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7. Administration, Compliance and Legislative Process

Introduction

7.1   Several of the principles set out in Chapter 3 reflect a desire for greater simplicity and efficiency in Canada’s administrative, compliance and legislative processes. The principle that Canada’s international tax rules should be straightforward to understand, comply with, administer and enforce is obviously crucial in this regard. Open and timely consultation in advance of legislative change should help ensure new tax rules are well understood and operate as intended. Benchmarking our tax system’s processes against those of other countries can help identify ways to make the tax system function more smoothly.

7.2   In Chapter 3, the Panel notes that having an effective self-assessment system requires a culture of mutual responsibility and cooperation. Throughout this report, the Panel recommends measures toward this goal. For example, our recommendations to simplify the current system should help reduce the potential for conflict between the CRA and businesses, while the recommendation and suggestions for targeted anti-avoidance rules aim to clarify for taxpayers and the CRA what types of planning should not be pursued.

7.3   In this chapter, the Panel sets out recommendations for simplifying the current system and easing the compliance burden of taxpayers and the administrative burden of the CRA in the following areas:

• mutual responsibility and cooperation,
• resources for administering the international tax system,
• transfer pricing administration,
• waivers from withholding tax obligations under regulations 102 and 105,
• taxable Canadian property,
• legislative process, and
• information management.

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Enhancing mutual responsibility and cooperation

7.4   During our consultations, the Panel heard negative comments from various perspectives regarding the relationship between businesses and the CRA. These comments and the opposing positions behind them concern the Panel deeply. Further deterioration in the relationship could jeopardize the ongoing viability of Canada’s self-assessment system, resulting in higher compliance and administration costs as well as more potential for dispute and litigation. Businesses, their advisors and the CRA all have a responsibility to ensure that our self-assessment system works effectively.

7.5   There are many positive instances of current government/taxpayer communication in the international taxation area. For example, the CRA and the Department of Finance often take part in presentations at private-sector conferences and provide comments on recent developments. Businesses told the Panel that they would benefit from more guidance from the CRA on international tax issues. The Panel believes these types of communication would assist both businesses and the CRA and should therefore be encouraged and expanded.

7.6   The Panel believes that a self-assessment system based on mutual responsibility and cooperation is critically important. More direct action is needed to reverse the current trend and improve the current relationship, and better two-way communication is the place to start. The government should take steps to begin this dialogue.

Recommendation 7.1: Take immediate action to enhance the dialogue among taxpayers, tax advisors and the Canada Revenue Agency to promote the mutual responsibility and cooperation required to uphold Canada’s self-assessment system.

7.7   In the Panel’s view, improving communication and undertaking more consultation, as we recommend throughout this report, are important first steps toward a more robust self-assessment system. Achieving this goal should promote better compliance, facilitate enforcement, and reduce occasions for dispute.

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Resources for administering the international tax system

7.8   Just as Canadian businesses face increasing complexity with the rise of international activities, the Panel recognizes that pressure on the CRA and the Department of Finance is also mounting, increasing their need for additional resources. The Tax Executives Institute told the Panel that the CRA needs more resources to:

• improve guidance for business taxpayers,
• better train CRA auditors and senior management in the global financial and business environment, and
• pay industry-competitive salaries and benefits to attract and retain tax professionals at all levels.¹¹³

7.9   The increase in international activities has spurred growth in the tax advisory community, making it more difficult for the CRA and the Department of Finance to compete for and retain appropriately skilled employees. For example, both the private sector and the CRA are devoting more resources to the recruitment of professionals who specialize in transfer pricing. Discrepancies between the public and private sectors in compensation levels for international tax specialists are compounding the CRA’s challenges in retaining experienced employees.

7.10   Expanding the CRA’s resources for improving communication and providing more clarity in areas where it is needed will help businesses, including small businesses, understand their obligations. Better compliance and fewer disputes should result. The government should consider further measures for improving communication and reducing the tax compliance burden related to the international expansion of small and medium-sized businesses.

7.11   The Panel’s recommendations to simplify the existing system should help the CRA and the Department of Finance reduce administration requirements. For example, the possible elimination of the requirement for taxpayers to prepare surplus calculations should ease pressure on CRA resources. The proposals set out later in this chapter to simplify compliance obligations would also reduce or eliminate the CRA’s administrative burden in these areas, allowing CRA professionals to reallocate their limited resources and focus their training on other areas, including transfer pricing. However, for Canada’s system of international taxation to function smoothly and address the issues noted above, the Panel suggests the CRA and the Department of Finance allocate more resources to the international tax area. The Panel also thinks that interchange programs with the private sector should be considered.

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Transfer pricing administration

Introduction

7.12   The Panel’s review of Canada’s transfer pricing regime focused on its administration. As discussed below, the Panel formed a subcommittee to provide comments and assistance with this review. In the course of our consultations, the Panel also heard about various substantive matters relating to the transfer pricing rules that could be considered to improve the system. However, given the Panel’s primary focus on administration, this report addresses these substantive matters only briefly.

Canada’s approach

7.13   “Transfer pricing” refers to the prices set for tax purposes of goods, services and intangibles transferred between related parties in cross-border transactions. The transfer pricing rules are intended to ensure that prices charged for goods, services and intangibles within the global corporate group reflect the same prices that would have been charged and paid if the transaction had involved unrelated parties or parties dealing at arm’s length.

7.14   Canada’s transfer pricing rules adhere to the “arm’s length principle”, which requires that transactions between persons not dealing at arm’s length (i.e., related parties) reflect terms and conditions to which arm’s-length persons (i.e., unrelated parties) would agree. All OECD member countries, including Canada, have adopted this approach.

7.15   In 1998, Canada adopted a new transfer pricing regime. These rules permit the CRA to adjust the quantum or nature of amounts to what would have been agreed to between arm’s-length parties.¹¹⁴ These new rules also added a compliance penalty, which focuses on the taxpayer’s efforts in determining an arm’s-length price. Unless the taxpayer has prepared, obtained and updated the required supporting documentation (“contemporaneous documentation”), the taxpayer may be subject to penalties for failing to make reasonable efforts to determine appropriate transfer prices.¹¹⁵

Process

7.16   In general, when the audit division of the CRA issues an income tax reassessment to which a taxpayer objects, the taxpayer files a Notice of Objection, which is reviewed by the CRA’s Appeals group. If the taxpayer is not satisfied with the decision of the CRA’s Appeals group, the taxpayer can file a Notice of Appeal with the Tax Court of Canada and proceed with litigation through the court system.

7.17   The process of resolving transfer pricing disputes is the same but may involve an extra step. The CRA’s reassessment of a company’s transfer prices may cause tax to be payable to more than one country on the same item of income, resulting in “double tax”. For example, if the CRA reduces the cost of a good (bought by a taxpayer resident in Canada from a related party resident in another country) from $120 to $100, the ultimate profit of the Canadian resident when that good is sold in Canada would increase by $20, yet the related party would have paid income tax on that same $20 of income in the other country. This $20 of income has been taxed by both countries, and relief from double taxation is commonly obtained through tax treaties.

7.18   The Canadian competent authority is a group within the CRA having the authority to resolve double tax issues under Canada’s tax treaties. In cases of potential double taxation, the taxpayer may ask the Canadian competent authority to negotiate the case with the officials from the other taxing jurisdiction,¹¹⁶ a process which occurs under the mutual agreement procedure article of tax treaties.

7.19   A Canadian competent authority request is normally made after the taxpayer receives the reassessment. However, taxpayers must still file Notices of Objection and Appeal to retain their right to proceed to court later if they are not satisfied with the way the issue is ultimately resolved by the competent authorities. Normally, the CRA’s Appeals group and the Court hold the matters in abeyance while the competent authority discussions proceed. In short, transfer pricing disputes are like most other tax disputes except there is an additional layer of dispute resolution involving the competent authorities of two states.

Transfer Pricing Subcommittee

7.20   The Transfer Pricing Subcommittee was formed with the mandate to identify and comment on issues commonly arising under the administration of the current transfer pricing provisions of the Act. The Subcommittee received input and comments from officials of the CRA and the Department of Finance regarding some of the issues that arose in the Subcommittee’s review.

7.21   In its report, ¹¹⁷ the Subcommittee makes more than 20 recommendations to improve the process and administration of Canada’s transfer pricing rules, with special emphasis on crafting solutions to current issues that will help both businesses and the CRA.

7.22   The Panel recognizes that moving to a broader exemption system may exert more pressure on the application and administration of Canada’s transfer pricing rules. If more transfer pricing disputes arise as a result, eliminating irritants arising from the current transfer pricing rules is important to ensuring the rules work as smoothly as possible. The Subcommittee believes that its recommendations target the major issues related to transfer pricing and that addressing them would enhance the application and administration of transfer pricing in Canada. In the Panel’s view, the government should consider the recommendations in the Subcommittee Report as a basis for consultations in this area.

7.23   The Panel drew three main themes from the Subcommittee Report:

1. Dispute resolution — Resolving double taxation involves the interaction of two states and a process that is unique to international tax disputes. Rather than applying the general domestic rules and processes for resolving other tax disputes in the area of transfer pricing, adopting alternative processes may be more appropriate.
2. Centralization and consistency — Centralizing the expertise of CRA employees in the transfer pricing area and encouraging more knowledge-sharing among the CRA, businesses and advisors should foster mutual understanding and a more uniform approach to transfer pricing issues and audits for taxpayers and the CRA alike.
3. Guidance and technical matters — Offering more guidance on administration issues and resolving persistent technical issues could improve the application and administration of the transfer pricing rules by both the CRA and taxpayers.

Dispute resolution

7.24   The ways in which the domestic and competent authority processes interact can cause friction. Two recommendations of the Transfer Pricing Subcommittee regarding dispute resolution are as follows:

• When a taxpayer chooses to proceed to competent authority with a transfer pricing case, review of the Notice of Objection by the CRA’s Appeals group and the appeal process at the Tax Court of Canada should be held in abeyance automatically.¹¹⁸
• Rules regarding tax prepayment or security and deficiency interest in transfer pricing cases should differ from the general rules applying to other tax cases because, in double taxation cases, tax has already been paid to another government in respect of that amount.¹¹⁹

Centralization and consistency

7.25   Regarding centralization and consistency, two of the Subcommittee’s recommendations are as follows:

• The CRA should increase its centralization of experience and expertise in transfer pricing matters within their headquarters in Ottawa. Giving CRA headquarters authority over transfer pricing issues would facilitate more consistent application of the transfer pricing rules throughout Canada.¹²⁰
• The CRA should institute a program of exchanges and secondments between the private sector and CRA professionals. Such exchanges would benefit both sides by encouraging them to approach and analyze issues from the other’s perspective.¹²¹

Guidance on technical matters

7.26   Examples of additional guidance and solutions to technical issues that could be provided include the following:

• The penalties imposed under Canada’s transfer pricing regime do not apply where businesses make “reasonable efforts” to price their inter-company transactions appropriately. Additional guidance on what constitutes “reasonable efforts” for penalty purposes would be helpful.¹²²
• Waivers allow taxpayers and the CRA to discuss and explore issues beyond the reassessment deadline otherwise set by the Act, allowing many issues to be agreeably resolved before a reassessment is issued. The current rules often restrict the use of waivers for transfer pricing issues because they cannot be obtained after four years from the date of the reassessment, even though CRA has seven years to reassess these issues. The period in which waivers may be granted should be changed to correspond with the reassessment period for transfer pricing.¹²³
• Penalty thresholds could be raised so that small start-up businesses are not caught by penalties.¹²⁴

Conclusion

7.27   Applying and administering a transfer pricing regime requires special expertise in many areas, including international tax, economics and the relevant industry. Given this challenge, the Panel believes that making improvements in this area will require continuous attention and consultation. The Panel believes the Report of the Transfer Pricing Subcommittee is a solid starting point for consultations in this area.

Recommendation 7.2: Take steps to improve administration of the transfer pricing rules in resolving disputes, centralizing knowledge for better consistency, and resolving technical issues.

Safe harbours

7.28   The current transfer pricing rules require taxpayers to document all transactions with related parties, including charges for services provided by one related party to another. During our consultations, the Panel heard that businesses devote considerable time to documenting “routine, non-controversial cross-border service charges”.¹²⁵ The United States has introduced temporary regulations that allow specific support services¹²⁶ to be reimbursed at cost.¹²⁷ These types of services usually would not involve a significant arm’s-length mark-up on total service costs.¹²⁸

7.29   Safe harbours for low-value services would ease the compliance and audit burden of businesses and the CRA and improve the administration of the transfer pricing process. The Panel encourages the government to consider their use.

Transfer pricing and intellectual property

7.30   Through our benchmarking research, the Panel learned that taxation authorities and businesses in other countries are struggling with the appropriate taxation of income from intangible property. In our consultations within Canada, the Panel asked whether any issues exist regarding the transfer pricing rules and how they apply to intellectual property created in Canada and sold to related parties abroad. While Canadian businesses noted that significant disagreements arise with taxation authorities regarding the pricing of intangibles, they indicated that the current transfer pricing rules (which fix the value of the intangible at the time of the transfer) are sufficient to address these issues.

7.31   As noted, the Panel’s (and Subcommittee’s) review targeted the administration of the transfer pricing rules, not their design. During our consultations, we heard that businesses often choose to move intellectual property out of Canada. This tendency concerns the Panel because moving to a broader exemption system as the Panel recommends will make the transfer pricing rules, especially as they apply to intellectual property, even more important to the protection of Canada’s tax base.

7.32   Some other countries have adopted measures to deal with concerns about intangibles:

• The United States has adopted a “commensurate with income” approach, which ensures income paid for the transfer of an intangible corresponds to the income it generates.¹²⁹ This approach allows the U.S. tax authority to adjust income from sales of intangibles between related entities if it determines that payments were not at arm’s length.
• Germany adopted a similar approach in 2008, with new rules to allow tax authorities to make a one-time transfer pricing adjustment within 10 years of a transaction where the actual profits generated by the intangible property differ substantially from the forecasts on which the original transfer price was based. The rationale for these rules is that if the pricing was subject to uncertainties when set, unrelated parties would agree to a periodic adjustment clause.¹³⁰
• The United Kingdom had proposed to broaden the scope of income from intangible assets subject to tax under its equivalent of Canada’s FAPI regime. This proposal did not involve a transfer pricing issue related to the transfer of intangibles. Rather, the UK tax authorities considered a regime that would have included as passive income “any active income to the extent that it is, in substance, passive income. (This would include any income to the extent that it derives from the ownership of — or rights over — intangible assets….)”¹³¹ However, the United Kingdom appears to have abandoned this approach.¹³²

7.33   The U.S. and German approaches of adjusting consideration based on subsequent information are controversial, and the UK proposal was criticized. While contentious, these approaches reflect rising international concern over the mobility of intangibles. The concerns are largely over fixing an appropriate price when an intangible is transferred outside a country’s jurisdiction to tax. Determining arm’s-length prices for intangibles is difficult for a variety of reasons, including a lack of comparable data for industry-specific intangibles and a lack of knowledge regarding future profitability.

7.34   The Panel encourages the government to examine how the transfer pricing rules apply to transfers of intangibles to ensure the rules properly measure Canadian-source income. In accordance with the Panel’s principles, this review should include consultation and regular research to benchmark Canada’s international tax system against the tax systems of our major trading partners.

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Waivers from withholding tax obligations under regulations 102 and 105

7.35   Sections 105 and 102 of the Income Tax Regulations impose withholding tax on payments for services rendered in Canada by non-residents. Regulation 105 covers situations where a fee is paid to a non-resident for services rendered in Canada while regulation 102 deals with compensation paid to an employee who is working in Canada.

7.36   Under regulation 105, payments to non-residents for services rendered in Canada are subject to withholding tax at a rate of 15 percent. The withholding is not the final tax; it is a prepayment on account of the non-resident’s anticipated tax liability, which is determined when the non-resident’s tax return is filed. After the filing, all or part of the amount withheld may be refunded, for example, if the non-resident qualifies for an exemption from Canadian income tax under a tax treaty or if the non-resident’s total tax liability is less than the amount withheld.¹³³ If a foreign service provider can show, before performing the services in Canada, that the amount to be withheld is more than the ultimate Canadian income tax liability, the provider may apply for a waiver of the withholding tax under regulation 105.

7.37   Under regulation 102, non-resident employers have obligations similar to those of Canadian resident employers to withhold, remit and report amounts in respect of remuneration paid to an employee who renders services in Canada on behalf of the non-resident employer. Employers must remit withholding tax for each of their employees unless a waiver has been issued by the CRA. The withholding is not the final tax liability of the non-resident employee, who is required to file a Canadian income tax return to report the compensation or claim an exemption from Canadian tax under a tax treaty.

Issues under the current rules

7.38   Concerns regarding regulation 105 were raised frequently during the Panel’s consultations. Canadian businesses are frustrated by having to bear administrative responsibility for another person’s tax liability. The Panel heard that:

• the costs associated with complying with regulation 105 are significant,
• service providers commonly gross-up their fees to offset the withholding tax, which can result in additional costs to Canadian businesses and hamper their ability to engage skilled workers from outside Canada,
• the waiver process is cumbersome and so it is not used as often as it should be, and
• the service provider may suffer reduced or delayed revenues and cash flow problems if the service provider has not received a gross-up from the payer.

7.39   The Panel also heard that because regulation 102 applies to such a broad range of situations, it places a significant administrative burden on the non-residents, as well as Canadian corporations who carry out the administrative duties on behalf of related non-resident employers. For example, where a non-resident performs employment duties in Canada for just one day, a withholding obligation is placed on the employer. Although a waiver can be obtained if the employee ultimately will not be taxable in Canada, the time delay is often considerable, making the process unhelpful. In practice, it is difficult for non-resident companies to set up a process to withhold and remit various Canadian taxes for what may be small amounts.

The U.S. approach

7.40   The majority of Canada’s trade is with the United States, yet Canada’s withholding requirements regarding services and employment are much broader than the equivalent U.S. rules. While the United States requires withholding at the rate of 30 percent,¹³⁴ simplified procedures are in place to exempt amounts paid to a non-resident for services rendered in the United States if the recipient will be exempt from tax on that amount because of a tax treaty.

7.41   Under these procedures, the non-resident service provider files a form with the payer.¹³⁵ If the payer knows (or has reason to know) that any of the facts or statements on the form may be false or cannot be readily determined, then the payer must withhold. The non-resident is required to obtain either a U.S. social security number or individual taxpayer number and file a U.S. tax return.¹³⁶

Conclusion

7.42   In the Panel’s consultations, businesses indicated that the U.S. certification system for service providers (both employees and contractors) works well and is easier to comply with than the current Canadian system. The Panel foresees many potential benefits in adopting a similar certification system in Canada. Specifically:

• a certification system would shift the compliance burden at the withholding stage from the payer to the non-resident,
• Canadian payers would likely have to withhold less frequently, reducing administration for both businesses and the CRA,
• fewer withholdings would result in fewer gross-ups, producing cost savings for Canadian businesses,
• information reported on the non-resident’s certificate and by the Canadian payer would maintain the CRA’s ability to audit and enforce compliance, and
• the certification process would reduce the need to obtain waivers, eliminating administration for both businesses and the CRA.

Recommendation 7.3: Eliminate withholding tax requirements related to services performed and employment functions carried on in Canada where the non-resident certifies the income is exempt from Canadian tax because of a tax treaty.

7.43   See Appendix B for suggestions about how a Canadian certification system could be implemented in respect of withholdings under regulations 105 and 102.

7.44   Because the CRA would obtain the necessary information through the certification system to perform audits, there should be no significant impact on the tax due from non-resident service providers.

7.45   Moving from a system that requires either an advance waiver or withholding to a certification system may cause some decline in amounts collected. However, it would reduce the over-withholding of tax that can occur under the current system and the related costs to Canadian businesses.

Future considerations

7.46   Once fully in force, the fifth protocol to the Canada-U.S. tax treaty will increase pressure on the administration of regulations 105 and 102. The protocol increases the number of foreign service providers taxable in Canada because it broadens the definition of “permanent establishment”.¹³⁷ The protocol also expands the circumstances in which Canada and the United States may tax each other’s residents who exercise employment in the other contracting state.¹³⁸ While self-certification may reduce some of the current workload, other administrative changes may be needed to deal efficiently with non-resident service providers.

7.47   For non-resident service providers who will not qualify for an exemption from withholding based on the recommended certification system (for example, because they are not resident in a treaty country), the waiver process needs to be simplified, streamlined and better resourced by the CRA.

7.48   Simplified rules could be adopted for cases in which services are provided by related parties. Where the payer is a member of the corporate group, collection issues should be significantly reduced. Blanket waivers for services provided by parties related to Canadian businesses could be implemented. Annual reporting by Canadian businesses could function efficiently. Depending on the circumstances, security or guarantees could be required to ensure amounts waived could be collected if they are owed.

7.49   The CRA should consult with business groups about how the current reporting requirements could be streamlined to ease the compliance and administrative burden on taxpayers and the CRA.

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Taxable Canadian property

Current rules

7.50   “Taxable Canadian property” is a class of property that Canada considers to derive its value from sources in Canada. A non-resident is taxable in Canada on gains from sales of such property unless the non-resident is eligible for benefits under one of Canada’s tax treaties. On selling certain taxable Canadian property, the non-resident must notify the CRA and the purchaser must withhold 25 percent of the proceeds, unless the non-resident presents a certificate of compliance (commonly known as a “section 116 certificate”) to prove that the purchaser’s withholding and remittance obligations are reduced or eliminated.

Issues under the current rules

7.51   Many foreign businesses with interests in taxable Canadian property are eligible for treaty benefits and so they view the section 116 certificate process as a costly nuisance that can cause delays. To obtain a section 116 certificate, the non-resident must file with the CRA one or more applications supported by numerous documents. Unless the purchaser has obtained either a section 116 certificate or a letter from the CRA that administratively relieves the purchaser of its withholding obligations, the purchaser must remit any amounts withheld. Because the CRA currently faces a backlog in processing section 116 certificates, it regularly provides letters to non-residents to facilitate trade settlement, closings, escrow or security arrangements, and other transactions. The non-resident also must file a Canadian tax return (with the section 116 certificate attached) to finalize a claim for treaty benefits or to obtain a refund of amounts remitted to the CRA.

Recent relief

7.52   Recent changes will streamline the section 116 certificate process starting in 2009. Recognizing that most tax treaties allow Canada to tax capital gains only on Canadian real property and resource and timber properties (and shares of companies that derive most of their value from such properties), there is no longer a need to withhold tax on dispositions of other property that Canada will not ultimately tax (“treaty-protected property”). Non-residents who dispose of treaty-protected property no longer have to obtain a section 116 certificate or file a Canadian tax return as long as they do not owe Canadian tax for other reasons.

7.53   The recent measures are expected to improve the section 116 certification process. Canadian and non-resident businesses welcome the reduced tax compliance burden.

More relief required

7.54   During the Panel’s consultations, however, businesses called for more changes. They told the Panel that the measures do not go far enough to provide purchasers of taxable Canadian property with certainty about their withholding and remittance obligations. Further, the changes offer no relief to members of partnerships and other non-corporate entities that are eligible for treaty benefits on a look-through basis. This may negatively affect Canada’s ability to access foreign capital, particularly by private companies.

7.55   Additionally, some non-resident investors or their financial intermediaries must still obtain section 116 certificates when they sell certain Canadian securities (such as units of some business income trusts or limited partnerships). The Panel considered whether the sale of such securities should be excluded from the section 116 process without the need to determine if gains on such securities are treaty-protected. Currently, only shares listed on certain exchanges and mutual fund trust units are so excluded. In the Panel’s view, the exclusion should cover the full range of publicly traded Canadian securities.

7.56   To simplify and reduce the compliance burden for purchasers of taxable Canadian property, the Panel has concluded that the section 116 certificate process should be simplified by adopting a treaty benefit certification process and by excluding all publicly traded Canadian securities from the section 116 certificate process.

Recommendation 7.4: Eliminate withholding tax requirements related to the disposition of taxable Canadian property where the non-resident certifies that the gain is exempt from Canadian tax because of a tax treaty.

Recommendation 7.5: Exclude the sale of all publicly traded Canadian securities from notification and withholding requirements under section 116 of the Income Tax Act.

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Legislative process

7.57   The development and adoption of new tax legislation in Canada is a complex process that involves many concerned parties. Divergent groups take part in the tax policy debate in Canada, including political and business organizations, unions, policy institutes, public interest groups, and individuals.

7.58   In developing its tax policy agenda, the government seeks input from these groups and the general public through many channels. The House of Commons Standing Committee on Finance conducts pre-budget consultations and releases a pre-budget report that makes tax policy recommendations to the government. The Minister of Finance also conducts pre-budget consultations to obtain input from Canadians directly. Consultations on particular issues — such as those conducted by the Panel — also occur periodically.

7.59   Once the government decides on a tax policy, the Tax Policy Branch of the Department of Finance drafts the tax legislation to implement it. Most of the time, proposed tax legislation is released in draft form to solicit comments and suggestions from interested parties. Draft tax proposals are announced as part of the annual federal budget and throughout the year by news release. Once the government is satisfied with the changes put forward, the proposed legislation is tabled in a bill in Parliament, where it undergoes the normal parliamentary review process. The bill is enacted into law when it receives royal assent.

7.60   Certain features of the legislative process in Canada make it more open and accessible to taxpayers than the processes in other developed countries, notably the United States. For example, the Department of Finance often accommodates taxpayers by issuing “comfort letters” that confirm the Department’s intention to recommend changes to fix technical flaws in the tax law. This practice, which has been a feature of Canada’s legislative process for more than 20 years, is one example of how the current process can address taxpayers’ needs.

7.61   There is scope, however, for improving other aspects of the process. The existing process gives Canadians opportunities to raise their concerns with the government at different stages. The Panel heard calls for the government to consult more extensively before policy decisions are reached. This issue arises in other countries, such as Australia, which has undertaken a detailed review of its legislative process.

7.62   Open and timely consultation is one of the principles set out by the Panel in Chapter 3. Allowing businesses and their advisers to raise their concerns at the policy design stage would reduce the risk that a new rule would produce unintended and adverse results, making the process more efficient. Consultations at an early stage could also increase the transparency of the legislative process. Transparency is crucial to sustaining a fair and open process for making tax policy in Canada.

7.63   The Panel encourages the government to make every effort to achieve more transparency. The government should resort to confidentiality only where necessary, for example, where proposed tax policy changes could affect financial markets or commodity prices or where these changes could have a material revenue impact. The government should also provide better public access to information and analysis supporting proposed tax policy changes, such as by publicizing revenue impact estimates.

7.64   The Panel also observed a strong consensus that retrospective legislation should be avoided. Proposed legislation that remains outstanding for a long time period and has a coming-into-force date that precedes its date of adoption can also be problematic, especially for companies that must prepare their financial statements in accordance with “substantively enacted” legislation. Australia’s Tax Design Review Panel (cited above) recommended that most new tax measures should be prospective and introduced in Parliament within 12 months of their announcement, with all retrospective measures introduced within six months of announcement. The Panel agrees that the Canadian government should avoid introducing tax legislation with retroactive application.

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Information management

7.65   The CRA and the Department of Finance need access to information about taxpayers and their cross-border transactions. The CRA needs information to administer Canada’s system of international taxation, assess compliance risk, and better target its enforcement efforts. The Department of Finance needs information to assess properly the current system and evaluate new policy initiatives so that all relevant information and analysis is considered when making tax policy decisions.

7.66   The CRA collects much of the information the government requires directly from taxpayers. To be useful, this information must be relevant, reliable and timely. The government also needs adequate information management systems for processing and analyzing this data efficiently.

7.67   In conducting our work, the Panel had difficulty obtaining certain data needed to evaluate the current international tax system and assess other options. These problems are due in part to the quality of the data collected and in part to the lack of any requirement for taxpayers to provide certain information. More importantly, the information management systems in place to store and analyze data from taxpayers do not seem to have the same functionality as the systems typically in place in the private sector.

7.68   Other governments face similar challenges in collecting and managing taxpayer information.¹³⁹ While the CRA and the Department of Finance have made considerable efforts to improve the situation, more can be done to enhance the government’s ability to properly assess the impact of proposed tax changes and anticipate possible behavioural responses.

7.69   The Panel believes that the government should take steps to streamline and optimize its approach to the collection and use of taxpayer information in the international tax area. Existing information management systems should be improved to allow for more efficient use of the data currently collected. The CRA and the Department of Finance should also collaborate and undertake consultations toward developing a comprehensive, long-term plan to optimize the way taxpayer information is collected and used. This plan should specify:

• what and how much information is required, and for what purposes,
• how, when and from whom the information should be collected,
• how the information should be captured, stored, maintained, validated and distributed, and
• what systems are needed to analyze and make the best use of the information.

Recommendation 7.6: Develop a comprehensive, long-term plan to optimize tax information collection, and set up the information management systems needed to efficiently process and analyze this information.

7.70   As a first step, the Panel has undertaken a preliminary review of options to improve some of the forms and returns used to gather information on cross-border transactions. Input from business and the government was obtained through an ad hoc subcommittee composed of Marvin E. Lamb, CMA, and Monika M. Siegmund, CA, of the Tax Executives Institute and France Marengère of the CRA. The Panel would like to thank the members of the subcommittee as well as the individuals who participated in their consultations.

 

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¹¹³ Submission of the Tax Executives Institute to the Advisory Panel on Canada’s System of International Taxation, at p. 7.

¹¹⁴ Subsection 247(2) of the Act.

¹¹⁵ Subsections 247(3) and (4) of the Act.

¹¹⁶ In the area of transfer pricing, the Canadian competent authority is the Competent Authority Services Division within the International and Large Business Directorate of the CRA.

¹¹⁷ Transfer Pricing Subcommittee, The Administration of Canada’s Transfer Pricing Rules: Issues and Recommendations (August 2008), report prepared for the Advisory Panel on Canada’s System of International Taxation (herein referred to as “the Subcommittee Report”).

¹¹⁸ Recommendation 5 of the Subcommittee Report.

¹¹⁹ Recommendations 7, 8 and 9 of the Subcommittee Report.

¹²⁰ Recommendation 17 of the Subcommittee Report.

¹²¹ Recommendation 20 of the Subcommittee Report.

¹²² Recommendation 10 of the Subcommittee Report.

¹²³ Recommendation 3 of the Subcommittee Report.

¹²⁴ Recommendation 11 of the Subcommittee Report.

¹²⁵ Submission of the Tax Executives Institute to the Advisory Panel on Canada’s System of International Taxation, at p. 20.

¹²⁶ For example, certain payroll services, accounts receivable services, and accounts payable services.

¹²⁷ Treas. Reg. §1.482-9T(b).

¹²⁸ Rev. Proc. 2007-13, 2007-3 I.R.B. 295, January 16, 2007.

¹²⁹ The “commensurate with income” provision was added to Section 482 of the Internal Revenue Code in 1986.

¹³⁰ Sec.1(3) sentences 11 and 12 of the Foreign Tax Act (AStG), as discussed in footnote 28 of Salim Damji and Ulrike Wolff, “German Business Tax Reform, Transfer Pricing Impacts”, Der Schweizer Treuhander 2007/9, at pp. 684-688. Also see Richard Resch and Andreas Perdelwitz, “The German Tax Reform 2008 – Part 2”, European Taxation, April 2008, at pp. 159-168.

¹³¹ HM Treasury and HM Revenue & Customs, Taxation of companies foreign profits: discussion document (June 2007), at para. 4.21.

¹³² HM Treasury, Open Letter and Technical Note (July 2008).

¹³³ Under most treaties, business income earned by a non-resident in Canada is taxable in Canada only if the non-resident carries on the business through a permanent establishment in Canada.

¹³⁴ Section 1441 of the Internal Revenue Code requires 30 percent federal income tax withholding for independent personal services.

¹³⁵ See Form 8233, “Exemption from Withholding on Compensation for Independent (and Certain Dependent) Personal Services of a Nonresident Alien Individual” and Form W-8BEN, “Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding”.

¹³⁶ Returns need to be filed if the compensation income exceeds the personal exemption amount (currently $3,500).

¹³⁷ The fifth protocol to the Canada-U.S. tax treaty added a special rule for services to Article V, paragraph 9 of the treaty.

¹³⁸ Article X of the fifth protocol.

¹³⁹ See, for example, U.S. Department of the Treasury, Report to The Congress on Earnings Stripping, Transfer Pricing and U.S. Income Tax Treaties (November 2007) at pp. 26 and 28.

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