Submission to the Department of Finance on The Taxation of Corporate Groups

Transcription

1 Submission to the Department of Finance on The Taxation of Corporate Groups Prepared by the Canadian Bankers Association April 11, 2011 EXPERTISE CANADA BANKS ON LA RÉFÉRENCE BANCAIRE AU CANADA

2 Introduction The Canadian Bankers Association (CBA) welcomes the release of the government s consultation paper regarding the taxation of corporate groups and appreciates the opportunity to participate in this consultation process. As noted in the consultation paper, Canada is one of the few countries which does not have a formal system to consolidate the tax reporting of corporate groups or to otherwise offset the profits and losses of the members of a corporate group 1 despite a lengthy history of discussion papers and reports recommending the implementation of a tax consolidation system. We believe that this is a unique opportunity to find a solution to eliminate this longstanding deficiency in Canada s corporate tax regime. We recognize that the interests of stakeholders may differ and, in particular, that the priorities of the business community and the provinces may diverge. Our most important priority is to improve on the status quo by implementing some form of tax consolidation system. An equally important priority is that all provinces agree to participate in a new system. The benefits of a new system will not be achieved, and may well be outweighed by increased complexity 2, if provincial participation is not unanimous. As a result, we believe that a review of the present system of interprovincial allocation will be critical to achieving consensus. We have included in this submission a discussion of a potential new approach to provincial allocation, particularly as it would apply to banking groups. For convenience, we have addressed the questions in the consultation paper in the order they were raised. In addition, we have addressed other questions which arose in meetings with provincial officials. Policy Objectives The Government is interested in stakeholders views regarding the most important benefits that they expect would be obtained from a new system for the taxation of corporate groups. CBA members expectations are that a new system for the taxation of corporate groups, implemented by all provinces, will provide the following policy benefits: Certainty and simplicity a new system would provide greater certainty for taxpayers and governments. Transparency a new system would provide greater predictability and control of tax revenues for provincial governments. Efficiency a new system would reduce the compliance burden for some taxpayers and the administrative burden for tax administrators. This may require a preference for administrative simplicity over design purity. 1 Finance Canada, The Taxation of Corporate Groups Consultation Paper, November 23, For example, the group taxation regime in the U.S. is neither harmonized between the federal and state level nor from state to state. 2

3 Effectiveness losses should be available for use within a corporate group in the period in which they occur. Ideally the tax paid by a corporate group should in aggregate be no more than the tax paid by a single corporation operating through business divisions. Neutrality a new system should reduce the impact of the tax regime on business decisions, e.g. to avoid making an investment in a new business venture because of the uncertainty of utilizing losses or to undertake a costly and complex corporate reorganization in order to utilize tax losses. A new system would be available to all corporations regardless of size and other constraints which may be preventing them from utilizing the current ad hoc system. Neutrality a new system should allocate corporate income and losses equitably among the provinces. Flexibility a new system should provide flexibility to deal with evolving methods of doing business and changes in business structures. International competitiveness a new system should make Canadian corporations more competitive in domestic and international markets in comparison to corporations based in jurisdictions with a system of consolidated tax reporting. Timely access to tax losses would reduce risks and encourage businesses to make new investments critical to economic growth and job creation. Loss Utilization in Canada Currently The Government invites stakeholders to comment on the current approach, and the most significant types of costs and benefits related to this approach. Corporations, including financial institutions, carry on business through a variety of organizational structures driven by regulatory constraints, risk management, ownership issues, economic efficiency and other business reasons. Frequently these structures involve the use of separate legal entities which are nonetheless economically integrated 3. Taxation at the legal entity level does not reflect this economic integration. The current system of ad hoc loss utilization transactions provides flexibility but has significant drawbacks: Some companies are precluded from using the current system due to business and regulatory constraints. The uncertainty with respect to the ability to utilize losses means that companies are less willing to take the risks of investing in new business ventures in Canada. Additional administrative effort is required to project taxable income in individual entities within the corporate group and to take proactive steps to avoid losses wherever possible. Businesses incur permanent losses when they are unable to fully utilize tax losses or other tax attributes stranded in a member of the corporate group. The process of planning and executing loss utilization transactions under the current system, including CRA rulings, is time consuming and involves sizeable legal, accounting and administrative costs. CRA audits of loss utilization transactions, especially in cases where rulings were not sought by the taxpayer, are time consuming for both taxpayers and CRA staff. 3 The reasons for operating through subsidiaries rather than divisions were described in some detail in the 1985 Department of Finance paper, A Corporate Loss Transfer System for Canada. See pages

4 The system impairs cash flow between members of a corporate group. There is a loss of liquidity while funds are tied up awaiting the completion of loss utilization transactions. We understand that the current system also has drawbacks for provincial governments in that it lacks certainty and transparency. Provincial tax revenues are unpredictable as they may change unexpectedly as a result of redistribution arising from ad hoc intercompany loss utilization transactions. Provinces have no advance warning of these transactions and the impact is only noticeable after the fact. For example, provincial tax revenues from a profitable corporation in one province could be reduced or eliminated unexpectedly by an offsetting claim for the losses of an affiliate operating in another province (to the detriment of the first province), or the reverse could happen (to its benefit). Provincial / Territorial Considerations The Government invites stakeholders to comment on whether a new system of group taxation should incorporate changes to the method of determining provincial income allocation, and if so, how this could be accomplished. The CBA believes that changes to the method of determining provincial income allocation will be required if the system is to apply at the provincial as well as the federal level. The retention of an allocation at the legal entity taxpayer level in combination with any form of consolidated tax reporting will continue to arbitrarily allocate losses to individual provinces in a non-transparent manner. We also believe that a new allocation system will be required regardless of which form of consolidated tax filing is adopted. We understand that some provinces believe that a full consolidation tax system could become the basis for a more equitable allocation method as this system would remove the distortions created by intercompany transactions, including loss utilization transactions. However a full consolidation system would be inordinately complex for some taxpayers and would not address hybrid corporate groups, such as banking groups, which operate in different lines of business and which include entities with up to four different allocation formulae under the current system. The CBA believes that the needs of the business community for an improved system of taxation for corporate groups and those of the provincial governments for a more equitable system of allocating corporate income would be best met if the two objectives were addressed separately. The challenge will be that historically the provinces have been unable to agree on any changes to the allocation system, and it will be very difficult to obtain consensus for a significant overhaul of the formulae. To improve the probability of achieving consensus, it may be beneficial for a new system to retain as many as possible elements of the existing system. While that may delay the resolution of allocation issues that appear to be unique to deposit taking institutions (discussed below), we are prepared to see those issues addressed in a separate but parallel consultation process. Changes to the allocation system could be accomplished in a number of ways. The existing general allocation formula could be applied in such a manner that the factors (gross revenues, salaries and wages) are determined on an aggregate basis for all members of the tax consolidation group and the resulting provincial allocation is applied to the taxable income of each member of the group. This would imply that 4

5 each member of the tax consolidation group is deemed to have a permanent establishment (PE) in every province in which any member of the group has a PE and the income and losses of all of the members of the group are shared among those provinces. This approach would be effective regardless of which system of group taxation is chosen and would closely approximate the allocation that would result if the tax consolidation group were a single corporation with divisions in each province. The taxable income of financial sector groups could also be allocated based on gross revenues and salaries and wages. The special factors currently in use by banks, trust companies and insurers would be used to attribute the gross revenues of the institution to each province 4. This approach is described in greater detail in the Appendix. The weighting of the factors would need to be determined but could be based on the predominant operating company in the group. These factors would be determined on an aggregate basis for all members of the tax consolidation group and the resulting provincial allocation applied to the taxable income of each member of the group, as in the general model described above. Interprovincial allocation of income: deposit taking institutions Changes in the manner in which financial products and services are produced and delivered, new financial instruments and increasing complexity in the structure of financial services groups have raised concerns among provinces that the existing allocation methods no longer produce an equitable result. These concerns relate primarily to which assets and liabilities of deposit taking institutions are included in the attribution process and the criteria by which they are attributed to a jurisdiction. There are frequent provincial challenges of the results of the allocation formula in which individual provinces may unilaterally reassess an institution to increase their share of the total pie. Resulting appeals can take as long as 10 to 15 years to resolve. These disputes create uncertainty for all provincial governments with respect to their tax revenues for a particular year since all must ultimately agree to a revised allocation. They also create uncertainty for the financial institutions involved with respect to their tax liabilities since they may end up paying tax twice on the same dollar of income and are charged interest on late payments when the allocation between provinces is changed as a result of a challenge. All parties involved incur greater administrative costs. The CBA looks forward to working with the federal and provincial governments to address these issues as part of, or on a parallel track to, the consultation process relative to the taxation of corporate groups. Possible Approaches The Government is interested in stakeholders views on: how the efficiency and competitiveness of Canada s current loss utilization rules compares to more explicit, but often less flexible, rules in other countries; how a new system of taxation for corporate groups would improve the efficiency and competitiveness of Canada s tax system and the approach Canada should take for a new system for the taxation of corporate groups. 4 The applicable measurement factor for banks is the total of loans and deposits; insurers net premiums; and trust and loan corporations revenues from loans and other business. 5

6 The options for a new system of taxation of corporate groups represent a continuum with a loss transfer system at one end and a full consolidation system at the other. CBA member banks agree that a loss transfer system similar to that in place in the United Kingdom would be preferable to the status quo as it would significantly reduce the costs and uncertainties associated with the current Canadian system while achieving most of the policy benefits identified earlier in this submission. In particular, it would achieve the main objective sought by taxpayers, which is the ability to use tax losses and credits currently if there is capacity in the corporate group. Moving along the continuum would include measures that would provide more comprehensive relief but at some cost to legislative and administrative simplicity. We acknowledge that there are merits to a full consolidation system if fully and properly implemented; however, such a system raises issues that would need to be examined and addressed: Full consolidation would require far more complex legislation. Full consolidation adds considerable administrative complexity, for example, to deal with the tax treatment of intercompany transactions. Full consolidation would add costs and administrative effort to produce consolidated financial statements for the domestic tax consolidation group. The consolidated financial statements prepared pursuant to GAAP cannot be used as they include numerous legal entities which would not be members of the tax consolidation group because they are non-residents or do not meet other eligibility criteria, e.g. the required degree of common ownership. Full consolidation would also reduce the foreign tax credits (FTCs) available to taxpayers to the extent that certain deductions in computing taxable income, such as the 110(1)(k) deduction for Part VI.I tax and the 110.1(1) deduction for charitable donations, which grind the tax base and therefore the Canadian tax otherwise payable for FTC purposes, would be trapped in the consolidated taxpayer. In the current system, these deductions may be allocated to members of the group which do not have foreign source income. In the absence of effective and workable solutions to address these shortcomings, our preference at this stage would be for a loss transfer system similar to that in place in the United Kingdom. Design Parameters Unless noted, our views regarding the design parameters of a new system of taxation of corporate groups are based on an assumption that the new system will be a form of loss transfer system rather than a full consolidation system. Eligible Groups Degree of Common Ownership The Government is interested in stakeholders views regarding: The appropriate threshold of common ownership for a corporation to be included in a corporate group; and 6

7 The appropriate meaning of ownership to be applied for determining if a corporation meets the ownership threshold (e.g. votes, value, or both). The choice of an appropriate threshold of common ownership for a corporation to be included in a tax consolidation group is not a high priority for banks. Canadian banking groups have few affiliates in which they hold less than a 90% interest. While 90% would be consistent with existing Income Tax Act provisions, a lower percentage, e.g. the existing related party test, could be advantageous as it would maximize the number of eligible members and minimize the number of corporate group members that would continue to require access to an alternative system. We recommend that the ownership threshold should be based on both votes and value. Non-Corporate Entities and Non-Resident Corporations The Government is interested in stakeholders views regarding how trusts or other non-corporate entities and the Canadian branches of non-resident corporations that are part of a Canadian corporate group should be treated in a group taxation system. We recommend in the interests of simplicity that trusts and non-corporate entities not be eligible for inclusion in a tax consolidation group. Some of the special purpose vehicles in current use by banks will in any case be rationalized with the implementation of IFRS. Canadian branches of foreign corporations should be eligible for inclusion but permitted to opt out if participation in the system were mandatory, given that they may already be included in a tax consolidation group in their home jurisdiction. Foreign branches of Canadian corporations would be included 5 and foreign affiliates of Canadian corporations should be excluded given their current treatment under Canada s domestic and international taxation regimes. Common Parent Corporation The Government is interested in stakeholders views regarding whether eligible groups of corporations should have a common parent corporation, and if not, how groups without a common corporate parent should be treated in a group taxation system. We recommend that all affiliates which meet the ownership test through common ownership by an individual or non-corporate entity, a Canadian parent corporation, or a foreign parent corporation be permitted to create a tax consolidation group. 5 The eligibility of foreign branches to join a tax consolidation group could be reconsidered if their tax status were altered as proposed in the United Kingdom. The U.K. proposal would harmonize the treatment of foreign branches and foreign subsidiaries but would also exclude foreign branches from eligibility to become members of a domestic tax consolidation group. 7

8 Range of Attributes The Government is interested in stakeholders views regarding the most important attributes which should be considered with respect to a new system for the taxation of corporate groups. We recommend that the highest priority be given to the ability to transfer capital and non-capital losses, investment tax credits and foreign tax credits between members of a tax consolidation group. We recognize that appropriate safeguards may be required in regard to capital losses to prevent the replication of losses up the corporate chain but we believe that the additional legislative complexity is warranted. Elective Components The Government is interested in stakeholders views on the extent to which participation in a group taxation regime should be voluntary or mandatory for the group and/or individual group members and to what extent corporate groups should have flexibility in determining which attributes to transfer or consolidate. We recommend that participation by a corporate group in a new group taxation regime be voluntary. In addition, individual members of a corporate group should be able to elect into a tax consolidation group their participation should not be mandatory and there should be an option for a member of the corporate group to leave the tax consolidation group after a specified lock-in period. That then leads to the question of what the appropriate lock-in period should be. Our preference is to retain as much flexibility as possible. However, in practice, the administrative complexities would not warrant corporate group members opting in or opting out of the tax consolidation group on a frequent basis. We also recognize that annual elections may be of concern to the provinces due to the additional volatility that could result. We would consider a three to five year lock-in period to be reasonable. Related to this issue is the question of whether to retain or modify rules around loss carry-forwards and carrybacks. The ability to carry back losses is not a high priority for the banking industry. We recognize provincial concerns regarding the volatility in corporate tax revenues created by loss carry backs. We recommend that the current rules (3 years back and 20 years forward) be retained for pre-transition losses but are prepared to accept restrictions on the loss carry back period for new losses after a new group taxation regime has been implemented. 8

9 Pools of Unused Tax Attributes The Government is interested in stakeholders views on what constraints would be appropriate on the use of existing pools of losses when an eligible group is formed, when a corporation enters or exits the group, and on a yearto-year basis. We recommend that pre-existing losses of new entrants to a tax consolidation group be streamed and limited to the income of that same legal entity. When a new group is formed, the rules should produce the same economic results as the current rules for amalgamations. Existing Approach The Government is interested in stakeholders views about the impact of combining the introduction of a formal group taxation system with a restriction on the ability to undertake loss utilization transactions amongst corporate group members outside of the formal system. In our view, the ability to undertake loss utilization transactions under the current system must remain in order to deal with prior year losses and for the use of entities which are not eligible to join a tax consolidation group (e.g. because they do not meet the common ownership threshold). We do not support the request by the Government of Ontario that loss utilization transactions which transfer losses across provincial boundaries be prohibited immediately as this would potentially strand losses prior to the implementation of a new system. Use of Previously Accumulated Tax Attributes in a New System The Government is interested in stakeholders views regarding what restrictions in a new system of group taxation would be appropriate regarding the use of losses and other attributes accumulated by corporate groups prior to the introduction of such a system. The CBA recognizes that the current fiscal constraints faced by the federal and provincial governments will necessitate that losses and other attributes accumulated prior to the introduction of a new system will be retained by the legal entity which incurred those losses. However, we would recommend that any pretransition losses remaining five years after the introduction of a new system be transferable within the tax consolidation group in order to avoid a twenty year transition period. Conclusion The CBA welcomes the federal government s initiative in releasing a consultation paper on the taxation of corporate groups and the willingness of provincial governments to participate in the process of developing a group taxation system. We believe that such a system will supplement the initiatives previously undertaken by Canadian governments to improve the competitiveness of the corporate tax regime and, by reducing uncertainty and risks, will encourage Canadian businesses to make new investments critical to economic 9

10 growth and job creation. We also believe that the method of allocating income among provinces can be amended in a relatively simple manner to reduce the volatility in tax revenues experienced by provincial governments as a consequence of the current ad hoc loss transfer system. The CBA looks forward to working with the federal and provincial governments and other members of the business community to develop an improved approach to the taxation of corporate groups and a more equitable manner of allocating the income and losses of corporate groups among the provinces. 10

11 Appendix: Proposed Allocation Method for a Tax Consolidation Group In the present system, corporate income is generally allocated to a province based on the proportion of a corporation s gross revenues earned in the province and the proportion of the corporation s salaries and wages paid in the province. As a result, the proportion of the corporation s taxable income allocated to Province A would be: Gross revenues earned in Province A X ½ + Salaries and wages paid in Province A X ½ Total gross revenues Total salaries and wages paid In the proposed group allocation approach, each member of the tax consolidation group would determine the gross revenues and salaries and wages attributable to each province as before. However, the taxable income for each member of the group would be allocated to a province based on the proportion of the aggregate gross revenues and aggregate salaries and wages of the members of the group allocated to that province. The result closely approximates the allocation that would have resulted if the tax consolidation group were a single corporation with divisions in each province. Example Assume that the tax consolidation group has two members, Corp and Subco. Corp operates only in Province A and has taxable income of $100. Subco operates only in Province B and has taxable income of $25. Under the current system, Corp s entire taxable income is allocated to Province A and Subco s entire income is allocated to Province B. Step 1: Aggregate gross revenues and salaries and wages: Total Province A Province B Gross revenues Corp Subco Total gross revenues Salaries and wages Corp Subco Total Step 2: Calculate provincial attribution percentage (PAP): The percentage of the aggregate taxable income allocated to Province A would be 400/500 X ½ + 112/187 X ½ = 70%. Similarly the percentage of the aggregate taxable income allocated to Province B would be 100/500 X ½ + 75/187 X ½ = 30%. Step 3: Allocate the taxable income of each member of the tax consolidation group based on the PAP for the group: Taxable Income Total Province A Province B Corp Subco Total

12 Proposed allocation method for a hybrid group in the financial sector In the present system, banks, trust and loan corporations and insurers allocate their taxable income to provinces using unique factors and weightings: Banks allocate income to a province based on the proportion of loans and deposits booked in the province (weighting 2/3) and the proportion of salaries and wages paid in the province (weighting 1/3). Trust and loan corporations allocate their taxable income to a province based solely on the proportion of revenue from loans and other income earned in the province. Insurers allocate their taxable income to a province based solely on net premiums from customers located in the province. In order to create a common factor that can be aggregated, an additional step would be added to the proposed group allocation method in which these special factors would be used to allocate to each province the gross revenues of banks, trust and loan corporations and insurers. Step 1: Each member of the tax consolidation group calculates its factors (loans and deposits, revenues from loans and other business, net premiums, salaries and wages) and allocates them to a province or territory based on the current rules in Part IV of the Income Tax Regulations. Step 2: group 6 : Calculate gross revenues attributable to each province for each member of the tax consolidation 2.1 A bank s gross revenues in Province A equals loans and deposits attributed to province A pursuant to Regulation 404 X total gross revenues total loans and deposits pursuant to Regulation An insurer s gross revenues in Province A equals net premiums attributed to province A pursuant to Regulation 403 X total gross revenues total net premiums pursuant to Regulation The gross revenues of a trust or loan corporation in Province A equals revenues from loans and other business attributed to Province A pursuant to Regulation 405 X total gross revenues total revenues from loans and other business pursuant to Regulation The gross revenues of any other member of the tax consolidation group in Province A are the gross revenues of the corporation attributed to Province A pursuant to Regulation Consideration may need to be given to adjusting gross revenues to exclude intercompany dividends as the amounts involved could be large enough to distort provincial allocations. 12

13 Step 3: Calculate the provincial attribution percentage for each province. Province A s share of the taxable income of each member of the tax consolidation group (its provincial attribution percentage) would be: the sum of the gross revenues attributed to Province A by each member of the tax consolidation group the sum of the gross revenues assigned to all provinces by the members of the tax consolidation group multiplied by a weighting to be determined plus the sum of the salaries and wages attributed to Province A by each member of the tax consolidation group the sum of the salaries and wages assigned to all provinces by the members of the tax consolidation group multiplied by a weighting to be determined. Step 4: Allocate the taxable income of each member of the tax consolidation group using the provincial attribution percentages calculated in Step 3. Example Assumptions: The tax consolidation group consists of a bank with permanent establishments in all four provinces, SUB1 with a permanent establishment in Province D and SUB2 with a permanent establishment in Province A. The group factors have been given arbitrary weightings of 2/3 for gross revenues and 1/3 for salaries and wages. The weighting of factors may need to be adjusted depending on the predominant operating company in the group. SUB1 incurs a loss of $1000 which is transferred to SUB2. 13

14 Model of proposed allocation method for a hybrid group in the financial sector TOTAL PROV A PROV B PROV C PROV D Gross Revenues BANK 10,000 5,000 2,500 1,500 1,000 SUB1 5, ,000 SUB2 5,000 5, TOTAL 20,000 10,000 2,500 1,500 6,000 Salaries and Wages BANK 4,500 2,500 1, SUB1 1, ,000 SUB2 3,000 3, TOTAL 8,500 5,500 1, ,500 Provincial Attribution Percentage 100% 55% 12% 7% 26% (weighted 2/3 gross revenues & 1/3 salaries and wages) BANK Taxable income 2, , Adjustment for loss transfer 0.0 Adjusted taxable income 2, , Loss carried forward 0.0 Adjustment to loss carried forward 0.0 Adjusted loss carried forward 0.0 SUB1 Taxable income Adjustment for loss transfer Adjusted taxable income Loss carried forward -1,000.0 Adjustment to loss carried forward 1,000.0 Adjusted loss carried forward 0.0 SUB2 Taxable income 1, Adjustment for loss transfer -1,000.0 Adjusted taxable income Loss carried forward 0.0 Adjustment to loss carried forward 0.0 Adjusted loss carried forward 0.0 Total taxable income (before loss transfer) 3, , Total loss carry forward (before loss transfer) -1,000.0 Total adjusted taxable income 2, , Total adjusted loss carry forward

15 Results The taxable income of each member of the tax consolidation group is allocated based on an aggregate provincial attribution percentage. The result is a proxy of the allocation that would occur if the tax consolidation group were a single corporation with permanent establishments in each province. If Province A were to have a higher tax rate than Province D, the current system would provide an incentive to transfer the loss from SUB1 (in Province D) to SUB2 (in Province A). In the proposed model, the allocation to each province is not impacted by whether the loss is transferred to the BANK or to SUB2. 15