Budget 2015 – tax policy issues for consideration
Dear Minister Oliver,
Budget 2015 will provide the Government of Canada with an opportunity to continue its commitment to improving economic prosperity for Canadians. Canada has maintained relative economic stability despite the recent challenges of a slow global recovery and sovereign debt issues in Europe. Despite some improvements in the global economy, we believe that sustained economic growth in Canada will be impeded without improvement to our nation’s lagging productivity, as discussed in our report series The Future of Productivity1.
Canadian tax policy can play an important role in helping Canada to be more productive and globally competitive by creating a tax ecosystem capable of fostering innovation and investment while supporting the objective of a balanced budget. The available mix of taxes — corporate, personal and indirect — allows the Government to encourage economic growth through targeted tax incentives or allowances while allocating the tax burden across elements of the economy in a fair and equitable manner.
As Canada requires capital that must be sourced from outside of our borders, fiscal policy must ensure that Canada remains competitive in attracting foreign capital. Recent legislative changes – as well as the anti-treaty shopping proposals in the 2014 budget – risk discouraging foreign investment by creating uncertainty as to the interpretation and scope of these proposals.
Accordingly, our policy recommendations for Budget 2015 can be summarized in six broad categories:
- Protect Canada’s competitiveness regarding inbound investment
- Consider introduction of patent box model
- Spur a “start-up economy” with improved financing support
- Encourage foreign investment through full refundability of SR&ED tax credits
- Attract and retain the world’s most talented people
- Enhance certainty through efficient tax administration
DELOITTE’S BUDGET 2015 RECOMMENDATIONS
1. Protect Canada’s competitiveness regarding inbound investment
Canada’s competitiveness in terms of attracting inbound investment must be protected. We are concerned that the anti-treaty shopping proposals contained in the 2014 budget would, if enacted in their current form, hurt Canada’s ability to attract such investment by being too far-reaching and creating significant uncertainty as to the tax consequences of inbound financing arrangements. Foreign investors may choose to invest elsewhere. Since the announcement of the anti-treaty shopping proposals, we have observed that the uncertainty has negatively affected investment decisions and may discourage inbound investment into Canada.
Canada is a small, open economy and has capital needs well beyond that which its residents can provide. Foreign investors have a broad range of opportunities as to where to invest their capital. Thus, introducing Canadian tax policy changes, such as the anti-treaty shopping proposals, that create uncertainty and reduce investment yields will undermine foreign inbound investment into Canada. To attract foreign capital, Canadian projects generally must support higher potential yields than comparative investments located in the home country of a capital source (e.g., the United States). This is a particular issue for the energy and resources sector, given this sector’s significant need for and difficulty in accessing capital. We refer you to our submission on the anti-treaty shopping proposals2 for a more in depth discussion of our concerns with the anti-treaty shopping proposals. We are encouraged by the fact that on August 29, 2014, the Department announced that it was not, at that time, moving forward with draft legislation regarding anti-treaty shopping until further work has been done by the Organisation for Economic Co-operation and Development (OECD) in this area.
In the context of inbound investment as well as in considering the broader base erosion and profit shifting (BEPS) initiative, we would recommend that unilateral actions that are not coordinated with Canada’s trading partners could adversely impact competitiveness and should not be undertaken.
2. Consider introduction of patent box model
The global competition to attract research and development (R&D) spending has increased significantly in recent years. Not only are countries adopting or expanding R&D tax incentives to promote research activities but they are also providing new tax incentives to encourage the commercialization of that R&D, as outlined in our recent report Global Survey of R&D Tax Incentives3. These incentives, often referred to as “patent boxes”, allow corporate income related to the sale of patented products to be taxed at rates which are significantly lower than the rates applied to regular business income. This preferential treatment of IP income is meant to provide firms with a stronger incentive to innovate and commercialize the innovations domestically 4.
As identified in our 2011 productivity report Future of Productivity: An eight step game plan for Canada5, Canada’s patent intensity has been poor when compared internationally, despite a strong performance in academic research. To encourage companies to commercialize and retain patents in Canada, we recommend that the Government study whether a patent box regime should be implemented in Canada. Our country may be at a competitive disadvantage without such a regime as a number of Canada’s trading partners that are also members of the G20 (e.g., the United Kingdom, China and France6 ) are continuing to utilize and support these regimes. In addition, based on the OECD’s recent report Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance7 released in September, it appears that patent box regimes will survive the OECD’s BEPS initiative, although the recommended structure of the patent box is still being debated8. In fact, recently, Ireland, Italy and Switzerland have announced new and/or improved IP regimes. In addition, the United Kingdom and Germany have announced an agreement as to the structure of these regimes going forward.
3. Spur a “start-up economy” with improved financing support
In the OECD’s report Supporting Investment in Knowledge Capital, Growth and Innovation, private sector risk capital is recognized as playing a critical role in supporting business growth, innovation and new employment creation 9. Also, as identified in our 2011 productivity report10, one of the factors contributing to Canada’s relatively low productivity is the lack of capital for start-up enterprises. From early seed financing through to initial public offerings, it is our observation that Canada’s financing ecosystem does not provide enough support to home-grown enterprises with world-class potential. As a result, start-up firms may not be able to secure financing and may be leaving Canada for jurisdictions where risk capital is more readily available.
We encourage the Government to commit to a long-term strategy for a successful venture capital community. Although the Government’s new funding announced in the 2012 federal budget is an important step in the right direction, it is our view that this one-time contribution of funds is unlikely, in and of itself, to be adequate support to create a vibrant self-sustaining venture capital ecosystem.
We believe that the first priority in enhancing Canada’s financing regime should be to improve support for the early stages of innovation when risks are higher, as we have previously noted in our comments11 on July 27, 2012 to the Department of Finance in response to the Government’s request for feedback on the issue of support for venture capital. We strongly recommend the introduction of an angel tax credit. Targeted credits will serve to encourage investing in high-growth small businesses by mitigating the risks associated with these investments. An angel tax credit is the logical starting point for the creation of a sustainable venture capital industry financed by the private sector and it is the incentive that can have the greatest impact on growing our economy.
4. Encourage foreign investment through full refundability of SR&ED tax credits
While innovation is one of the most important contributors to persistent and sustained economic growth and a key solution to Canada’s lagging productivity, Canada’s position as a leading global destination for innovative businesses is under threat. To enhance Canada’s global attractiveness and encourage foreign investment, we believe that the scientific research and experimental development (SR&ED) investment tax credit (ITC) should be made refundable for all corporations carrying on business in Canada, rather than only for certain private companies. In our prior submissions12 to the Department of Finance, we have recommended a broad based extension of ITC refundability to all businesses. While we continue to support that goal, in light of the important objective of balancing the budget, we recommend the Government consider offering partial refundability to all businesses at this time.
Currently, only qualifying small Canadian-controlled private corporations may claim a refundable credit while all other companies only receive the benefit of the ITCs in years with corporate taxes payable. Long-term planning is made difficult for these organizations as many operate in cyclical industries and cannot predict the years in which they will have sufficient corporate tax liability to make the SR&ED tax credits of any value. Expanding the refundable credit to all corporations would appropriately reward the risks inherent in performing R&D in Canada, communicating a strong message to foreign companies seeking new investment opportunities.
In addition, Canadian companies that are subsidiaries of U.S. parent companies and perform R&D in Canada benefit from the SR&ED ITCs only as a timing difference and not a permanent savings. Although they benefit from the Canadian SR&ED ITCs reducing their Canadian tax payable, ultimately a parent company’s U.S. tax increases when funds are repatriated from Canada to the United States due to the U.S. foreign tax credit rules. If the ITCs were refundable, from a U.S. tax perspective, they would not reduce Canadian tax otherwise payable but rather would reduce the R&D expenditure.13 Thus, for many of these U.S.-based multinationals, refundability means the difference between the incentive being a permanent tax savings and a tax deferral which can be a powerful distinction in perceived value.
Therefore, we recommend that the government implement a model of refundability for corporations currently not eligible for refundable ITCs that allows these corporations to earn at least partial refundability of ITCs if they meet certain requirements. For example, a corporation could receive partial refundability of SR&ED ITCs if it can demonstrate an increase in its labour force over a prior period. This approach would support the creation of employment in an important sector of the Canadian economy, and would align with the Government’s goal of increasing the number and types of jobs for Canadians.
Enhancing the Government’s support for innovation through the SR&ED incentive program is a critical step that will allow Canada to be a leader in innovation, both in the knowledge economy and in new technologies designed to exploit energy and resources.
5. Attract and retain the world’s most talented people
A key focus must be attracting and retaining the individuals most likely to drive innovation in the economy and improve Canada’s productivity. Accordingly, we encourage the Government to focus on enhancing the competitiveness of the personal tax regime, improving immigration policies and encouraging retirement savings.
Increase top personal tax rate threshold
Attracting and retaining globally mobile and highly productive individuals depends upon many factors —not only economic drivers. Canada is a wonderful place to live and a stable environment in which to raise a family. These factors are already a powerful source of attraction to Canada. We believe, however, that more individuals would stay in Canada or move to Canada if the Government were to increase the threshold at which the top rate of tax begins.14
The suggested changes to the personal tax thresholds can be scheduled over the next five to ten years, starting when the budget is balanced. However, a signal of this intention now would be attractive to Canadian residents and potential immigrants. To the extent that the adjustment to the top threshold resulted in an overall reduction in personal income tax collected, we believe that the shortfall could be recouped with consumption taxes, which are low by global standards.
Recently, the Government has introduced a proposal for income splitting for couples with children as a tax-saving measure for individuals. We would suggest that the Government place a higher priority on adjusting the personal tax rate threshold. This adjustment would have a more positive impact to a broader group of taxpayers.
Increase targeted immigration – meeting Canada’s future needs
With Canada’s aging population and skills shortage, our country’s human capital needs should be articulated in a reasoned and practical multi-year plan aimed at increasing immigration to fill gaps in the Canadian workforce and to support a sound knowledge base. We applaud the Government for already announcing steps to transform Canada’s immigration system to ensure that more individuals with necessary skills will have ready access to the appropriate sectors of the Canadian economy. We encourage the Government to continue improving the immigration process by increasing overall targets and sharpening existing programs. It is vitally important that we are able to meet skill shortages in an expedient fashion in order to maintain a competitive position in the global marketplace.
Increased immigration to Canada by individuals who are educated, productive and innovative will not only improve the ability of Canadian enterprises to compete globally, but will also enhance government revenues from corporate and personal taxation. A larger population of well paid, skilled individuals will contribute significantly to an increase in the overall amount of personal taxes collected.
Encourage retirement savings – planning for tomorrow
Canadians still do not save enough for retirement, with more than $700 billion in RRSP contribution room remaining unused.15 Although the Government has recognized the importance of encouraging retirement savings, new approaches are needed, as noted by Deloitte and others before the Standing Senate Committee on Banking Trade and Commerce. A specific proposal put forward by Deloitte to the Committee is a flow-through of the tax benefit of certain forms of income (e.g., dividends paid by Canadian corporations and also the capital gains preference) when withdrawn from Canadian retirement vehicles. We strongly encourage the Government to introduce creative and appropriate incentives to increase savings such as the recommendations outlined in The Final Report of the Standing Senate Committee on Banking, Trade and Commerce, Canadians Saving for their Future: A Secure Retirement.
Enhancing Canada’s incentives for retirement savings will further improve the attractiveness of Canada to new immigrants. Thus, we recommend that new immigrants be allowed to contribute to their RRSPs in the year that they arrive in Canada. Currently, since earned income is measured on a one year lag basis, new immigrants can only contribute to their RRSPs in the year following their arrival into Canada. Allowing a carryback of contributions made in the first four months of the following year for new residents with deemed contribution room based on their first year eligible income would allow an efficient mechanism to encourage such activity.
Furthermore, we recommend moving out the age that triggers mandatory minimum withdrawals from registered retirement income funds (RRIF). As discussed in the C.D. Howe report Outliving Our Savings: Registered Retirement Income Funds Rules Need a Big Update17, life expectancy rates for Canadians have increased but the rules for the age at which mandatory withdrawals are required have not. With people expecting to live longer after retirement and lower returns on investments, RRIF holders are in danger of inadequate tax-deferred savings in their later years. Adjusting the age at which withdrawals are required would help solve this problem.
6. Enhance certainty through efficient tax administration
Tax administration plays a key role in advancing competitive tax policy.
Sound tax policy requires efficient tax administration. Moreover, certainty in tax law is essential to attracting and retaining corporate investment and global talent. The tax community as a whole - revenue authorities, taxpayers and tax advisors - all benefit from a clear understanding of the law at any point in time. In this context, we respectfully offer the following recommendations:
- Administrative red tape and filing complexities should be reduced to create a more competitive business environment. For example, foreign employers are currently required to withhold tax on employees who have Canadian business days regardless of whether or not they are subject to tax in Canada.
- Increased resources for the Canada Revenue Agency (CRA) together with streamlined processes to enhance the timely completion of audit activity would reduce frustrations associated with carrying on business in Canada. Resolving stale issues is very resource-intensive given normal labour turnover and the erosion by time of memories, whether personal or corporate. In addition, with the likely introduction of new rules and increased transparency globally as a result of the BEPS project, the volume of tax disputes is likely to increase globally. As such, increased investment in areas that help resolve disputes (e.g., competent authority, advance pricing agreements, mutual agreement procedures, rulings, appeals, voluntary disclosures, etc.) will be required. Increased use of technology, in particular data analytics, can also assist in making audits more efficient. Increased training and ensuring that assessments continue to be principled and based on enacted law would also be welcome.
- While not within the exclusive purview of the Department, we believe that the relationship between the CRA, business, and the broader tax community could be improved. We would welcome forums that allow for greater communication between the CRA, the Department of Finance, taxpayers and tax practitioners. Improving communication should enhance certainty and allow for increased efficiency in both compliance with and administration of the tax legislation.
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Deloitte is committed to playing a key role in shaping Canada’s future. We trust that our policy recommendations will provide helpful guidance as you move forward with Budget 2015. We would be happy to meet with you personally or with anyone you suggest from the Ministry of Finance to discuss any of these matters further.
Albert Baker, FPCA, FCA
National Tax Policy Leader
Copies to: Mr. Brian Ernewein
General Director, Tax Policy Branch
Department of Finance Canada
Mr. Andrew Marsland
Senior Assistant Deputy Minister
Department of Finance Canada
4 Atkinson, R.D. and S. M. Andes. “Patent Boxes: Innovation in Tax Policy and Tax Policy for Innovation.” The Information Technology & Innovation Foundation Report. October 2011.
6 Other countries with patent box regimes include Belgium, Hungary, Ireland, Liechtenstein, Luxembourg, the Netherlands, Spain and Switzerland.
7 OECD, Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance (Paris: OECD, September 2014), http://www.keepeek.com/Digital-Asset-Management/oecd/taxation/countering-harmful-tax-practices-more-effectively-taking-into-account-transparency-and-substance_9789264218970-en#page1.
8 The issue of patent boxes was addressed during our appearance before the House of Commons Standing Committee on Finance on October 27, 2014 for the pre-budget consultations (http://www.parl.gc.ca/HousePublications/Publication.aspx?DocId=6742252&Language=E&Mode=1&Parl=41&Ses=2).
9 OECD, Supporting Investment in Knowledge Capital, Growth and Innovation (Paris: OECD, October 2013), http://www.keepeek.com/Digital-Asset-Management/oecd/industry-and-services/supporting-investment-in-knowledge-capital-growth-and-innovation_9789264193307-en#page1.
13 Even delayed refundability (e.g., refunding ITCs if not used within three years) would achieve the U.S. tax benefit with a modest cost to the Government.
14 Murphy, Robert P., Jason Clemens and Niels Veldhuis, The Economic Costs of Increased Marginal Tax Rates in Canada, Studies in Budget and Tax Policy at the Fraser Institute (Vancouver: Fraser Institute, October 2013). This study compares the competitiveness of Canada’s top personal tax rate with that of the United States. Although Canada’s top federal rate is lower than the U.S. federal rate, when the combined federal/provincial personal tax rate and the threshold at which the top tax rate applies are considered, the study concludes that Canada is not competitive.
15 Statistics Canada. CANSIM table 111-0040.
16 Some of the recommendations from this report include: encouraging multi-employer pension plans, ensuring withdrawals from RRSPs, while taxable, have no impact on eligibility for the amount of federal income-tested benefits or tax credits, allowing contributions to RRSPs to be made until the age of 75, and educating all Canadians on the importance of saving for retirement.
17 Robson, W.B.P, and A. Laurin, Outlining Our Savings: Registered Retirement Income Funds Rules Need a Big Update, C.D. Howe Institute E-brief (Toronto: C.D. Howe Institute, June 4, 2014), http://www.cdhowe.org/pdf/e-brief_175.pdf.