Subject: Press Release Proposed Improvements to the Application of the GST/HST to the Financial Services Sector

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1 SENT BY MAIL & Mr. Bob Hamilton Assistant Deputy Minister Tax Policy Branch Department of Finance 140 O Connor Street Ottawa ON K1A 0G5 Dear Mr. Hamilton: Subject: Press Release Proposed Improvements to the Application of the GST/HST to the Financial Services Sector On behalf of the Investment Funds Institute of Canada (IFIC) I am writing to you to express a number of concerns that our membership has regarding the proposed GST changes related to, Allocation Methods pertaining to GST Recovery, the Annual Information Schedule for Financial Institutions and Imported Services, all of which are outlined in the above referenced press release. The Investment Funds Institute of Canada is the trade association representing the investment fund industry in Canada, including both the investment companies and the distributors. Our members collectively manage over $650 billion in investment fund assets within over 1,700 funds and represent the vast majority of the fund industry in Canada. Our members include banks, securities dealers, insurance companies as well as independent fund companies. General Remarks While it is our intention to comment on each of the above three matters separately, we wish to offer the following general comments. It is fair to say that our members want to be tax compliant and are not averse to paying our fair share of taxes. However, in order to do this we need rules that give certainty for taxpayers, are equitable and reasonable to administer. We are concerned about the complexity that would be introduced as a result of each of the proposals. This additional complexity would result in: uncertainty over how to comply with the rules and it would increase the risks that reporting errors are made, an increased compliance burden (i.e., increased pressure on staff and technical resources), and higher business costs to comply with the measures.

2 Mr. Bob Hamilton, Assistant Deputy Minister, Tax Policy Branch Page 2 Increased uncertainty, compliance burden and costs are in no stakeholder s interest our members, the public or the government. It is our view that the proposed changes in their current form will have an adverse effect on the financial services sector and there needs to be a step back and reconsideration as to whether the changes are going to achieve the desired policy results. 1. Allocation Methods Pertaining to GST Recovery As you can appreciate, the methodology to recover GST paid on inputs is one of the most important tax matters for a financial institution. The need for certainty and simplicity is important; however, any proposed regime must first and foremost be equitable. Ultimately any methodology a financial institution may use to recover GST paid on inputs must be predicated on how the business actually operates and functions. As regards the proposed rules, we would remark that overall there are a great many unanswered questions surrounding both the implementation of the regime and its actual operation, including the following: It is not at all clear as to how the 15% prescribed rate for securities dealers was determined. Suffice it to say such a rate would negatively impact our members and any proposed rate should be empirically based on industry standards. The rate does not reflect the fact that some of our members are involved in activities which can result in a higher recovery rate (e.g., administrative services to distributors). If the goal is to give our members a choice between (a) a simple residual recovery rate of 15% and (b) a more sophisticated methodology that results in higher recoveries but at greater expense, it our view that this has not been accomplished due to the low fixed rate. We would be happy to collaborate with you to achieve a fairer percentage. For many of our members it could prove problematic to make use of the transitional election as they have not been audited by CRA within the appropriate timeframe. We have not received comfort from CRA that this issue will be managed sufficiently to ensure that the transitional election is available for all. There is also a significant exercise to be undertaken to simply try to understand which category of financial institution you fit in, each of which in turn has a different set of rules. Furthermore, this exercise will have to be undertaken on an annual basis for many financial institutions, which greatly increases the compliance burden. Many of the rules in their proposed present form grant what we would consider inappropriate power to the CRA to make critical decisions. For example, CRA would have the ability to accept or reject the application of a particular method. Furthermore, CRA would also be given the ability to direct a method at any time where it determines that the method being used does not result in a fair and reasonable recovery. It is unclear how this authority would be implemented in practice. Moreover, the right to recourse for a taxpayer as the result of a dispute with CRA when seeking to put in place a particular method or respond to a direction is not sufficiently robust and greater clarity and certainty is required before any process can reasonably be implemented. Other jurisdictions notably the United Kingdom have a process where allocation methods are negotiated but through a much simpler and fairer process. An

3 Mr. Bob Hamilton, Assistant Deputy Minister, Tax Policy Branch Page 3 escalation to the courts under a judicial review is not appropriate in these circumstances. In this regard we understand that some thought has been given to the development of a fairness committee (e.g., similar to the GAAR committee) and we would strongly encourage that Finance ensures implementation. There is an overall lack of flexibility in the proposed regime which could have an adverse impact on a taxpayer; that is, unable to adapt its agreed particular method on a timely basis to reflect fundamental business change. Again the UK has a more flexible regime and we see no reason why a like process could not be implemented in Canada. 2. Annual Information Schedule for Financial Institutions There is a desire to introduce a new Annual Information Schedule for Financial Institutions, ostensibly to assist in the development of tax policy. Once again we are unclear as to the need for this amount of data. More specifically: The proposed schedule will be difficult to manage as it is our view that you are seeking data which is not readily available or, in fact, obtainable. Considering the difficulty of complying with the data requests it calls into question the integrity of the data that would actually be reported on this information schedule and whether ultimately it will have any value, despite the best efforts of affected businesses. We have some concerns as to whether the financial impact on our members is proportionate to the benefit of compiling this data and its subsequent use. There are also the matters of timing and costs to comply with these reporting requirements, not to mention the need to file a specific schedule. The fact is that systems changes to facilitate any reporting requirements are timely and expensive and are extremely difficult to justify internally when it is not clearly understood why this information is required. Should it be deemed absolutely necessary to proceed with this initiative we believe that this reporting requirement should be on a prospective basis only, ideally with a minimum implementation period of 12 months from the date of Royal Assent. We were also surprised by the scope of application of the information schedule. It will capture entities under paragraph 149(1)(b) of the ETA and those that have a filed an election under section 150 of the ETA. The rationale behind subjecting these entities to this reporting requirement is far from clear. We have heard that Finance will encourage CRA to allow discretion on the requirement to fully complete the information schedule early on. This latitude does not offer the benefit you may perceive. Where a member would be obligated to file the schedule but was unable to provide all of the requested information it would be very difficult for a finance director or financial officer to attest to being in full compliance with all statutory obligations. As you can appreciate, in today s reporting environment not being able to provide such an attestation is unacceptable. In fact, it would appear that CRA already has access to much of the data to be reported so the proposed new schedule is, in many respects, duplicating current reporting requirements. In our view it would seem to make more sense to liaise with the relevant industry associations to obtain any data required rather than add additional reporting burdens on businesses, which

4 Mr. Bob Hamilton, Assistant Deputy Minister, Tax Policy Branch Page 4 already operate in a robust regulatory environment. It is notable that IFIC in its capacity as the voice of industry has not in the past been asked to provide any data to the Department of Finance or engage in any discussions on GST policy for the sector. 3. Imported Services We appreciate and understand the rationale behind the need to tax non-arm s length services rendered to Canadian establishments from outside of Canada. However, in our view this should be limited to services that would otherwise be taxable if supplied in Canada. It should not extend to what is effectively the imposition of GST on inputs to financial services (i.e., the taxation of inputs into the making of otherwise exempt financial services). Non-taxable input costs such as salaries, wages and insurance should not form part of the base for self-assessment. The policy rationale behind this is not at all clear. More specifically: We find the introduction of the complex terms qualifying consideration and loading to be of particular concern. We are not alone in grappling with their meaning and ultimate impact. At present there is uncertainty over how these concepts would apply in practice. The need to file another return and then make a payment at a different date simply increases the administrative burdens, unnecessarily in our view. It would seem to make more sense to have the filing of all returns at the same time. There is a potential to create a situation where imported services become more costly from a GST perspective than those sourced domestically (e.g., the section 150 of the ETA election does not apply to cross-border services). Notwithstanding the potential issues surrounding NAFTA and GATS, this will penalize our members unnecessarily who have strong linkages with non-canadian entities. Surely this is not the policy intent. Finally, we are concerned about the coming into force provisions which would appear to have retroactive application for the entire 2005 period notwithstanding the 17 November 2005 announcement date. The retroactive application of tax law should only be used in the most extraordinary of circumstances and the resulting uncertainty for taxpayers is unacceptable. Besides, even if the provision were only to have application for the period from 17 November onwards, there is no prescribed form, as required in the legislation, which would have been required to account for GST this past 31 March. Conclusions I trust you find the above information useful and would reiterate our desire to engage in a dialogue to assist the Department of Finance in its policy deliberations for the financial services sector. In conclusion we feel that the proposed changes will not achieve what we perceive to be the desired policy result. We think it would make sense to step back and revisit the proposed changes to ensure that they give certainty for business, are equitable and are simple to administer.

5 Mr. Bob Hamilton, Assistant Deputy Minister, Tax Policy Branch Page 5 Please do not hesitate to contact me if you have any questions or would like to discuss any of the matters contained herein in more detail. Sincerely, John Parker VP Finance, CFO C.c. Lalith Kottachchi