Proceedings of the Standing Senate Committee on
Issue 30 - Evidence - November 27, 2012 (Morning meeting)
OTTAWA, Tuesday, November 27, 2012
The Standing Senate Committee on National Finance met this day at 9:34 a.m.
to examine the subject-matter of all of Bill C-45, A second Act to implement
certain provisions of the budget tabled in Parliament on March 29, 2012 and
other measures introduced in the House of Commons on October 18, 2012 (topic:
Part 1/amendments to foreign affiliates rule).
Senator Joseph A. Day (Chair) in the chair.
The Chair: I call this meeting of the Standing Senate Committee on
National Finance to order. This is our eighth meeting on the subject matter of
Bill C-45, A second Act to implement certain provisions of the budget tabled in
Parliament on March 29, 2012 and other measures.
This morning, we will be focusing on section 49, part 1, page 93, of the bill
pertaining to amendments made to the Income Tax Act and regulations thereunder,
more specifically, transfer operations by foreign entities.
We are pleased to welcome Pierre Gratton, President and Chief Executive
Officer of the Mining Association of Canada; Ross Gallinger, Executive Director
of the Prospectors and Developers Association of Canada; Steve Suarez, Taxation
Lawyer with the law firm of Borden Ladner Gervais; and Jocelin Paradis, Vice
President Taxation Canada, Rio Tinto.
We are pleased that you are here to help make what appears to be a
complicated set of rules more understandable so that we can decide what to do
with those proposals. I should point out we have a submission that will be the
basis of Mr. Gallinger's submission to us today, and we have also received a
letter from the Toronto Stock Exchange and the Venture Exchange that relates to
this issue. They have not been able to arrange for their appearance here, but
their letter to us will be put in as evidence as well.
With those introductory remarks, Mr. Gallinger, if you would like to get us
started on this particular section, we would be pleased to hear from you.
Ross Gallinger, Executive Director, Prospectors and Developers Association
of Canada: I am Ross Gallinger, the executive director of the Prospectors
and Developers Association of Canada, which represents over 10,000 individuals
and corporate members, many of whom will be directly impacted by the proposed
changes. I am joined by my colleague Pierre Gratton, the president and CEO of
the Mining Association of Canada. MAC is the national voice of Canada's mining
and mineral processing industry and represents more than 30 members engaged in
diverse mining and mining-related activities. We are also joined today by tax
specialists Steve Suarez and Jocelin Paradis.
Thank you for the opportunity to appear today and share our perspective on
this important piece of legislation. The focus of my remarks centres on the
foreign affiliate dumping measures currently before this committee for
consideration in Bill C-45.
The fundamental policy objectives of the foreign affiliate dumping measures
were described in Budget 2012 as being to curtail transactions that ``reduce the
Canadian tax base without providing any significant economic benefit to
Canadians.'' Let me begin by saying unequivocally that PDAC and MAC fully
endorse these policy objectives. However, our members are very concerned that
the current drafting of these measures exposes the Canadian economy to the risk
of serious adverse consequences. In particular, this includes harmful impact on
the junior exploration and mining sector and Canadian capital markets, as well
as other elements of the mining ecosystem that provide a broad range of
significant economic benefits to Canadians, on Main street and on Bay and Howe
Streets, and in numerous and often remote communities across the country.
It is our respectful submission that these measures can and must be refined
in a manner that would exclude their application to bona fide Canadian public
corporations that meet certain conditions that would be designed to ensure that
they do not dilute their effectiveness in achieving their fundamental policy
objectives, while at the same time, also as noted in Budget 2012, ensuring that
bona fide business transactions are not affected. We have outlined our
suggestions in this regard in our submission to the Minister of Finance, a copy
of which has been provided to members of the committee.
The main focus of our concerns relates to the manner in which these measures
could impede the normal growth of Canadian public corporations and their pursuit
of bona fide business transactions, to the general detriment of the Canadian
Under the foreign affiliate dumping measures as currently drafted, bona fide
expansion of an existing business line or diversification into a new business
line remains unaffected if it occurs within Canada. In contrast, bona fide
diversification outside Canada would be penalized, even where no Canadian tax
advantage is being sought. In addition, even the bona fide expansion of an
existing business line would be penalized if the existing business line is
located outside Canada.
The penalty would come in the form of the imposition of a special tax equal
to between 5 per cent and 25 per cent of the cost of the investment. For
example, in a conceivable scenario, an investment of $1 billion would give rise
to an immediate tax cost of $250 million, and this would apply even before a
single penny of profit is made by the corporation. It is also conceivable in
certain scenarios that these measures could give rise to multiple impositions of
this type of penalty, as companies dispose of unattractive ventures in order to
reinvest in more promising ventures.
We do endorse the minister's bold action to protect the Canadian tax base
from abusive transactions. However, we do not believe that it is appropriate for
these measures to categorically presume that the expansion of an existing
foreign business line or diversification into a foreign business line is
abusive. Public corporations generally make bona fide investments for bona fide
business reasons and do not generally make what might be referred to as
``investments of convenience.''
Under Canadian law, public corporations are controlled by a board of
directors bound by fiduciary duties to all their shareholders. Despite the
ability to elect and remove the directors from the public corporation, the
controlling shareholder cannot unilaterally direct the actions of a public
corporation. Public corporation directors have full decision-making authority
over the company's foreign subsidiaries and, due to their fiduciary duties, must
act in the best interests of the company and all of its shareholders.
Canada's mining industry is particularly affected by the foreign affiliate
dumping proposals. In a majority of cases, investors use Canadian corporations
as a vehicle for investing in mining projects outside of Canada, not because of
any perceived Canadian tax benefit but rather because they are attracted to the
infrastructure located in Canada that exists to support the mining industry: the
bankers, lawyers, accountants, geologists, the TSX and the TSX-V, and Canadian
corporate and securities laws applicable to corporations created and listed
here. These investors currently choose to come to Canada, but they have
alternatives and cannot be taken for granted.
To understand what is at stake, one must understand how the current state of
affairs will be affected by these measures. Currently, Canada is home to the
largest concentration of junior companies in the world, hosting 70 per cent. In
2011, 152 new junior companies were listed on the TSX Venture Exchange, one
company every two and a half days. These new companies accounted for
approximately 12 per cent of the exchange's total 1,275 listings for the year.
In 2012, Canadian-based companies accounted for the largest share, 37 per
cent or $7.5 billion, of global exploration spending. Eight hundred of these
companies are active exploring outside Canada in over 100 countries, resulting
in Canadian firms accounting for the largest share of exploration spending in
the United States, Central and South America, Europe and Africa.
TSX-listed mining companies operate a total of approximately 3,500 projects,
of which 63 per cent are located outside of Canada. An additional 2,408 projects
outside of Canada are owned by TSX Venture-listed companies. Investors from
Canada and around the world injected a total of $7.25 billion in TSX and TSX
Venture mining companies operating projects outside of Canada, compared to $2.16
billion raised for mining companies with projects located in Canada.
The robust picture painted by the above statistics cannot be taken for
granted and will erode under the FAD measures as proposed. By constricting the
ability of Canadian mining companies to make and finance bona fide foreign
investments, these measures reduce their ability to compete internationally. The
result will be a deterrent for new mining companies to incorporate in Canada, an
incentive for those already here to leave for a more favourable tax
jurisdiction. As the junior sector erodes, the supporting financial, legal and
other areas of expertise that surround it, namely our competitive advantage,
will erode with it.
International competition is intense for the high-value financing and
management activities arising from mining projects in Africa, Latin America and
Asia, particularly from the United Kingdom, which recently revised its tax
regime to make it very attractive for foreign investors to use U.K. companies
for foreign projects, and its AIM market.
These competitors will be very quick to identify and alert mining decision
makers to changes in Canadian tax law that make Canada less tax-neutral and
therefore prohibitive as a base of operations for foreign projects. This makes
it very important to ensure that anti-avoidance provisions, such as the foreign
affiliate dumping proposals, are carefully targeted so as not to impose
prohibitive tax costs or create needless complexity and expense for the junior
mining companies that have neither the funds nor the management tolerance to
plan their way around rules that ought not to apply to them in tax policy terms.
As indicated above, new mining companies are created almost daily, and it is
important for Canada not to give those deciding where to establish their
operations any reason to look elsewhere. Although it is not too late to refine
these measures, I would be remiss not to advise the committee that the proposed
measures have already begun to have an impact. PDAC and MAC have been alerted
that the tax experts are already advising their junior mining clients not to
incorporate in Canada in anticipation of the proposed FAD measures.
Specifically, we submit that it would be appropriate to exclude all Canadian
public corporations from the application of the proposed FAD measures. Short of
that, it would be appropriate at a minimum to exclude Canadian public
corporations that meet conditions that are designed to protect the Canadian tax
base. Such an exclusion would ensure that Canada remains an attractive location
for junior mining companies that may require significant additional investment
in the future and enhance the value of existing Canadian-controlled companies
that are currently seeking additional investors, whether they be Canadian or
Members of the committee, the concerns we are sharing with you are widely
held. In addition to us, concerns have been expressed by every major accounting
and corporate law firm in the country with mining clients. The TSE has made
identical points to Finance Canada on three occasions. Much is at risk. We are
hopeful you will give our remarks serious consideration.
Thank you for your time, and we would be pleased to take your questions.
The Chair: Mr. Gallinger, thank you very much. Could you describe a
typical situation to which these rules would apply, that they have not been
applying to up until now, to a publicly traded company in Canada with
subsidiaries? How does this all work in practice?
Mr. Gallinger: Could I pose that response to Mr. Suarez? He might be
able to walk you through the tax implications and how that works in much simpler
detail than I can.
The Chair: Thank you.
Steve Suarez, Taxation Lawyer, Borden Ladner Gervais: Learned members
of the committee, thank you for letting me appear today before you. I have a
couple of preliminary remarks. First, I am proud to appear alongside MAC and
PDAC. The work they do is very important for this country. Second, I am not
being compensated in any way today for my appearance and time or expenses. I am
here because mining helps puts a roof over my family's head. Mining helps put
dinner on the table for my family. This is important.
The Chair: Thank you for being here.
Mr. Suarez: Yes, sir. In terms of the fact patterns to which these
rules would apply today that did not apply previously, I wonder if I could start
by laying out the fact pattern that caused the government to act in the first
place. It is important to understand what mischief caused the government to act.
If we see that base case and compare that to the range of situations in which
these rules will apply, I respectfully submit that you will see quite a big gap
between the two.
Foreign affiliate dumping or debt dumping can best be explained as follows:
Under Canada's rules for taxing distributions from foreign affiliates, basically
if a Canadian company, let us call it CanCo, a company resident in Canada, has a
10 per cent or more direct or indirect equity interest in a foreign company, a
foreign subsidiary, I will call that ForeignCo, the Canadian rules work to say
that if ForeignCo is resident and carrying on business in a country with which
Canada has a tax treaty or a tax information exchange agreement, then dividends
from ForeignCo up to CanCo will not be taxed in Canada. There is basically an
outright exemption for not all but most dividends from ForeignCo to CanCo in
that situation. That is number one. That is a key tax rule to have in the back
of your mind.
Broadly speaking, if CanCo borrows money or incurs debt to make an investment
in ForeignCo, the interest on that debt will be deductible to CanCo in computing
its income. Therefore, we have a combination of two rules. One is a relatively
good interest deductibility regime in Canada; the other is a fairly robust
exemption and credit system whereby dividends from ForeignCo up to CanCo
generally are not taxed in Canada. The basic principle is that if ForeignCo is
carrying on business in a tax treaty jurisdiction, Canada assumes that it has
borne a sufficient level of tax in that ForeignCo's home country that we do not
need to tax it in Canada. It has already been taxed once in the foreign
country's jurisdiction. That is the principle behind exempting dividends from
foreign companies to CanCo.
Here is what was happening, and this is what caused the government to act.
Let us say CanCo has a foreign parent company. I will call that ``Parent.'' The
picture is Parent, on top of CanCo, on top of ForeignCo. There were instances
where Parent would say to CanCo, ``I want you to borrow $100 million from
someone else in our group, in our multinational group, and I want you to use
that money to buy the shares of some other foreign affiliate in the group.'' Let
us say it is the Brazilian member of the group. CanCo borrows $100 million from
the parent and buys the shares of BrazilianCo, which will thereby become a
foreign affiliate of CanCo.
What happens, or what could happen, is that now CanCo will have interest
expense deductions on that $100 million that potentially reduce its Canadian
source income, its income from whatever operations it has in Canada. The shares
of BrazilianCo, which are now underneath CanCo and which are supporting the
interest expense deduction — that was the use of the borrowed money; the
borrowed money was used to buy shares of BrazilianCo — basically that will be a
deductible interest expense to CanCo. However, as we discussed at the outset,
dividends paid from BrazilianCo up to Canada will probably not bear tax in
What the government was upset about was foreign multinationals dumping
BrazilianCo under Canada and incurring a whole bunch of interest expense
deductions in doing it. That was debt dumping, explained in a nutshell. It was
causing your Canadian subsidiary to borrow a bunch of money from within the
group to buy the shares of a foreign affiliate, dividends on which probably will
not be taxed in Canada, but the interest expense on the purchase price debt is
deductible in Canada.
Canada says, ``You know what? You guys are gaming our foreign affiliate
system. That is not what these rules were meant to allow.'' ``In particular,''
says Canada, ``you are doing that not for any valid business reason; there is no
particular business reason that BrazilianCo needs to be under Canada. You are
just doing this to create a bunch of interest expense deductions in Canada. That
is not fair.'' That, in a nutshell, is debt dumping. That is what the mischief
was that caused the government to act.
I think it would be fair to say that if the goal were to stop that, that
could be done in a relatively concise, not-too- hard-to-do manner. The FAD
rules, however, go far beyond that. They go far beyond that fact pattern to
encompass a bunch of other things.
Let me say one thing at the outset. Those responsible for designing and
implementing tax policy at the Department of Finance do not have an easy job. I
will be the first to tell you that. This relatively small group of dedicated
public servants does a huge amount of work. It is difficult to achieve the right
balance amongst the goals of raising the revenue that Canada needs to provide
the services and do the things that Canada needs to do; protect the tax base
from inappropriate erosion, potentially like the debt dumping I just described;
ensuring that compliance costs for taxpayers are kept to no more than they need
to be for the proper functioning of the system; and encouraging, or at least not
impeding, the kind of economic activity that benefits Canada. Reasonable people
can fairly differ as to the trade-off amongst those objectives.
That said, it is my respectful submission — and I think the view of the tax
community generally — that the FAD rules simply put far too much emphasis on
preventing base erosion; and all, or substantially all, of that objective could
have been achieved with a much more focused rule that would not create the undue
compliance and planning burden generated by the FAD rules or cause foreign
groups or investors to reduce the economic activity they undertake in Canada,
which is already occurring.
With that background, I have described the kind of transaction that caused
the government to act in the first place. These rules would definitely put a
stop to that; I can promise you that. However, they go beyond that. If it would
help the committee, I would be happy to spend a couple of minutes describing how
these rules operate. If that is not what the committee wants, that is fine. I am
here to serve you.
The Chair: We have to vote on these rules, so we had better try to
Mr. Suarez: Okay, sir. Let us go back to the same three companies I
talked about earlier: Parent, which is the foreign company at the top of the
group; CanCo, in the middle; and ForeignCo beneath it, or potentially beneath
it. It does not have to start beneath it.
These rules apply where a corporation that is resident in Canada, which I am
calling ``CanCo,'' and that is controlled by a non-resident corporation, which I
am calling ``Parent,'' makes an investment — and that is a defined term — in a
corporation not resident in Canada that is a foreign affiliate of CanCo, which
is to say that is, or immediately after the investment is, a company in which
CanCo has at least a 10 per cent-plus direct or indirect interest. You need a
foreign-controlled CanCo that makes an investment in a foreign affiliate.
What is an investment? Here is where we start to go off the road a little
bit. An investment includes an acquisition of any debt of ForeignCo. If you loan
money to ForeignCo, that is an investment. If you acquire shares of ForeignCo,
that is an investment. If you confer a benefit on ForeignCo or make a capital
contribution to ForeignCo, that is an investment. If you acquire options in
respect of or an interest in any ForeignCo shares or debt, that is an
investment. If you have a debt of ForeignCo that you extend the maturity date
on, that is an investment. If you have shares of ForeignCo that have a fixed
redemption date and you extend that date, that is an investment. If you acquire
shares of another Canadian corporation, more than 75 per cent of whose property
is shares of ForeignCo, a so-called indirect acquisition, that is an investment.
What we have is a very broad charging rule, a very broad range of
transactions that will trigger the application of these rules. It is not only a
broad charging rule, but it is phrased very broadly, so it also applies where
CanCo is not controlled by Parent at the time of the investment but, as part of
the same series of transactions that includes the investment, CanCo becomes
controlled by Parent. It also applies where ForeignCo is not a foreign affiliate
after the investment but, as part of the same series of transactions, it becomes
a foreign affiliate. Under the Canadian tax jurisprudence, the degree of linkage
between two transactions to make them part of the same series of transactions is
To give you a simple example of how these rules might work, let us say you
have Parent and CanCo and ForeignCo, and let us say CanCo makes a capital
contribution of $100 million down to its wholly owned subsidiary, ForeignCo, so
a wholly owned chain. Your starting point for the result that produces is that
CanCo is deemed to have paid a dividend of $100 million up to Parent.
A payment down the chain to a wholly owned subsidiary is treated as though
the money had been distributed up out of Canada, and dividend withholding tax
applies. The rate of dividend withholding tax is 25 per cent under the Income
Tax Act of Canada, so $25 million, unless reduced by a tax treaty between Canada
and Parent's jurisdiction. It could be as low as 5 per cent. It is somewhere in
These rules apply to, in effect, treat a payment down the chain to ForeignCo,
a wholly owned subsidiary — the money is still beneath Canada — as the
equivalent of a dividend by Canada up the chain, triggering dividend-
There are some relieving provisions that in some but not all circumstances
will allow the deemed dividend to instead be used to reduce the paid-up capital
of CanCo shares held by Parent. That potentially produces a delayed deemed
dividend because that paid up capital is something that could have been used by
CanCo to make a distribution to Parent as a return of invested capital. There
are two kinds of distributions CanCo can make — a dividend, which triggers
dividend-withholding tax, and a return of capital previously invested. The rule
is that you get that out without dividend-withholding tax because that is money
that you put in in the first place. You are entitled to get your capital back.
Down the chain, payment is either a deemed dividend from CanCo to Parent
today, or, under the rules that allow for this in certain circumstances, the
deemed dividend is replaced with a reduction of the paid up capital of CanCo
shares that will produce a deemed dividend later, when CanCo goes to make a
distribution and finds its paid up capital gone. It just got absorbed, ground
down on the original investment down the chain.
That is a real shift in tax policy. Treating a payment down the chain as if
it were a payment up in Canada is a real change in tax policy and could
potentially trigger double taxation because, when CanCo makes the payment to
ForeignCo — a deemed dividend for Canadian purposes — dividend-withholding tax
applies. If CanCo then, at some point, takes the same funds or different funds
and makes an actual dividend to foreign Parent, dividend-withholding taxes will
apply again. There is a significant scope for double taxation to arise under
these rules, and that is something that really gets foreign investors thinking.
It is one thing to prepay your dividend-withholding tax and pay it sooner than
you should have. It is another thing again when you are not only potentially
incurring immediate tax just by making a payment to your wholly owned subsidiary
but also may end up paying tax twice.
Pierre Gratton, President and Chief Executive Officer, Mining Association
of Canada: I will ask Mr. Suarez or Mr. Paradis to elaborate a bit more,
but, to give a mineral exploration company example, you would have a situation
where CanCo will invest, say, $100 million in an exploration project overseas.
That $100 million is there to finance the development of that project. It is a
legitimate business transaction. Without that money, that project would not be
When CanCo invests in that project — and that is part of our whole argument
around the mining ecosystem that exists in Canada, for which we are globally
renowned — that transaction, though it is an investment in a foreign property
somewhere else in the world, will use Canadian lawyers, geologists, assayers and
Canadian engineers. Studies done by Natural Resources Canada in the past have
shown that, even though it is a foreign property, Canadians are involved in
multiple layers. Of course, there are a lot of supply and services generated in
the foreign country, but Canada and our mining ecosystem benefit significantly
These measures take that $100 million to finance that project and tax that
investment, which is a far cry from what the foreign affiliate dumping rules
were designed to do. You are not supposed to be taxing an investment in economic
development. That is the rub. That is the problem.
Mr. Suarez: I just have a couple of comments in terms of why these
rules are so much broader than the mischief that they were originally directed
The investment that CanCo makes in ForeignCo triggers the rules. The rules
apply whether or not that investment generates any taxable deductions in Canada.
The original mischief was buying some shares that got you a deduction for
interest expense in Canada. These rules apply whether or not the investment that
CanCo makes in ForeignCo generates any deductions in Canada. It does not matter
whether they do or do not. These rules apply whether or not the investment in
ForeignCo that CanCo makes produces taxable income in Canada, income that Canada
will get its tax on. It does not matter whether it does or does not. This is
sort of goes back to the example we talked about; these rules apply even where
no net assets have been extracted from Canada. They apply on a value for value
transaction where CanCo spends $100 million and gets $100 million of property in
return. No net assets have been extracted from Canada. Everything is still
beneath Canada, but the rules still apply. That is why characterizing it as
dividend is such a big change in tax policy. A dividend is when CanCo pays the
money and gets nothing back in return. The money is gone. That is a dividend. To
characterize a value for value transaction where CanCo spends $100 million and
gets property of $100 million back in return as a dividend, I cannot square that
One of the government's objectives was to preventing the undo extraction of
corporate surplus from Canada. I understand that. However, these rules apply
whether or not CanCo has any corporate surplus. You do not have to have retained
earnings or a corporate surplus for the rules to apply.
This is probably the most important point: These rules apply whether or not
the transaction has any Canadian tax motive or purpose or achieves any Canadian
tax advantage. The original version of this rule, when it came out in the
budget, had a business purpose test. To be caught, you had to be doing something
primarily for tax reasons. The government backed away from that in the August
and October versions of the legislation. There is now no business purpose test.
That was the primary filter, in my respectful submission, for separating what
should be caught from what should not be caught. The original transactions that
we talked about — these debt-dumping things — were people causing CanCo to incur
a bunch of debt to buy BrazilianCo totally for tax reasons, just to generate
deductions. There is no business purpose test in these rules. It does not matter
if what you are doing has no Canadian tax motivation whatsoever. That is
As we talked about, it can apply to produce double taxation in numerous
instances. Double taxation is a big problem. It really turns foreign investors
off. It does not differentiate between investments that CanCo makes down the
chain to wholly owned subsidiaries that are still beneath Canada and investments
that CanCo makes up or across the chain to sister companies outside of Canada.
These rules do not differentiate between those things in any meaningful way.
They are very different in tax policy terms. If stuff is still beneath Canada,
then those assets are still within the Canadian taxation system. Payments that
CanCo makes to sister companies that are not beneath Canada are different.
These rules do not differentiate between investments CanCo makes with other
group members and investments that it makes with arm's-length, totally
third-party entities. The original transactions that we were focused on were
totally intra-group transactions, where Parent tells CanCo, ``You buy the shares
of BrazilianCo and incur a bunch of debt.'' Everything is within the group.
These rules apply even on investments that CanCo makes with arm's-lengths third
parties. These apply to public corporations, if CanCo is a public corporation or
if it has minority shareholders. There are severe limitations on what CanCo
cannot do under Canadian corporate securities law. These rules apply
nonetheless, even though Canadian public companies and wholly owned Canadian
subsidiaries are in a very different position.
The last point I will make is that there is limited grandfathering and no
differentiation between foreign affiliates of the Canadian company in place
prior to the announcement of these rules and companies that become foreign
affiliates of CanCo after these rules are announced. Existing structures are in
place where CanCo has foreign affiliates. For perfectly good business reasons,
there is no special treatment being offered in a serious way for people in that
fact pattern to deal with these rules that change the game.
The Chair: Thank you, Mr. Gratton and Mr. Suarez, for your examples.
They are helpful, and you have explained it well, I believe, to honourable
Our briefing note from the Library of Parliament indicates, under foreign
affiliate dumping background, that the proposed changes would not apply to
transactions that meet a business purpose test, such as pertinent loans,
indebtedness, corporate reorganization or strategic business expansion. Does
that business purpose no longer apply? Has that been dropped?
Mr. Suarez: The original version of the rules that came out in March
had a business purpose test. That was dropped in the August and October
versions. Instead of there being a general business purpose test, there are now
specific exceptions for certain corporation reorganizations and for certain
kinds of loans. As well, there is a closest business exception test, which is
meant to allow for certain investments but which, in my respectful submission,
is so complicated and so unworkable that it will be of limited practical value.
There is no longer a general business purpose. There are specific exceptions
for the three things that you mentioned.
The Chair: That is still referred to by the taxation department as a
``business purpose test,'' notwithstanding.
Mr. Suarez: I have not seen the document to which you refer, but in my
respectful submission, I would not call that a business purpose test.
The Chair: I want to clarify that because honourable senators would
have heard your comment, read this, and thought there was a conflict. It is an
interpretation of words.
Mr. Suarez: I can assume that the Department of Finance looks at those
three specific exceptions and says, ``That is meant to function as a business
purpose test.'' With the greatest of respect for the Department of Finance, in
my view it does not do that.
Jocelin Paradis, Vice President, Taxation Canada, Rio Tinto: If I may
explain the exemption for business purpose test, a company needs to be more
closely related than any other company of the group to the business abroad. It
means that in our case, there is a Canadian publicly traded company in which we
own 51 per cent of the shares, and 49 per cent are owned by the Canadian public.
It is building a copper mine in Mongolia, which is a $9-billion project. Rio
Tinto has copper mines abroad, and the business of that Canadian company listed
on the Toronto Stock Exchange is less closely related to the Mongolian business
than to other businesses of Rio Tinto. This means that the Canadian publicly
listed company is not doing an investment, which is fine from the business
purpose test. Even if it is the owner of the mine, even though it did fund a
project 10 years ago, and even though it spent all the money needed to make the
investment, it is not considered to be a bona fide business for the rules, which
are too narrowly drafted for us.
Mr. Gratton: Between August and the October tabling, these additional
measures that were brought forward, which are not a business purpose test, as
mentioned, were welcomed by us. They somewhat addressed some of the concerns we
had been raising. In our respectful submission, they sort of play around the
edges and do not really solve the core issue at play here, which Mr. Suarez
The Chair: Two things flow from that. One is that there was some
consultation prior to the rules being promulgated into a draft bill; is that
correct? Have all of you had some input?
Mr. Gratton: We have been in regular contact with the Department of
Finance since the beginning of September after the draft of proposed legislation
was made public for consultation. Certainly, we saw improvements from August
through October, but still there are some pretty fundamental issues that we
continue to raise. We remain in conversation with the Department of Finance. I
should point out that as recently as the last few days, we have received both a
letter from the Minister of Finance and a follow-up from officials expressing an
interest, which I take is sincere, to sit down with our sector and work through
the issues. My sense is that they have heard us and realize that these rules
have created unintended consequences, for our sector in particular, and want to
work through them. However, we have not solved the problem and still need to
work with Finance to address them. That is in process. We would be remiss if we
did not acknowledge that they seem to have heard us, but we still have a lot of
work to do.
The Chair: If you have any specific amendments that you would urge the
government to make, we would be pleased to hear from you on that.
Senator L. Smith: To follow up the chair's point on communication with
the government, do you have or will you have your top three points that you want
to focus on? It would appear that after listening to you discuss and brief us on
the current situation, Mr. Suarez, the government has built something that is
like a trap, and you are trying to catch as much as you can because there has
been some manipulation. In order to create the right balance, maybe you could
give us some simple suggestions from a business perspective as opposed to a
technical perspective. Most of us would not understand the latter necessarily
because we are not tax experts. From a macro level, could you give us a couple
One of the things in the letter that you received from the government was the
implication of the junior sector. There seems to be a strong focus on the junior
sector — usually start-ups and organizations that may not have the capital
required to move forward. Could you give us a little background?
Mr. Suarez: Certainly. Your question is an astute one. There are
differences in terms of how these rules affect the juniors versus the Rio Tintos
and other behemoths of the world. I would be happy to spend a couple of minutes
on that if it would be helpful.
In terms of your specific question, if I had a wish list, honestly, putting
the business purpose test back in these rules would truly make a difference. It
was in the first version of the rules. Going back to the original mischief that
motivated these transactions, we see that these transactions were undertaken
purely for tax reasons. It was all about creating interest expense deductions in
Canada by dumping a foreign affiliate under Canada. A business purpose test
would achieve an awful lot of what the government is trying to do.
If you are doing something that is tax motivated, then it is a different
kettle of fish than just trying to start up a project somewhere in Latin
American and using a Canadian holding company because that is where all the
bankers, lawyers and financiers are. I have a ton of respect for the people at
the Department of Finance, who are smart, dedicated public servants that could
be earning a lot more in the private sector. They have my respect; but, with
respect, a business purpose test that differentiates between bona fide business
transactions not being undertaken to achieve Canadian tax results and the kind
of tax-motivated debt dumping that was the mischief behind these rules would go
a long way toward solving the issue. In a way, exemptions for public companies
and arm's-length transactions are a kind of offshoot of that. They all have the
same theme: Guys, we are not doing this to try to erode the Canadian tax base or
generate tax deductions. We are doing this for business reasons.
If you allow businesses to do the transactions that they would do and create
the economic activity in Canada that they want to create, we could get to a
place where the Canadian tax base is enhanced rather than eroded while the
government's objectives are met.
Senator L. Smith: Mr. Gratton, you mentioned that communication is
going on between your groups and the government. Obviously you want to continue
those discussions. Are you proceeding to that next step of prioritizing your
recommendations and moving those forward with the government group?
Mr. Gratton: Yes, absolutely. In our submissions to the Department of
Finance on the business purpose test question, which was dropped, our
recommendations have focused on how to develop some kind of exemption for
publicly listed companies with the argument that those companies are accountable
to their shareholders and cannot engage in the kind of mischief that Mr. Suarez
has been describing. In addition, why would you acquire debt in the mining
industry through investments overseas in which you were not interested? You
acquire a project overseas because it is a good project. That is your
motivation. It is not to avoid tax; it is because you are developing your
We have focused on the qualified public company exemption because our
perception was that the business purpose test issue was behind us and we had a
very short time frame to find ways through this. We are now in the process of
assembling a team, as Finance has asked us to do, of people who can work through
these issues with their officials. The kind of approach they have outlined is
very much what we have been looking for. I would characterize it up until now as
largely us putting our views forward and then hearing back from them. What is
now being proposed is what we would really like, which is to have everyone
around the table trying to fix a recognized problem.
These are complicated rules and, as Mr. Saurez said, you are trying to find
the right balance. The industry does not want to allow mischief to erode the
Canadian tax base. We totally accept that the debt dumping that has been going
on should be eliminated.
How do you craft that? If we can get together and work through the issues
with an understanding and recognition that there is a problem that needs to be
solved, then I am hopeful that we will be able to do that.
Senator L. Smith: One thing that the government would probably expect
from you folks is the creation of the proper discipline within your members to
try to avoid the manipulation that can take place when you have —
Mr. Gratton: With respect, on that, Finance has acknowledged from the
beginning that we were never the target. They did not have their sights on the
mining industry. We were never seen to be among those that were engaged in this
kind of debt dumping.
They cast the net so wide that we feel like dolphins in the net, and we need
to fix that, because we were not the ones they were after.
Senator L. Smith: Hopefully you will continue those dialogues and move
forward in a positive way.
The Chair: ``Dolphins in the net'' is an interesting analogy.
Senator Hervieux-Payette: For countries that are in the same situation
as ours, such as Australia more specifically, a country that also has a large
mining sector, but also Brazil and probably the United States, what is the
taxation system in this area? Are we acting alone, or are we joining the rest of
the Western countries that do not mind collecting taxes now and again?
Mr. Paradis: Rio Tinto does business in approximately 50 countries and
no other country has this type of rule. Canada stands alone.
Senator Hervieux-Payette: So we are quite innovative then.
Mr. Gratton: If I may add something, what concerns us is the fact that
Great Britain changed its regulations to become more attractive. As you know, a
few years ago, the London Stock Exchange attempted to purchase the Toronto Stock
Exchange. There was quite a reaction to that, and at that time, everyone said we
really needed to protect the Toronto Stock Exchange, and that its great success
was partly due to its specialization in the mining sector. What worries us now,
is that with London becoming more attractive, we run the risk of losing our
jewel, indirectly because of these new regulations. This is what concerns us.
Senator Hervieux-Payette: What I am wondering is whether the issue we
are discussing is finance or the mining sector. To hear you speak, $100 million
will be raised on the financial markets — meaning lawyers, accountants, all
those people — but in that case, if the headquarters are located in Brazil, if
they wish to develop a mine in another country, why would they go through Canada
for those $100 million, if not for fiscal reasons?
I would like to know the real reason because, after all, if you look at Rio
Tinto's consolidated financial statements, everything ends up in the same pot.
So why make a detour through Canada to invest in New Guinea?
Mr. Paradis: Canada is a place that has developed a great deal of
engineering knowledge for the mining sector. There are major research centres in
the town of Sudbury, and even the Rio Tinto people in Australia decided of their
own accord to invest in research and development in Sudbury, which is recognized
for its skill in running and developing underground mines. Because a major
proportion of mine exploration financing is done across Canada, Canada has
developed an internationally recognized expertise for this type of project. So,
having local funding, engineers and people who do research and development, is
an advantage for Canada. Our goal is for this to continue in Canada, and to
develop Toronto, Sudbury, Vancouver and other regions in order to create a
favourable environment for our economy.
This is done across Canada because it is a good place to do so. We could
invest through Canada without paying taxes in Canada, but while creating
economic activity. If we had to start paying taxes, to pay a tax for using
Canada to develop external resources, there is a risk of things changing and
people may stop using Canada as a conduit to an external mining project.
Senator Hervieux-Payette: I am not quite convinced by what you are
saying. What I currently see is that first of all, there are companies such as
SNC-Lavalin who all have expertise in the mining sector and who, like you, work
in 35 or 40 countries; they may work in all the countries. The same is true for
your engineers, they can go work outside of Canada, supervise the development of
new mines, whether that be in Africa or Asia. Technical know-how is one thing;
financing is another. Why shouldn't it be the parent company that invests the
$100 million? Why go through Canada? We need to see some evidence as to the
number of jobs that will create here.
In the end, you are making use of expertise that already exists. Will that
create jobs? It may create work for people who already have a job. But the jobs
will be created in the mine that is located in the foreign country, not here;
they will be created wherever the $100 million is being invested. I am trying to
see the net benefit for Canada in all this.
To wrap up my question, I would like to know — and I'm not certain what the
French word is for this — what the withholding tax is with Brazil? Apparently,
it is between 5 per cent and 25 per cent; I would like to know what it is for
you, since your headquarters are in Brazil.
Mr. Paradis: No, they are in England.
Senator Hervieux-Payette: In England, I am sorry.
Mr. Paradis: In England, it is 5 per cent. The point I am trying to
make is that we are participating in a project in Mongolia through a Canadian
public company. There are minority shareholders who represent 49 per cent of the
investment — people like you and me — in the pension fund. Those people have the
right to expect a reasonable return on their investment, in keeping with the
company they have purchased. At Rio Tinto, we cannot bypass minority
shareholders and make direct investments in the company's best foreign assets
and leave them with only less lucrative assets. The company's management would
not be allowed to do that because they have a fiduciary duty towards all the
stakeholders and towards the company. It is not because we do not wish to go
through Canada, it is because we have no choice given Canadian regulations and
also because we must protect Canadian investors.
When we are talking about a company that is Canadian, and that is 100 per
cent foreign-owned, it is easy to bypass Canada. When it is a public company, it
becomes quite difficult to do so without creating issues with minority
Senator Hervieux-Payette: And how many countries across the world does
Rio Tinto Canada have foreign investments in, besides Mongolia?
Mr. Paradis: There is a company called Turquoise Hill Resources which
is a public company. This company has investments in about 10 countries. Rio
Tinto only holds 51 per cent of the assets.
If we set that aside, as for the rest of 100 per cent Canadian companies in
Rio Tinto, we currently have assets in four countries, and we are on track for
others in two other countries in the long term. The first one is Brazil, because
its rules prevent us from restructuring. There would be a capital gain or there
would be taxes to pay to Brazil. The second country is Oman, a Muslim country in
which the rules for changing stockholders are quite difficult.
Aside from that, there are only those two rather minor investments under Rio
Tinto Canada's activities that are 100 per cent Canadian. Our problem is the
Senator Bellemare: I have a brief question about Quebec's Northern
Plan. For some time now, Quebec's activities have been slowing down. We know
that there are international considerations involved. However, in the context of
the Canadian tax system's problems, is there a connection between the slight
slowing down of the Northern Plan in Quebec and the taxation environment that is
developing? Or does this really only affect foreign investments?
Mr. Gratton: It is a little too early to be able to say that. I can
give you an example which does not deal with the Northern Plan as such, but that
does affect Canada. The Polish company, KGHM, that bought out the Quadra FNX
company, wanted to establish their global copper branch here in Canada because
of all the reasons my colleagues mentioned, because of the expertise here.
Because of the rules, they are now reconsidering this investment. They think
that under the new regulations, it might be better to locate that branch in
That is a major company, but we are also concerned that other companies,
including junior companies, will start saying that the system is too complex.
Furthermore, as Mr. Gallinger pointed out, many junior companies are still
unaware of the regulations, but when they do become aware of them, they will
conclude that it is easier to go to London than stay here. Should that arise, we
risk losing all the expertise that we have and that we are so proud of here in
Canada. That is what will affect the Northern Plan because it will have a
negative effect on the foreign investment that we need in order to develop our
mining projects in Canada.
Senator McInnis: Thank you for coming. My question is a follow-up from
my learned colleague Senator Smith, more to do with protocol and procedure. How
proactive are you in dealing with government? For example, does your
organization meet on a regular basis with Finance or Natural Resources? You are
nodding that you do. What departments do you meet with? Is it an overall
briefing that you give? Do you host receptions? What do you do to communicate
Mr. Gratton: Is behind your question the question of how we got here?
Senator McInnis: I think I know how you got here.
Mr. Gratton: I can explain, in part. Everything was going along
swimmingly until mid-August. What we were expecting was what they announced in
the budget, which was a plan with a business purpose test to address the
legitimate issue of debt dumping, and then in mid-August they came out with
these draft rules. It was unfortunately the middle of summer, so it was about
the first week of September that my colleague Mr. Paradis and a few others
within our membership said, ``Oh my God, what have they done?''
There was a one-month time frame for consultation, so a fairly narrow
consultation period for some pretty fundamental rule changes that had not been
anticipated based on what the budget had indicated would be happening. We
responded very quickly at that time, met with Finance officials and started to
submit a series of letters.
By October, so a month after that, the actual legislation came forward, and
it addressed a number of the concerns that our members had raised, and I do want
to acknowledge that. However, it left a number of issues unaddressed. We have
been engaging directly with Finance and NRCan and all the usual suspects you
would have expected us to since then, but it is a very complex file. It has
taken us some time. I do not know how much experience people have with Finance.
It takes a long time. The onus was on us pretty well consistently to convince
them that there was a problem. We would raise one set of issues, and we would
get another set of questions. We would do some more research and answer those
questions, and it would lead to more questions. It has been that kind of
relationship up until now.
It has actually been only more recently that we feel we have got to the point
where we will sit around the table and work this through. We have certainly been
very active on this particular file, but it has only been since the beginning of
September, I would suggest. The time frame for such a significant tax change was
really rather narrow, and it has caught a lot of people off guard.
Senator McInnis: The mining sector is a major component of the economy
of Canada. Do you have ongoing dialogues? Are there briefings? Do you
communicate with government on a regular basis?
Mr. Gratton: Yes, of course we do. The irony here too is that, as an
association, we have in recent years not spent an awful lot of time at Finance
because Canada has become, from a general tax perspective, a much more
attractive country. We have low corporate tax rates and so on. Within our
association, tax issues were not at the top of the list. This issue came out of
left field, because there was no reason, based on the budget announcement, to
anticipate that this would affect us in this way.
The Chair: Gentlemen, we are out of time. This has been a very helpful
session. We are very pleased to hear that you are in dialogue.
Our concern, after a quick look at the bill, is that once this bill passes,
this provision is retroactive to March; it comes in automatically. There does
not seem to be the flexibility to allow for it to be held in abeyance while you
continue negotiations. We will work on seeing if we can find a way to allow you
to continue that negotiation. We have heard what you have said in relation to
what the fix might be, and hopefully that can be worked out to the interest of
your industries and all Canadians.
Mr. Gratton: Finance has indicated to us that they have many tools to
try to address this rather quickly. It does not necessarily require, at least in
the first instance, new legislation. The minister could issue a bulletin, a news
release or a signal like that, which can be done pretty quickly and would have a
quick effect across the mining and tax community to provide the reassurance we
need. There is the potential, anyway, for a fairly quick response once we all
agree on what is required.
Mr. Suarez: The point I would like to leave you with is that this is
what is different in mining from other industries, especially in the junior
sector. In mining, it is quite common for foreign investors that have a foreign
project — nothing to do with Canada — to use a Canadian company as the
headquarters because that is where the bankers, lawyers, geologists, financiers,
the TSX and Canadian corporate law is. It is quite common, unlike other
industries, for foreigners to decide to use Canada as a base of operations, a
headquarters for a project that has nothing to do with Canada — Latin America,
Asia, something like that. These folks do not have to come here. They can go to
the U.K., list on the AIM exchange and use the U.K. tax system. Those are the
ones we are most at risk of losing. The ones that are here might go, but the
real danger from these rules is the ones who will not come. I would just leave
the committee with that thought. People have a choice. They do not have to come
to Canada. They do in mining because of our infrastructure and all the jobs that
creates, but they do not have to come.
The Chair: Thank you very much. I am sorry the time is over. Thank you
for being here, Mr. Suarez from Borden Ladner Gervais; Mr. Gallinger,
Prospectors and Developers Association of Canada; Mr. Gratton, Mining
Association of Canada; and Mr. Paradis, Rio Tinto and the project in Mongolia.
Many of us are quite familiar with that Oyu Tolgoi project, and we wish you well
on that and your other ventures and hope that you continue to show a strong
interest in Canada and the services we have to offer. Thank you very much, all
We will allow for the members of our next panel to take their places.
The Chair: Honourable senators, we are going to continue our
examination of the subject matter of Bill C-45, A second Act to implement
certain provisions of the budget tabled in Parliament on March 29, 2012 and
During the second part of our meeting, we will consider amendments to the
scientific research and experimental development investment tax credit.
That is clause 9, Part I, page 14.
From the Canadian Advanced Technology Alliance, and it is also referred to by
CATAAlliance, we are pleased to welcome Russ Roberts, Senior Vice
President, Tax and Finance; and from the Certified Management Accountants of
Canada, we are pleased to welcome Richard G. Monk, Advisor of National Affairs,
President and Chief Executive Officer of Msight Global Inc.
I understand that both of you have a few brief opening remarks, and we will
begin with Mr. Roberts and then Mr. Monk. After that we will get into a
discussion. Mr. Roberts, would you like to begin?
Russ Roberts, Senior Vice President, Tax and Finance, Canadian Advanced
Technology Alliance (CATAAlliance): Thank you for inviting us to
attend. I will give you my background because it may be relevant to shaping some
of your questions. I enjoy answering questions, so I am looking forward to that
section of our talk.
My background is that when the tax credits were created, I was brought in
from the National Research Council to help set that up. I have seen the policy
development process, particularly as it related to what is eligible SR&ED. I
followed it for almost its total period of evolution over time. I have followed
its administration, the shifts in it and how it has worked over that same period
of time. Eventually, I spent about eight or nine years in the private sector
working on claims themselves, so I have seen the other side of the story as
well. Maybe that will be useful to you. I will try to explain my observations
from that perspective as we go.
In terms of SR&ED and innovation policy, which is where we were last year
when the budget was brought forward, we were pleased by some changes that we saw
in the discussion. We saw the discussion had shifted very much from a focus on
research to a focus on commercialization: How do we achieve commercialization?
How do we get businesses to focus on taking the IP that they develop here and
doing something with it here in Canada?
Our concern was that most of the discussion previously had focused on
research, getting more money into research and more researchers creating IP,
yet, what were we doing with the IP? It was moving offshore often.
We conducted a discussion on our website for about three months before the
budget, and we were surprised by the feedback. It was really focused on whether
there was too much going into research. How do we take advantage of all these
skill sets? It was not a lack of innovation; it was a lack of ability or
willingness to commercialize what we had here.
In that respect, we were strongly in favour of the tone of the budget. It was
moving in that direction, but when we looked at the changes that took place in
the SR&ED program, we did not see how all this meshed together as a result.
Particularly, when we looked at the way the program was being managed by the
CRA, what we were being told but also what we saw, the program has been shifting
much more to an orientation that is directed at research rather than what
engineers do to create innovative and advanced technologies.
It is not getting less complex, in our opinion and in our members' opinion.
In that sense, we were not necessarily comfortable with the direction of the
changes unless there was more to come with the next budget. That was our
fundamental position. Where is all of this going? Can it pick up the slack that
is being created by these changes in the budget? Are there opportunities? We
think so. Could these changes all mesh together? Yes. One of the ideas that we
have looked at is a patent or innovation box, which is being developed in other
countries. It is being looked at closely. It is a way of encouraging companies
to actually commercialize their IP. The credit actually applies on the profits
when it occurs, so it is a pull by rewarding success rather than using the push
approach. We are very much in favour of that.
Our members are also less likely to be comfortable with direct grants or
direct funding. They much more prefer the tax mechanisms, tax credits or lower
tax rates. The innovation box approach definitely has merit for them.
To balance the losses to SR&ED with this budget proposal, the way it has been
shaped, we see that you need something like the innovation box. We also see that
the extension of the facilitated writeoffs helps because the major impact of
these changes is around the incentive for expenditures in capital. That is where
the biggest impact occurs, in the large firms as well. That is why it picks up
there, will actually pull forward on it and help pick up the gap. That is what
we are saying.
Even so, unless we figure out how to get the tax credits to be managed
efficiently and effectively, we still have concerns about the effectiveness of
the program. The direction it is going in is very much focused on research, and
that is a criterion. I can explain that later on if you wish, but that is what
is happening and has been happening for a number of years.
We had identified a different way of going at this rebalancing. About a third
of the claims are termed retrospective. What occurs is that, as a practitioner,
I would go into a firm, go through all of their development projects, figure out
where their R & D lay and I would file it after the fact. Our contention is that
those are not working effectively as an incentive, so we asked ourselves if
there was a better way of doing this. Could we get rid of that group of claims —
somewhere between 500 million and a billion — and come up with a more effective
incentive itself which does not have the same type of structural impacts as the
current proposals? We think we could. We do not think there was enough time to
get at those questions in the discussions, and we are just now beginning to see
people talk about it as we go out into the community.
The Chair: Thank you. Mr. Monk?
Richard G. Monk, Advisor of National Affairs, President and Chief
Executive Officer of Msight Global Inc., Certified Management Accountants of
Canada (CMA Canada): Honourable senators, I am pleased to be with you this
morning representing Certified Management Accountants of Canada, also known as
CMA Canada. Thank you for inviting us.
I would like to take a moment to tell you about Certified Management
Accountants. We are strategic management accounting professionals who combine
accounting skills and business acumen with professional management skills to
provide leadership, innovation and integrating perspective to organization
decision making. We have over 50,000 members working in the private and public
sectors and also working in the government sector.
You have asked CMA Canada to discuss the provisions of Bill C-45 regarding
changes to the Scientific Research and Experimental Development Tax Credit,
commonly known as SR&ED. We think it is fair to say that the SR&ED is Canada's
best known and most used vehicle for R & D in this country. As the Jenkins
committee report says, it is the flagship of federal support for innovation.
In spite of this, studies have repeatedly documented that business innovation
in Canada lags behind that of other highly developed countries. Therefore, we
believe that it is not unreasonable to make some modifications to the program.
Bill C-45 includes some important changes to the SR&ED tax credit.
CMA Canada has been advocating for several years, primarily in pre-budget
consultations, including this fall, that government policy measures should focus
on improving Canada's productivity. The track record on productivity has been
weak over the past decade or longer. CMA Canada has advocated that change to the
SR&ED is one of the means of contributing enhanced innovation as a key driver of
We also participated in government consultations on the Review of Federal
Support to Research and Development launched in December 2010. In our
submission, we recommended expanding the refundability of the SR&ED tax credits
to claimants of all sizes, getting credits more quickly into the hands of
innovators and reducing the complexity of program administration. Measures such
as these, implemented in tandem with our legal framework protecting the
intellectual property of Canada's innovators, would contribute to innovation and
productivity. In our view, the ultimate objective of improving Canada's
productivity should be to increase the living standards of Canadians.
When looking at the proposed amendments to the SR&ED program in Bill C-45, we
suggest that the ultimate question to be asked is this: Will these changes have
a positive impact on Canada's innovation and productivity? We think this is the
real test of success.
It may be too early to make this judgment. There will be a transition period
as these changes come into effect over the next year or two. Moreover, there may
be more changes coming in Budget 2013 to respond to the Jenkins report
recommendations to shift resources from indirect support through the SR&ED
program. We will want to take a closer look at any measures that are introduced
in the future before making any comments in that regard.
We understand that Canadian manufacturers are concerned with some of the
proposals in Budget 2012 affecting the SR&ED program. Two specific concerns they
have are reducing their SR&ED investment tax credit from 20 per cent to 15 per
cent and eliminating capital expenditures from expenses eligible for the
investment tax credit. This group estimates that these two measures will take
out $770 million and $94 million respectively from the SR&ED program between
2014 and 2017.
What we do not know is whether this will be balanced with the positive
effects resulting from other measures included in Budget 2012 intended to
redeploy government funds from the tax credit to a more complete set of direct
support initiatives to help encourage businesses to invest in R & D. That is the
issue we have.
In closing, CMA Canada supports measures aimed at improving Canada's
productivity. The SR&ED is one of the programs that can be improved in ways to
effect productivity in a positive manner. I look forward to your questions and
The Chair: Thank you, Mr. Monk.
Senator Buth: Thank you very much for being here today.
Mr. Roberts, you offered — and I will take you up on your offer — to comment
on how this program focuses more on the research side of things instead of I
think you said innovation or commercialization.
Mr. Roberts: What has happened is the following. If you look at what
the intent of the legislation originally was, it was to be focused on applied
research predominantly, on the research side of the story, but also on
experimental development, which is the advancement of technologies done very
much within the context of advancing products and processes. In other words, it
is not standing alone with a nice new advancement in the technology, but a
technology that is used for something. That is the way the definition is
In the last three years many reviewers have imposed, on top of the
engineering design methodologies, the requirement that they be able to see the
scientific method employed. While it is quite often there at a micro level in
what is done by the engineers, the way you manage these large, complex
developments is using a much broader approach to finding problems, bringing them
together and seeing where the issues are coming from, and finding the solutions.
If you impose this rigid, linear, almost laboratory-oriented approach to
scientific method in its application, you get down to the micro level and miss
the projects. You miss what is there. It requires the imposition of a different
methodology on top of what is a good way to get to a product cost-effectively.
It also requires additional documentation and systems put in place, some of
which are contradictory to the efficient design process. The net result is micro
projects and a reduction of what can be claimed.
Does that make some sense?
Senator Buth: Micro projects and a reduction in what can be claimed?
Mr. Roberts: What can effectively be claimed. It does not change the
entitlement; it changes what you are able to effectively put into a claim to the
point where many people drop out of the program or are not interested in it
because of the sheer work required to do so. It explains why the number of
consultants is up to 70 per cent of the claims. That was not the case five years
ago. Consultants are saying that it has become sufficiently complex and you need
Senator Buth: I am a curious just about the comment that one third of
the claims are retrospective.
Mr. Roberts: It is approximately that.
Senator Buth: Part of what the government is trying to deal with is to
move toward incentivising research, which is what the savings from SR&ED will be
Mr. Roberts: Except they have not approached that issue. They have
done a series of changes within the structure of the quantums, while they have
not dealt with the claims that are retrospective. You have a system right now
where you can file up to 12 months after the six-month point when the T2 is
filed for your corporation. That gives you a minimum of 18 months on a file.
These projects are often started before that. You end up with people like myself
examining the development work that the company has done, figuring out where R &
D was being done and then developing a claim around that, rather than it
influencing and having it already influenced the decision making to do that
It is basically a claim which generates tax revenue, but it did not have much
influence on the way people thought about R & D in the decision making. As we
would work with companies, we would get out of that situation because we would
put in systems so the company could recognize it. The intention is that more and
more the company take responsibility, and often we develop claim processes that
In principle, you would move outside of those claims as you work with
companies as a practitioner. That is another part of the story, but still, every
year, a large number of claims are retrospective and those are terribly
difficult to support because they are after the fact. They were not documented
with the SR&ED program in mind, and that is where, for most of us, the major
issues of the claims have come from. Last year when we were making proposals to
the Department of Finance and the government on this, a number of practitioners
identified this as an interesting and serious cost-efficiency to the program.
They go beyond CATA in that respect.
Senator Buth: The savings from the SR&ED program as announced in
Budget 2012 will go toward direct support. I am curious about your comment on
direct support. Mr. Monk, you made a comment, but I am not sure whether the
members are in favour of direct support or whether it was Mr. Roberts. Could you
both comment on that? Clearly the government is committed to that fund for
direct support and will move toward how they are going to disburse those funds.
I am curious to hear your comments.
Mr. Monk: We had been promoting measures to improve productivity for
several years when we appeared before the House of Commons Standing Committee on
Finance, and part of that is SR&ED program. We know the SR&ED program is a
flagship for our innovators in Canada. We also know, based on research, that we
are not moving the bar from a productivity perspective for Canadians. We are
encouraged by changes. There is no point in doing the same thing over and over
again if it will not make the change. We wholeheartedly agree with intention of
taking 5 per cent out of the credit system for large corporations and putting
that toward other incentives or measures to improve productivity. The issue is
that we do not know what the results will be for some of these and perhaps there
are more that could improve productivity; we will be suggesting more when we
appear before the House of Commons Standing Committee on Finance soon. We have
other suggestions as well, including the patent box that Mr. Roberts mentioned.
That is the issue we have. At the moment, the issue is not with a change from
20 to 15 or eliminating the capital expenditures from the inputs of the
calculations for expenses that qualify. The issue is what happens with those
Senator Buth: Thank you very much.
The Chair: Perhaps this is a good time to get an explanation of this
innovation box or patent box. What is this all about?
Mr. Monk: I am sure Mr. Roberts has more information than I do, but
the patent box is a program that is throughout some countries in northern
Europe, and the U.K. is bringing it in, in 2013. Revenue earned from patents is
taxed at a more favourable rate than regular revenue. It gives a favourable tax
rate for direct revenue earned from patents. It is a fairly complicated process,
but that is essentially the issue.
The Chair: Mr. Roberts, is that okay?
Mr. Roberts: I agree that is exactly it.
The Chair: The terms ``innovation box'' and ``patent box'' are the
same? Does it have to be an actual patent or something less?
Mr. Roberts: That is the point of using the word ``innovation.'' It
depends on which country you are in. Some focus only on patents, and we think it
needs to be broader. Others focus on innovative design and copyright, et cetera.
It is getting that box right. That is why we used that phrase and other
countries are as well. The process of getting to effective box, whatever it is,
understands what to include, how you spin off and what your country is able to
do in Canada.
The Chair: You are recommending that, but we have not seen it in
Mr. Roberts: Yes. It needs to be worked on closely and discussed by
leading experts to get to the right box.
Senator Hervieux-Payette: I will wait until the gentleman can hear me.
I just wanted to tell you that it is not out of laziness but rather because
there are people listening to us who speak French. From time to time, it is nice
for them to be able to hear our language.
I am trying to understand your last three lines, Mr. Roberts, where you say:
The CRA's focus is now on the science research model that is making the
program irrelevant to many historical users of the program. Without
attention to how the program is managed, our efforts and yours may become
If I am interpreting this correctly, it does not seem very positive, and I
was wondering if everything that is called ``research and development'' should
be considered equally for the purposes of government assistance.
I am thinking for example of new engineering technologies; new engineering
uses in plants, whether it be in aluminum plants or manufacturing plants, as
opposed to the aeronautics sector, the biotechnology sector or even the computer
sciences sector. In the case of computer sciences, paragraph 9(11)(d)(i)
To acquire, from a person or corporation, an asset that is the capital
property of the taxpayer, [. . .]
The same formula is there, except that the expenses are not broken down in
the same way, certainly not in relation to the percentage. When one works in a
factory and wishes to create a new product, a pilot project is often launched,
which requires material and new equipment. What I understand is that it will no
longer be possible to obtain a tax credit for this equipment, but only for the
person using it. However, the equipment will often cost 5, 10 or 20 times more
than the person using it.
How then can we increase productivity? Because that is where we can really
increase productivity: with new equipment, new ways of doing things that are
more closely linked with engineering than with information technology where, in
the end, it all comes down to the intellectual ability of people to create new
programs, and they do not have to invest much.
In biotechnology, more technical equipment is needed. In aerospace — I am
thinking of the Bombardiers of this world — to develop new things, new designs
and new drafting tables are needed, but they also need templates and equipment.
Are we aiming at the wrong target when it comes to the productivity of the
entire Canadian manufacturing sector?
Mr. Roberts: The way it is currently written or in the future?
Senator Hervieux-Payette: What I see when we are excluding.
Mr. Roberts: The way the legislation is currently written, it has
historically been focused on supporting the capital expenses associated with the
prototyping, et cetera. That has been very much captured. I mentioned earlier
that the impacts of these changes hit very hard on the biotech claims, and any
of the prototyping that goes on in the IT sector, as well. That zone is
In terms of a balancing and redistribution, we have said that if that is
being picked up by new proposals with the next budget, basically we need to see
what they are to see how it fits together before we can comment. It is
conceivable that a more effective regime, or sets of regimes, can pick up on
what is now being not supported as effectively by these proposals with other
ideas like the patent box, which would help to pick up what you are talking
about — it would have picked up the capital associated with those production
Senator Hervieux-Payette: Would you see a complement to this budget in
2013 — that this one would just be part of the changes? When you talk about the
next budget, which one are you talking about — this one or the one after this
Mr. Roberts: We hope we arrive quickly at an understanding of how the
SR&ED integrates with other measures. Right now, you are correct: These
proposals do lead to a gap. That gap is particularly around the capital expenses
associated with starting up a new technology and getting it going, as you are
saying. If measures are put in place that pick that up, then there is
potentially a good balance. It may be better targeted and maybe even less
cumbersome than some of the aspects of the current legislation in SR&ED. We made
the current legislation in SR&ED work, as it was. In my view, that is not a huge
issue, but it still was complex. Does that help?
Senator Hervieux-Payette: The other question would then be this: Is it
well balanced between research and development in terms of the way the program
will now be applied? Will we see more development and more commercialization
with these measures, or are we missing the target?
Mr. Roberts: In our opinion, without another complementary program, it
is imbalanced now.
Senator Hervieux-Payette: Thank you.
Senator Bellemare: You mentioned, during your presentation, that the
United Kingdom in particular tends to offer higher incentives than those offered
in Canada. You spoke of the patent box; are there other things that are done,
particularly in the United Kingdom, to support research and development?
Secondly, do you take into account the fact that under the SR&ED program as
we knew it, businesses in the new technology sector incorporated tax credits to
fund the payroll of their employees? That is always a bit sensitive because
research and development is something that we wish to encourage on an ongoing
basis; but at the same time, when one funds salaries that could also contribute
to production, is there not a way of separating them?
Do you consider that the program, as it has been in the past, allowed for
overspending because salaries were funded, for example? In other words,
businesses could have funded them anyway without the tax credit; are there not
new ways to encourage research and development other than funding salaries?
Mr. Monk: With respect to the U.K. patent box, or the innovation box,
there have been other countries, as well. We are suggesting not necessarily
implementing that; we are suggesting that it be reviewed with a Canadian
perspective to see if that would also be another measure that may incentivize
investment and productivity and so on. It is just another measure.
There are several other measures, as well. Australia has a lot of programs in
place, such as commercialization. They have several separate programs where they
offer grants to start-ups. Some are on a 50-50 basis and repayable by royalties
from the new products that have been processed. Israel has a technological
incubator program you might be aware of that has been going for several years
and has seen 1,200 success stories come out of there.
There are many areas to be looked at from a Canadian perspective to see if we
can, along with SR&ED, improve productivity. That is where we are coming from in
that regard with the patent box.
With respect to payroll, many companies have large pools of tax credits and
cannot use them up because they do not have taxable income, the credits are not
refundable. The large companies accumulate these pools, and some go on for quite
a while and do not take advantage of that tax relief that can come for the
smaller companies that have the refundable credits.
The other issue is because of the complexities of the administration there is
quite a time lag. Mr. Roberts mentioned it could be up to 18 months by the time
you incur a cost and get a credit to be recorded. If payroll is part of the
cost, you could be outlaying money before receiving anything back from the
Senator Bellemare: Thank you very much.
The Chair: I had not heard you comment on the reduction from 65 per
cent to 55 per cent for the overhead costs and the simple way of doing it,
called a proxy method, as opposed to the detailed method of calculating the
overhead. Is that a major factor? Is that a reasonable initiative?
Mr. Monk: We think so. A corporation investing in SR&ED can calculate
the actual amount. Again, they would have to have systems in place to capture
that, but most companies now are fairly sophisticated and have good accounting
systems. They still have the opportunity of doing the actual overhead
calculation. The proxy amount coming down by a little bit may incent people to
be more accurate, using actual figures as opposed to a proxy figure.
Mr. Roberts: Basically we would say the same thing. Going from 65 to
55 per cent probably in many situations brings you to the point where going over
to what is termed the traditional becomes appropriate for a company to figure
out if there is an advantage to it. It was close to it for many companies
actually at 65 per cent, in my experience. You just go with the proxy because it
was easier. By lowering it, you have not simplified. You now have companies
needing to go through both approaches to see which benefits them the most.
The Chair: You indicated as well a concern about money going out to
the third parties, and there is provision in here, I understand, that reduces
the profit portion to any third-party contracts. Is that a reasonable way to
deal with what is perceived as a problem of too much of the funds going to third
Mr. Roberts: I was just thinking about my experience. Normally the
market defines the cost of those contracts, so I think the market tends to work,
but there are exceptions. That is the way to put it. By dropping it to 80, you
are bringing it down to what is anticipated to be close to the normal markup.
You are legislating a standard. In that sense, it probably stabilizes the points
you are making. In other words, you have less of an opportunity to raise the
rate, the amount, and inflate the contracts. There would be less of a chance to
The Chair: You might be inclined as a third party to put more into
overhead than you otherwise would have.
Mr. Roberts: It comes down to simply how well the market is working.
Senator Cordy: Mr. Roberts, you were speaking about the SR&ED Program,
and in your written documentation to us you talk about the fact that it is
becoming more and more complex and that the CRA is out of synch with IT
projects, with complex engineering projects, and you are saying it is becoming
irrelevant to many historical users. What changes should be made so that SR&ED
is in fact up to date, modern and able to deal with more complex engineering
projects, as you said? Certainly with the phenomenal changes we have in IT over
the past number of years, it seems that CRA has not changed in the way it deals
with the SR&ED Program. I think you said 70 per cent of the people applying
require assistance of consultants. It should not be the case with government
programs to have 70 per cent of the applicants hiring a consultant in order to
understand how they can access funding. What do we have to do?
Mr. Roberts: The first critical step is to find a way to have
companies focus on SR&ED as they start the projects rather than going back and
trying to find the SR&ED in what has been done in a company. There are a number
of mechanisms for doing that. We had suggested ones for the last budget in our
discussions, but that is critical.
It has been proposed that CRA will provide upfront confirmation that it is
SR&ED as you file. This will help. There are ways of going at this. If you can
get companies to recognize their SR&ED projects at the beginning and to study
and follow their timeline and what is happening and mark milestones, then it
becomes much easier and better for both parties. That is the beginning of it.
We have been discussing the issue as to what SR&ED is with CRA. The community
has been discussing this with the new policies they have been developing. What
we saw a year ago certainly did not get there at all. Our hope now is that those
policies will clearly show that SR&ED is effectively operational in an
engineering environment and how to do it. We are waiting to see that.
Mr. Monk: I understand CRA is looking at this whole issue now, which
is very good, and I agree with Mr. Roberts' comments. One of the other things to
improve or reduce the complexity or the administration of it is to look for ways
to get these tax credits, especially the ones that will be refundable, to the
smaller companies sooner than, in some cases, almost two years. It is a long
time to cash flow your business. That would be something to look at, and there
may be ways of doing that through pre-approvals. There are ways it could be done
with interim filing and that type of thing.
Senator Cordy: Two years is a long time for a start-up company.
Mr. Monk: It is very long, and most of them have no revenue stream yet
other than funds from family, friends and interested bankers, and these SR&EDs
are receivables on the financial statements that take a long time to collect.
The Chair: I hear you both say that you recognize changes should be
made and changes are being made but it would have been nice if you knew where we
were going as opposed to changing and then saying we will just keep talking
about this. That is the same message we got from the last group, and you heard
that discussion. There are ongoing discussions, and changes are being made to
the existing situations, but we do not know where we will end up. Is that a fair
summary of the discussion this morning?
Mr. Roberts: I would agree.
Mr. Monk: I would agree, Mr. Chair.
The Chair: Thank you very much, Mr. Roberts and Mr. Monk. This has
been helpful. We understand what you have told us, and I do hope your
negotiations and discussions on a new program are what you are looking for. In
that case, we will probably have you back with the new legislation when it comes
Honourable senators, this is meeting is now concluded. We will meet again
this afternoon on finishing up with the government officials in the last two
sections of Part 4 at 2:15 in this room.