The 2021 Canadian Federal Budget:
The Government’s Direction
After a long COVID-19 pandemic induced hiatus and occasional less formal economic updates and statements, a Federal Budget was tabled in the House of Commons yesterday, April 19. Entitled “A Recovery Plan for Jobs, Growth, and Resilience”, it is a lengthy document that no doubt will be subjected to careful and critical scrutiny in the coming days. The Budget foreshadows expansive and fiscally expensive plans to encourage and facilitate economic reconstruction and continuing development as Canada recovers from the disruptions and institutional damage inflicted by the pandemic, and in that vein has an overarching tone of social, cultural, and economic fairness of treatment and opportunity. It reflects an explicit awareness of, indeed bears witness to the importance of establishing fiscal priorities first before engagement in their execution via tax and other regulatory machinery.
Taxation
Even so, there Budget proposes or anticipates important tax changes in a number of areas, particularly concerning Canada’s fiscal and tax place in the international tax community. The following briefly outlines some of them. Those interested will wish to consult the Budget document; notable page references are mentioned, in particular Annex 6 which describes in more detail the tax measures mentioned here as well as others.
Fairness
The tone of fairness is prominent. The Government says (page 304):
Taxes help pay for the government programs and services that benefit Canadians. They provide a social safety net on which all Canadians can rely in times of crisis. And they make sure that Canada can invest in people and in helping our economy grow and recover.
A tax system in which everyone pays their fair share requires action on multiple fronts: addressing aggressive tax planning schemes; aligning our rules with evolving international norms; ensuring that digital service providers pay their fair share of taxes; and strengthening the government’s ability to crack down on tax evasion, money laundering, and terrorist financing.
In other words, fiscal priorities first, and then tax “rules” that enable the achievement of the spirit of those priorities in step with the features of the international (tax) community of nations to which Canada belongs.
“Digital” Businesses
How to apply tax rules to “customer facing businesses” and “automated digital services” businesses dominates the international tax conversation orchestrated by the OECD via its Pillar One and Pillar Two projects. A number of countries, unhappy with the pace of working towards an international consensus, have enacted unique “digital services taxes”. Even as taxes on “income”, they have features of consumption taxes in so far as their incidence and possibly manner of collection are concerned. Canada indicated its willingness to go it alone, at least for a while, in its 2020 Fall Economic Statement, which anticipated enhanced GST/HST taxation for digital entertainment services as well as a broader enhancement of taxing powers for businesses able to be conducted fully using digital modalities and consequently able to be everywhere and nowhere at the same time relative to prevailing “norms” of international tax jurisdiction. The Budget proposes suitable changes to the GST/HST for the commonly described “Netflix” tax, but also going it alone to implement a digital services tax (where business is considered to be carried on in Canada through digital modalities that make the kinds of taxable presence on which income tax relies much less necessary or relevant) pending an international consensus (page 304):
The government is committed to ensuring that corporations in all sectors, including digital corporations, pay their fair share of tax on the money they earn by doing business in Canada. Increasingly, many digital companies earn revenues from the active collection and use of Canadians’ data. In the 2020 Fall Economic Statement, the government announced that it would be moving ahead to implement a tax on corporations providing digital services. This builds on the changes announced at that time to ensure that the Goods and Services Tax/Harmonized Sales Tax applies in a fair and effective manner to the growing digital economy.
Canada has a strong preference for a multilateral approach to this issue. Work is underway to reach a multilateral agreement on cross-border digital taxation by mid-2021, and Canada is optimistic about the progress made this year. However, multilateral discussions have been going on since 2013. That is why, while Canada’s hope and preference is for a multilateral solution this summer, whether or not a deal is reached, Canada intends to act.
Budget 2021 proposes to implement a Digital Services Tax at a rate of 3 percent on revenue from digital services that rely on data and content contributions from Canadian users. The tax would apply to large businesses with gross revenue of 750 million euros or more. It would apply as of January 1, 2022, until an acceptable multilateral approach comes into effect. This would help ensure that Canada’s tax rules capture new ways in which businesses carry out value-creating activities.
The details of the new DST (pages 731 to 739), meant to apply to "revenue earned by large businesses - foreign and domestic" and not to be creditable against other tax, include the following statement about tax effects:
Treatment for Income Tax Purposes: As with other non-income taxes, the deductibility of the DST liability of an entity in computing taxable income for Canadian income tax purposes would be determined based on general principles – e.g., whether it is incurred for the purpose of earning the entity’s income subject to Canadian income tax. DST liability would not be eligible for a credit against Canadian income tax payable.
Presumably the DST is meant to apply to "foreign and domestic" businesses to be even handed in competitive terms and therefore not discriminatory, recognizing that because of the possible or even likely incidence of the tax on consumers it will function with the effect of an excise tax, i.e., an additional GST / HST, which may also be the reason why it would not generate a Canadian income tax credit. It might also be, as has been noted to me by another observer, that de-linking the tax from the income tax would be thought to take the tax outside the ambit of tax treaties.
The Government is also pressing forward with the GST/HST changes announced in the 2020 Fall Economic Statement directed to various e-commerce products and services (pages 648 to 650)
Interest Deductibility and “Hybrids”
Significant changes to the tax law are proposed to implement at least the spirit if not the letter of recommendations made by the OECD as part of its Base Erosion and Profit Shifting (“BEPS”) project in Actions 4 and 2, respectively (pages 306 and 642 to 649).
Principally, the concerns are two.
First, deductible charges are a means by which a country’s tax base may be stripped, what the Budget document refers to as “earnings stripping” and what more broadly in Canadian tax practice is called “surplus stripping”. Whether Canada has at least an anti-surplus stripping sentiment if not much more (I am in the “much more” camp) has been debated for many years – indeed reaching back to the earliest stages of income taxation in Canada from the inception of modern Federal income tax. The issue was broached questioningly but not resolved by the Supreme Court of Canada in the celebrated Copthorne tax avoidance case. Surplus stripping, in particular using deductible charges that earned the epithet “debt dumping” (by non-Canadian multinationals repositioning global debt to Canada to finance foreign investments of limited business interest to Canadian members of their groups) was the inspiration for the “foreign affiliate dumping” provision in section 212.3 of the Income Tax Act (Canada). That provision has much company in the Act directed to variations on the surplus stripping theme.
The Budget announces Canada’s intention to follow the OECD’s “EBITDA” – “earnings before interest, taxes, depreciation and amortization” -- approach to restrict interest deductions for businesses perceived to present base erosion risks from 2023 to 40% and then 30% of earnings.
Second, situations in which countries whose tax systems are engaged see patterns of facts with different legal connotations abet mismatches of tax outcomes among countries, for example resulting in amounts deductible by a taxpayer in one country not being included in the income of another taxpayer elsewhere. Again, the Budget proposes that Canada follow the OECD’s lead to address these outcomes which the European Union is also confronting through its ATAD I and II (“Anti-Tax Avoidance Directives”).
Transfer Pricing and Tax Avoidance
In a brief reference (page 308), the Budget restates the resolve found in the 2020 Fall Economic Statement to recalibrate, recondition, and maybe even rehabilitate the transfer pricing regime in the Act as well as the GAAR. There is evident dissatisfaction with the state of transfer pricing, reflected in the Budget’s specific mention of the recent Cameco Corporation case sustaining the taxpayer’s international tax planning. The Supreme Court of Canada declined to hear an appeal of the case. Equally, particularly it may be with international considerations in mind, it is thought that the GAAR deserves a critical re-examination.
In this vein, other more specific proposals in the Budget are notable. Clearly, the initiatives directed to interest deductions and “hybrids” are in the nature of specific anti-avoidances. Though interest deductions are generally determined by a taxpayer’s purpose – that is, objectively by its use of borrowed money, the proposed rules will be mechanical, geared to financially accounting determined earnings. And, quite explicitly, the anti- “hybrid” rules are intended to be mechanical and not purpose based. The Budget document makes that clear. No more mucking about with “purpose” and whether it is “objective” or “subjective” or the same as “intention” and the other mantra of that line of inquiry, it would seem, where the integrity of the tax base is considered to be so vulnerable. And, the Canada Revenue Agency is to be allocated material resources and enhanced investigatory resources with tax avoidance circumstances, notably that obscure the visibility of events and circumstances otherwise within the compass of the Agency’s interest and responsibility in administering the Act.
Tax Reporting
The Act envisages comprehensive reporting by taxpayers. But the range and the instance for reporting will become much wider and more revealing of taxpayers’ circumstances and their and their advisors’ interpretive judgments in applying the Act.
The Budget proposes extensive changes in this area (pages 306, 307 and 634 to 639), evidently inspired not only by the OECD’s BEPS Action 12, but also the law and practices of the United States, Australia, and the United Kingdom which, variously, require taxpayers to disclose transactions that present problematic tax risk more or less contemporaneously with undertaking those transactions and also to proactively report what in practice and according to financial reporting are called “uncertain tax positions”. In this context another very recent Tax Court of Canada case, Paletta, comes in for “honourable mention” (page 634); it is a “straddle case” the technique of which is now largely if not thoroughly foreclosed by “anti-straddle” rules in the Act. Tax planning and advice related to activities and events considered to be problematic often shelter under claims of advisory privilege or are not readily or timely discoverable by the tax authorities who have not been as successful as they would wish in having taxpayers explain their “tax provisions”; the most celebrated recent judicial decision is the Federal Court of Appeal’s decision in the well-known BP Canada case.
Accompany enhanced disclosure obligations of taxpayers and their advisers who assist them to devise and implement their planning are enhanced penalties for failure to disclose and in some cases a suspension of the limitation period that would otherwise run to prevent the tax authorities beyond a certain period to take assessing actions. In so far as the circumstances of advisers are concerned when they render and are accountable for advice for which a standard of opinion (in practice parlance, “more likely than not”, “should”, “will”), there is a sense of the European experience with “DAC 6” (European Council Directive 2011/16, applicable since mid-2018, dealing with international tax planning, legislated in many countries Europe and the United Kingdom) in the European Union which is directed to making tax advice, particularly where it is “uncertain”, more evident to the tax authorities. Elsewhere these developments have caused advisors to reflect very carefully on how they express themselves to their clients and, where otherwise it would apply, whether and to what extent limits on the viability and reliability of legal professional privilege are affected.
Other Proposals
There are other tax, notably excise tax (GST/HST), and related proposals in the Budget, more than a brief post can address. But this selection of Budget subject is meant to give a flavor of the Government’s mindset as it thinks about taxation in the larger fiscal and world contexts.
A Modest Comment - Process and Economic Policy
In the spirit of “fairness”, which of course is a relative notion at the best of times, the Budget offers many measures directed to social and cultural awareness and opportunity, particularly as the platform for economic sufficiency, self-sufficiency, and recovery. But, removing restrictions and barriers to opportunity is not the same thing as clearly communicating an industrial policy that will direct, facilitate, curate, and harvest specific economic growth with the country’s human and physical resources in mind. We might recall an attempt to state an industrial policy a number of years ago, in two reports with some tax ramifications: Compete to Win (2008) by the Competition Review Panel and the “Jenkins Report” – Innovation Canada, A Call to Action (2011). Both Reports focused on industrial development of one kind or another, for which Canada is suitably or even uniquely situated.
While the Budget is long on a variety of support, well-being, and encouragement initiatives, there is little in it that reflects a deliberate, systematic, focused industrial policy. Yet, it is hard to imagine the fiscal objectives for recovery and advancement being achieved without growth, specific and targeted growth, that builds on the opportunities for unrestricted economic participation that the Budget seeks to foster. In other words, what generates growth and the “spillovers” relevant for community building that growth offers? As I and other colleagues once wrote, Why Not Kenora?” (Brian Mustard, Nick Pantaleo, and Scott Wilkie, Why Not Kenora? Reflections On What Canada’s Approach to Taxing International Income Is and Could Be, Canadian Tax Foundation (2009 Conference Report); and also Nick Pantaleo, Finn Poschmann, and Scott Wilkie, Improving the Tax Treatment of Intellectual Property Income in Canada (Institut C. D. Howe Institute, Commentary No. 379 (2013))
For example, in relation to the Budget’s mention of “trade corridors”, might one of the most serious impediments to broad-based Canadian economic opportunity be the “transactions costs” imposed on businesses that would otherwise locate in hospitable and welcoming communities? Because of transportation costs, for example, is the procurement of business inputs and the cost of product outputs made prohibitive and uncompetitive simply by the costs of distance? Within the guardrails associated with trade regulation (“subsidies”), what would happen if transportation costs were supported or even absorbed? What effect might that have on businesses” locational decisions if, in the spirit of the competitive imbalances meant to be rectified by the often dubbed “Netflix” but more broadly e-commerce tax, those costs became personal costs? What might the “spillover” effects be for communities? In relation to “innovation” other commentary I have shared reflects this kind of sentiment.
We do, perhaps, need more industrial policy and at least in relative terms proportionally less process. And since the process is good process, we then possibly need, again proportionally, a much more built out and targeted industrial policy to which the process driven opportunities can be channeled with specific guidance to many who are searching for their next opportunity and who no doubt feel overwhelmed by the circumstances in which they must do it. What to do with the opportunity to do it, is really important. Who is going to do what and how, and how does that happen?
- Professor Scott Wilkie (Distinguished Professor of Practice, Osgoode Hall Law School)
The insight that the proposed interest deduction rule and anti-hybrid rules indicate "no more mucking about with 'purpose'" may illuminate the thinking about reforming the transfer pricing rules (esp.s.247(2)(b)/(d)) and the GAAR. Thanks for the excellent commentary.