Canada: Wake Up To Tax Laws

The media spotlight on the "public policy" limitation on film tax credits in Bill C-10 may have eclipsed a more serious concern that we are being taxed without adequate democratic representation.

The recent debate on Bill C-10 has highlighted the fact that tax bills do not get the level of scrutiny they deserve. Since the now-infamous film tax censorship provision was initially proposed by the Liberals in 2002, no MP had noticed the "public policy" limitation until its existence was revealed by the media. In all fairness, it is hardly surprising that MPs do not bother with tax bills, as tax legislation is typically drafted in an incomprehensible style.

Since most MPs are likely unable to express an enlightened opinion on most rules contained in tax bills tabled before the House, such as Bill C-10, it seems that the legislative process has been abdicated to the unelected officials of the Department of Finance. To a certain extent this makes sense: Finance employs experts in tax policy and legislative drafting. This, however, does not mean that all tax rules drafted by them are well designed and adequately balance the interests of all Canadians. In this respect, several tax measures contained in Bill C-10, apart from the "public policy" limitation on film tax credits, are beset by serious problems. One is the set of anti-avoidance provisions which concern non-resident trusts (NRTs) for, and investments in, foreign investment entities (FIEs) by Canadians, which have been criticized as being unnecessary, unworkable and excessive in light of the narrow scope of the tax avoidance concerns at issue.

Another ill-conceived set of tax rules concerns restrictive covenants, such as a promise by a seller of a business to not compete with the purchaser. This legislation was first proposed by a news release in October, 2003, in reaction to a court decision, which ruled that the price paid for a non-compete is tax free. Simple and narrowly focused rules to reverse this ruling would have been sufficient and were widely expected by the tax community.

However, when Finance finally issued draft legislation in February of 2004, tax practitioners were stunned by the complexity, inappropriately broad scope and punitive effect of the restrictive covenant rules. The ensuing outcry received only a lukewarm reaction from the officials at the department. An updated draft in 2005 addressed some of the most outrageous and unworkable aspects of the legislation, but increased its complexity and left unresolved several patently unfair facets of these measures. Pleas from the tax community for a complete reevaluation and redraft of the provisions were ignored.

Despite that, these restrictive covenant rules apply to almost every good-faith sale of a business with potentially adverse tax consequences and increase transaction costs for businessmen in everyday transactions, this legislation has received no public attention and is likely unknown to MPs. Of course, Finance seems to prefer it this way.

Clearly, there is a vacuum in Canada's legislative process concerning tax laws, which surprisingly seems to be being filled in recent months by the unelected Senate. Traditionally, for both practical and constitutional reasons, the Senate's role in the Canadian legislative process has largely been that of a rubber stamp. However, recent initiatives to overhaul and potentially abolish the upper house of Canada's Parliament seem to have spurred a self-preservation reaction from Canadian senators, who have taken more seriously their role of providing a sober second look at bills coming from the "Other Place."

This is what is currently transpiring with Bill C-10, which is being closely examined by the Senate's committee on banking, trade and commerce. When the bill was first discussed by the committee in December, 2007, the members scrutinized the NRT and FIE measures and contrary to the Department of Finance's assurances that everything is hunky-dory, found certain serious flaws in them.

In particular, the senators focused their attention on an aspect of the NRT rules that could effectively treat an investment, say by a Canadian pension fund, in a U.S. business carried on through a U.S.-formed business trust, similarly to a tax-haven trust owned by a Canadian family. This issue caught the attention of the Senate committee because it effectively curtails the investment opportunities of Canadian pension funds. It led to the committee's virtually unprecedented decision to not rubber stamp the bill, but instead to ask the government to return with a solution.

Before the Department of Finance could propose an amendment to the NRT rules, "censor-gate" came to light and the Senate took it upon itself to give a fair hearing to all concerned parties. Notwithstanding that, the Senators have made it clear that the Commons "did not do their job in the first place" in actually "reading" Bill C-10 and they may well restart the legislative process by returning the bill to the Commons with an amendment to the "public policy" limitation on film tax credits. An amendment would also be required to fix the NRT issues noted above. And while it is at it, it is hoped the Senate could also look into the various other problematic measures, such as the FIE and restrictive covenant rules, contained in Bill C-10.

The Senate's willingness to jump in and seriously examine the rules contained in Bill C-10 is a most welcome check and balance on what heretofore has been a free ride for Finance.

Aside from the high-profile censorship issue, the controversy surrounding Bill C-10 has, as suggested herein, also exposed some fundamental issues with the process of making tax laws in Canada in general. It is hoped that in the aftermath of Bill C- 10, the elected House of Commons will be dedicating the level of scrutiny that tax laws deserve to ensure that Canadians are taxed pursuant to clear, fair, well-designed and democratically approved tax laws.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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