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May 1985, the Department of Finance advanced the debate by issuing a discussion paper entitled A Corporate Loss Transfer System for Canada, outlining a proposal to remedy this deficiency in Canada’s tax system. TEI commented on the Department’s 1985 paper and has subsequently raised the issue in multiple forums and in liaison meetings with representatives of the Department of Finance.

            We urge the Government to move forward to implement a loss transfer system.

Background

            TEI is the preeminent international association of business tax executives.  The Institute’s 7,000 professionals manage the tax affairs of 3,000 of the leading companies in North America, Europe, and Asia. Canadians constitute 10 percent of TEI’s membership, with our Canadian members belonging to chapters in Calgary, Montreal, Toronto, and Vancouver, which together make up one of our nine geographic regions, and must contend daily with the planning and compliance aspects of Canada’s business tax laws. Many of our non-Canadian members (including those in Europe and Asia) work for companies with substantial activities in Canada.  The comments set forth in this letter reflect the views of TEI as a whole, but more particularly those of our Canadian constituency.

            TEI concerns itself with important issues of tax policy and administration and is dedicated to working with government agencies to reduce the costs and burdens of tax compliance and administration to our common benefit.  In furtherance of this goal, TEI supports efforts to improve the tax laws and their administration at all levels of government.  We believe that the diversity and professional training of our members enable us to bring a balanced and practical perspective to the issues raised by the implementation of a loss-transfer system.

TO BE GLOBALLY COMPETITIVE, CANADA SHOULD
IMPLEMENT A FORMAL LOSS-TRANSFER SYSTEM 

            Recent federal budgets have focused on aligning Canada’s tax rate structure to become one of the most competitive jurisdictions in the world.  To accurately assess the competitiveness of the Canadian tax system and its relative tax burden, though, the government must consider not only the tax rate but also the tax base. Indeed, the government must consider all aspects of the tax system and, in respect of tax loss utilization for corporate groups, TEI regrets the Canadian system is too restrictive and subject to considerable administrative uncertainty.           

            Canada is currently one of the few developed countries in the world, and the only G7 nation, that does not have tax rules that provide some form of tax consolidation or loss transfer relief for a related group of companies.[2]  Clearly, Canada’s tax system is lagging most developed countries in this respect.[3] In evaluating the merits of a formal loss-transfer mechanism in the legislation (including its potential short-term revenue effect), the government should bear in mind that a formally legislated system will simplify, or obviate entirely, many loss transfers that are carried out routinely, though inefficiently, today.

            Specifically, the current informal ad hoc system for transferring and sharing tax losses among related Canadian companies requires companies to engage in various forms of corporate reorganizations. Such transactions are costly — requiring companies to divert time and administrative resources from other projects and incur substantial expenses — and generally depend upon administrative concessions being granted by the Canada Revenue Agency (CRA). 

            Even though CRA administratively permits related parties to transfer losses through such transactions, the tax result in any particular case depends upon the agency’s exercise of discretion and that engenders a degree of uncertainty for taxpayers.  For example, until the early 1990s, CRA routinely permitted intra-group loss utilization, but it challenged a particular loss-transfer arrangement in Mark Resources.[4]  In addition, judicial decisions occasionally prompt a pause in the issuance of advance rulings on reorganizations and loss transfers while CRA reconsiders its guidelines for administrative concessions.[5]  The Auditor General of Canada has also expressed concern about a system that depends upon administrative discretion.[6]  Despite the practical problems associated with the current administrative practices, many Canadian businesses have no choice but to use such tax-planning techniques to monetize their tax attributes.  Consequently, the adoption of a formal loss sharing and transfer mechanism in the Income Tax Act would make the administrative concessions unnecessary and provide much needed certainty of result and stability in the law; it would also reduce the potential for arbitrary results.

            As important, significant barriers impede some business taxpayers from availing themselves of the transactions and techniques that would permit them to use such losses or deductions. For example, some business reorganizations and loss transfers are precluded by regulatory restrictions thereby disadvantaging the regulated companies vis-à-vis unregulated businesses and global competitors. In other cases, the transactions necessary to effect the loss transfer may produce an ineffective management structure, which will generally result in a decision to forgo utilizing the tax loss.  In today’s competitive global environment, where investment capital and labour are highly mobile, TEI submits that the goal of achieving a tax-efficient corporate structure should not be at odds with a management-efficient structure. It is time to implement a formal tax-loss sharing and transfer system in the Income Tax Act in order to enhance the liquidity and competitiveness of Canadian businesses.

SCOPE AND FORM OF A LOSS-TRANSFER SYSTEM

            In principle, TEI believes that taxpayers should be entitled to full tax refundability of their tax losses. In other words, each corporate entity in a group should be able to monetize the tax equivalent of the loss in the year incurred to the full extent of the taxes previously paid by that entity. When recoveries from cumulative previously paid taxes are exhausted, loss corporations should be able to obtain refundable tax from other taxable corporations within the group. Indeed, the tax-recovery mechanism should extend to all tax attributes that cannot be fully utilized in a particular year.

            In 1985, the Department of Finance proposed a system to allow transfers of losses between subsidiaries and their parents or between subsidiaries within a group. To be eligible, corporations had to be taxable Canadian corporations and subject to an ownership threshold of 95 percent. The transfer of losses among the corporations in the group would be effected by an annual joint election and be restricted to current year non-capital losses. The loss corporation would reduce its non-capital loss by the amount transferred to one or more corporations within the group and the tax savings would accrue to the recipients of the loss. The recipients of the transferred loss would not be required to compensate the transferor for the loss or for the tax benefits, but if compensation were paid, the payers would not be accorded a deduction for the payment and the payee would not include the amount as taxable income.

            The Department considered three basic systems for group reporting: full consolidation, a refundable or negative tax system, and a deduction or loss-transfer system. In developing its proposal, the Department was mindful of four factors:

1. Complexity. The Department said that it was prepared to compromise on the “purity” of any single proposal in order to reduce overall complexity. Thus, although full consolidation of the members of an affiliated group of corporations was considered the most effective form of loss-transfer system (because it treats the group as though all the separate businesses of the corporate members are operated as divisions of a single entity), a full consolidated tax reporting system was rejected because of the extreme complexity such a system would engender.
    
2. Single economic benchmark. An important measure of the neutrality of a system was the degree to which the tax paid by a group of corporations was comparable to the tax paid by a single corporation operating through business divisions. The Department said that tax neutrality was important to ensure consistent tax treatment of similarly situated businesses and economic enterprises.
    
3. Effect on government revenues. The adoption of a loss-transfer system was likely to produce an adverse short-term revenue effect on both the federal and provincial governments. The Department was sensitive to the need to minimize the revenue loss.
    
4. Provincial loss transfer or consolidation systems. To achieve the full benefits of the system, cooperation from the provinces would be required to produce a harmonized federal-provincial system.  

            In its 1985 proposal, the Department decided to allow group transfers of non-capital losses on a current, single-year basis without a carryforward for pre-system losses.

            On November 6, 1985 and June 20, 2003, TEI submitted formal comments on implementing a loss transfer system.  We stated, and reaffirm today, “. . . adoption of such a system would represent a significant step forward in the effort to bring Canada’s tax policy in line with that of its major trading partners and in making the tax system and tax administration more equitable and efficient for government as well as taxpayers.” 

            Regrettably, almost 25 years have elapsed and, despite repeated urging by TEI and others, Canada has not yet adopted a formal loss-transfer system.  In addition to the concerns voiced by the Auditor General about the informal ad hoc loss-transfer system, the last two major studies of Canada’s system of business taxation have urged adoption of a legislated system in order to eliminate inefficiencies in loss utilization. Specifically, in its 1998 report, the Technical Committee on Business Taxation referred to the Department’s 1985 discussion paper as a starting point for the implementation of a formal loss-transfer system.[7]  More recently, the Advisory Panel on Canada’s System of International Taxation recommended that the federal and provincial governments work together to consider how a tax consolidation system should operate in Canada. [8]

TEI URGES THE GOVERNMENT TO ACT Immediately

            TEI believes taxpayers should be entitled to full refundability of their tax losses and other tax attributes.  As a practical matter, however, this may not be feasible given the fiscal, administrative, and policy constraints the government faces, especially with the provinces.  Accordingly, TEI urges the Department to reconsider the 1985 discussion paper and to issue a revised proposal by early 2011 and draft legislation following consultations on the proposals.  In crafting the revised proposal and draft legislation, the Department should consider the following:

1. Provinces. The federal government should harmonize any loss-transfer system with the provinces.  Concededly, such a step may adversely affect the revenue base of some provinces, but the legitimate concerns of the provinces can be ameliorated.  For example, the Department of Finance might consider permitting groups to determine their allocable provincial income (and corresponding provincial income tax liability) by applying Part IV of the current Income Tax Regulations to the combined taxable income of the entire group.[9]  If provincial government buy-in cannot be achieved, TEI recommends adopting a federal-only system. Thus, practicality should carry the day and the implementation of a federal system loss-transfer system should not be held in abeyance pending negotiations with the provinces.
     
2. Government Revenue. To minimize the short-term revenue effect, the existing pool of unutilized tax losses should not be part of the new system and should not be available for transfer from one member to another. Rather, as discussed in the 1985 discussion paper, only post implementation current-year losses should be freely transferable within the group. Any existing pool of losses at the implementation date, however, should not expire upon adoption of the new system; they should remain available to be absorbed by taxpayers to the extent that current law and current informal ad hoc techniques would permit their use.

3. Carryforwards. The current provisions for a three-year carryback period and a twenty-year carryforward period should be retained. Ideally, the carryforward period should be unlimited, as is the case for net capital losses.
    
4. Annual Election for Non-Capital Loss Utilization. At a minimum, any non-capital loss incurred by an entity within a group should be transferable in that year to any other member or members of the group that would otherwise have taxable income, or carried forward at the election of the loss entity.
    
5. Ownership Threshold. The required ownership threshold for transferring losses among related corporations should not exceed 90 percent.[10] Indeed, TEI recommends that the government consider adopting the 80-percent ownership threshold utilized in the United States.

6. Capital Losses and Tax Credits.  The legislative proposal should also address other tax attributes such as capital losses and tax credits that cannot be utilized on a current basis by a particular entity.  We recommend that companies be permitted to transfer and share capital losses with other group members.  Similarly, unused tax credits should be transferrable within the corporate group to a member or members that are able to use them.
    
7. Technical Issues.  A number of technical issues will need to be resolved in implementing the loss-transfer system.  Some of those issues were identified in the Department’s 1985 proposal and in TEI’s 1985 comments. (A summary of TEI’s 1985 comments and recommendations in respect of various technical issues is included in the Appendix to this letter.)  As additional technical issues are identified, TEI would be pleased to react to the Department’s concerns and provide comments and recommendations.

CONCLUSION

            TEI believes that the implementation of a corporate loss-transfer system has been delayed far too long and represents progressive and competitive tax policy.  We urge the Department to pick up its 1985 proposal, revise it as necessary, and issue an updated proposal for discussion in early 2011.  TEI would be pleased to assist the Department in that endeavour.  Following public consultations on the updated proposal, the Department should move expeditiously to release draft legislation on a loss-transfer system within 90 days.

            TEI’s comments were prepared under the aegis of the Institute’s Canadian Income Tax Committee, whose chair is Carmine Arcari.  If you should have any questions about the submission, please do not hesitate to call Mr. Arcari at 416.955.7972 (or carmine.arcari@rbc.com), or Rodney C. Bergen, TEI’s Vice President for Canadian Affairs, at 604.488.5231 (or Bergen@jp-group.com).

                                                                                    Respectfully submitted,

                                                                                    Tax Executives Institute, Inc.

                                                                                    Paul O’Connor

                                                                                    International President

cc:       Louise Levonian, Assistant Deputy Minister, Tax Policy Branch
            Brian Ernewein, General Director, Tax Policy Branch
            Gérard Lalonde, Director, Tax Legislation