the certainty and simplicity of Canada’s system of international taxation for large, medium-sized and small businesses.
1.5 The Panel will fulfil its mandate with an eye to complementing other elements of the government’s overall strategic policy. Establishing Canada’s competitive tax advantage is a key area of focus of Advantage Canada, the Government of Canada’s long-term economic plan. According to Advantage Canada, the tax policy needed to create that advantage is clear: Canada must achieve the lowest effective tax rate on new business investment in the G7. The Panel’s recommendations regarding Canada’s international tax system will harmonize with the direction set out in Canada’s long-term economic plan.
1.6 The Panel is following the work of Canada’s Competition Policy Review Panel (the “Competition Panel”) with great interest, given the Competition Panel’s complementary mandate and the government’s need for a coordinated policy approach. In this regard, two passages from the Competition Panel’s October 30, 2007 consultation paper will help guide our work:1
With our small domestic market, Canada must look outward. To that end, the [Competition] Panel has been mandated to investigate how best to encourage outward investment by Canadian firms.
[…] the government has a significant role to play in establishing the conditions that will assure Canada’s position as an attractive destination for investment, both by Canadians and those from abroad.
1.7 The work of the Competition Panel and our Panel is based on the same premise: outward investment by Canadians in foreign markets and investment by residents of other countries into Canada are critical to Canada’s long-term growth and development. Accordingly, Canada’s international tax system should facilitate both outbound and inbound investment.
1.8 The Panel’s primary focus will be on how Canada’s international tax rules affect Canadian businesses investing abroad as well as foreign businesses investing in Canada.
1.9 Although the Panel has not been asked to ensure its recommendations are fiscally neutral, we will be cognizant of the revenue impact of any proposal.
1.10 The Panel is supported by a secretariat and we will rely on the Department of Finance and the CRA for information and data regarding the current system. These data should help us assess potential concerns with the current system and their magnitude. We will also seek information and independent policy analysis through research from various independent contractors on selected topics, especially with respect to benchmarking Canada’s international tax system and understanding future directions that may be taken by our main competitors.
1.11 The Panel intends to provide its recommendations to the Minister of Finance by December 1, 2008.
The Current Tax Environment
1.12 Building a tax advantage for Canadian businesses is a key element of the government’s long-term economic plan. Canada’s international and domestic tax systems are linked, and changes to the domestic tax system can affect the competitiveness of Canadian businesses within Canada and abroad. One of the most significant domestic tax factors influencing the competitiveness of Canadian businesses is the corporate tax rate. Canada’s general corporate tax rate is dropping from about 34 percent at the start of 2007 to about 25 percent by 2012 (assuming a 10-percent provincial rate will apply in 2012). The government’s move to lower corporate rates and its objective of achieving the lowest effective tax rate on new business investment in the G7 support a competitive international tax policy.
1.13 Canada’s system of international taxation should support both Canadians investing abroad and those investing in Canada in order to promote growth and productivity in the Canadian economy and create wealth for the benefit of all Canadians. The figures below show the amount of foreign direct investment made in Canada by foreign investors as well as the amount of direct investment made by Canadians in foreign countries.
Flows of Direct Investment by Canadians Abroad and by Foreigners in Canada, 1970–2006 ($billions)
Source: Statistics Canada, CANSIM Table 376-0015.
Stocks of Direct Investment by Canadians Abroad and by Foreigners in Canada, 1970–2006 ($billions)
Source: Statistics Canada, CANSIM Table 376-0037.
1.14 Ensuring the competitiveness of Canada’s international tax system is especially important, given the changes in the global economic landscape in recent years. As the figures above illustrate, Canadian businesses are increasing their investments abroad, and foreign businesses are increasing their investments into Canada. A rising proportion of these investments are being made by tax-exempt organizations, including sovereign wealth funds.
1.15 The foreign competitors of Canadian businesses are growing in strength and number, aided in many cases by the tax policies of their home countries. Some countries have already reduced their corporate taxes in their efforts to compete for capital, jobs and growth. For example, the average corporate tax rate of member countries of the Organisation for Economic Co-operation and Development (OECD) has dropped from 34.1 percent in 2000 to 27.8 percent in 2007. A country can change its rules regarding business investment and alter the landscape at any time. Canada’s tax policy must anticipate continuous change in the global tax environment and have the flexibility to adapt accordingly.
Toward a Tax Policy Framework
1.16 Setting international tax policy entails trade-offs and practical constraints. Recognizing these considerations, the Panel’s initial views on a framework for developing Canada’s international tax policy are as follows:
- Canada’s international tax system has served the country well in many respects over the past few decades. Changes to the system should be made only in areas where significant improvement will be achieved.
- Canada’s tax system should support the goal of attracting foreign investment. In accomplishing this, Canadian tax rules should aim to create a level playing field for domestic business activity carried on by foreign and Canadian businesses while ensuring Canadian-source income is properly measured and taxed.
- Many countries seek to adopt international outbound tax rules that make their companies competitive. Canada’s outbound international tax rules should aim to maintain and enhance the competitiveness of Canadian businesses operating abroad.
- For taxpayers, certainty and simplicity in tax legislation and its administration are important. Business investments are long term, and sudden changes in tax policy without adequate transition cause significant disruption. Complexity should be avoided except, for example, where it is necessary to protect tax revenues.
- To ensure Canada’s international corporate and withholding tax regimes remain competitive, they should be benchmarked regularly against international norms and should anticipate global trends and changes.
- Fairness in the international tax context needs to be clarified. The Panel recognizes that this issue involves making policy choices amid conflicting objectives. The Panel’s initial view is that the notion of “horizontal equity,” whereby taxpayers in similar situations are treated similarly, is useful as a guiding principle. This view of fairness is consistent with the principles noted above and may be summarized as follows:
- Canada’s taxation of inbound investment should facilitate a level playing field for domestic business activity.
- Canada’s rules regarding the taxation of outbound investment should be competitive vis-à-vis the outbound tax rules of other major countries.
Specific Areas for Review
Outbound Taxation: Keeping Canadian Businesses Competitive
1.17 Canada’s domestic market is small: Canadian businesses have difficulty achieving global economies of scale while operating solely within the domestic market. Outbound investment is therefore important for Canadian businesses seeking to grow and compete with foreign businesses that have access to larger markets. Outbound investment also offers a vital means for Canadian businesses to acquire new technologies, resources and skills that may not otherwise be available within Canada, thus raising the economic potential of Canadian businesses and the value of their employees for the benefit of all Canadians.
1.18 A number of other countries have undertaken to change or initiate a detailed review of their current system for taxing foreign income earned through foreign entities of residents of those countries. For some countries, the objective of the change or the focus of the review seems to entail moving the country’s system for taxing such income closer to an “exemption system” or to further enhance the country’s existing exemption system to boost the competitiveness of its businesses that operate in global markets.2
1.19 In light of these developments in other countries, the government’s decision to review its current international tax system governing outbound investment is timely. However, it is noteworthy that countries seeking to move to an exemption system are looking at adopting certain features of the existing Canadian system. In examining potential modifications to the existing Canadian system, our preliminary view is that this system should be retained as the basic foundation for outbound investment. Accordingly, the Panel believes that any changes to Canada’s existing system likely would not be as comprehensive as those being undertaken by other countries.
1.20 We will review the current system and assess whether recommendations could be made to improve its efficiency, simplicity and competitiveness. In particular, we will review whether the existing taxation of foreign affiliate dividends could be improved by examining the scope of the exemption, the treatment of capital gains from the disposition of shares of foreign affiliates, and the allocation of costs to foreign-source income.
Inbound Taxation: Levelling the Playing Field for Canadian and Foreign Investment
1.21 Inbound investment is important for Canada in generating highly skilled jobs, research and development, technology and human capital. Canada stands to benefit by attracting such investment, and its tax policy should support this goal. In addition, the tax system should treat foreign and Canadian investors in domestic businesses similarly.
1.22 To this end, Canada’s tax rules should aim to balance the desire for domestic and foreign businesses to obtain similar treatment while ensuring that Canadian-source income is properly measured and taxed. Therefore, our review of the Canadian tax rules affecting inbound investment, such as certain interest deductibility rules, will be guided by the desire to strike a balance among these aims.
Additional Areas for Review
1.23 Canada recently eliminated its withholding tax on all arm’s-length interest and will phase out withholding tax on Canada–U.S. non-arm’s-length interest. We will review whether this policy objective should be broadened.
1.24 Transfer pricing rules are critical in allocating revenues and income with respect to international transactions. We will consult with taxpayers and the CRA to identify potential areas to improve the administration of these rules.
1.25 A simpler, more user-friendly system that is easy to administer and comply with and that provides the appropriate information about Canada’s tax system is desirable. We will consider how to improve these aspects of our international tax system.
1.26 The Panel is interested in understanding whether the increased outbound and inbound investment by tax-exempt organizations raises any specific issues that need to be addressed in assessing Canada’s international tax system.
1.27 Canada’s system of international taxation comprises numerous complex rules and deals with a wide range of different transactions and taxpayers. Many issues and questions of interest may arise in the course of our consultation process that are not covered in this consultation paper, and there may be options in addition to those identified in this paper. The Panel welcomes input on all issues and options that are relevant to the taxation of international business.
Call for Submissions
1.28 The Panel is committed to an open and consultative approach to obtain input from a broad spectrum of interested stakeholders including small, medium-sized and large businesses.
1.29 The Panel invites written submissions from any and all interested parties, and submissions will be accepted until July 15, 2008. All written submissions will be given our full attention. Submissions will be posted on the Panel’s website (www.apcsit-gcrcfi.ca) unless we are instructed otherwise. We kindly request that the submissions be written in English or French.
1.30 Chapter 6 provides details on the consultation process and how to make submissions to the Panel.
1 Competition Policy Review Panel, Sharpening Canada’s Competitive Edge, October 30, 2007, at page 3.
2 See the Appendix, “Selected Reports on International Taxation,” for references to studies in this regard undertaken by, for example, Australia, New Zealand, the United Kingdom and the U.S.