The Canadian government has been forced into an embarrassing climb-down over a tax-efficient measure before it became effective.
The minister of finance announced in the 2009 Federal Budget that he was repealing section 18.2 of the Income Tax Act, which he brought in only two years ago.
This provision, scheduled to have effect after 2012, would have limited interest deductibility where borrowed funds are used by a Canadian corporation to finance a foreign affiliate if a second deduction for such interest was available in a foreign jurisdiction.
"It was a very surprising proposal, the budget came out in March [2007] and by May the government had backtracked having received some critical comment, said Jeffrey Trossman, of Blake Cassels & Graydon in Toronto. "They scaled down the grandiose proposal to this proposal, which was [still] drafted in a very broad way."
"People in Canada were very upset by this initiative," said Michael Kandev of Davies Ward Phillips and Vineberg in Montreal. "I would even say incredulous. People could not understand why it was brought in."
"The international tax announcements are more about cancelling previous initiatives, it's more back-tracking than proposing new things," said Kandev.
The repeal comes after an expert panel, formed by the government to look at the country's international tax laws, urged ministers to abandon the law.
"The panel weren't actually asked to comment about section 18.2 but they received so many submissions that were highly critical of the section, that they took it upon themselves to recommend that the government repeal it" said Trossman. "And the government has done just that."
"In my view, it is an appropriate about-face because I thought the tax policy rationale was flawed to begin with," he continued.
"At this point there was very strong, unified support against these rules so they [the government] just couldn't keep them," said Kandev.
The minister said in his budget statement that the government was studying the report and would hold public consultations and provide its response in due course.
The budget also covered some issues that the panel referred to in its report, but didn't include others. For example, the government is to review the non-resident trust and foreign investment entity rules first introduced in Budget 1999, which is good news for taxpayers and their advisers.
"Taxpayers and businesses have been fighting against these rules for 10 years now," said Kandev. "Everybody believes that these rules, although their initial policy intent is acceptable and proper, were very broad and incomprehensible."
"The rules are overbroad, complex, convoluted, difficult to apply and virtually impossible for taxpayers to comply with," wrote the Tax Executives Institute in a submission to the advisory panel.
The minister reiterated the government's adherence to the tax policy objective of ensuring that Canadians are not able to avoid tax through the use of offshore intermediaries, which is the core aim of these rules.
On the other hand, the advisory panel recommended that the thin capitalisation rules should be tightened up by changing the debt equity ratio from 2:1 down to 1.5:1. The fact that this change wasn't included in the budget, will be a relief to some.
"I think taxpayers, particularly those involved in financing Canadian subsidiaries will be happy to see that that was not included in this budget," said Trossman. "That's not to say it won't ever be included in a future announcement."
The minister did increase the threshold for the small business tax rate, from C$400,000 ($325,515) to $500,000.
This will afford many businesses a much lower tax rate, although it only applies to Canadian controlled companies.
"In Quebec, the general rate for corporations is 30.5%, the small business rate is 19%, so that's a fair difference," said Kandev.
The budget also contained an increase in the expenditure limit for investment tax credits, accelerated capital cost allowance for manufacturing and processing and for computer equipment and systems software.
The budget went on to reaffirm the commitment of the government to reduce the general corporate income tax rate to 15% by 2012. But this decrease was not brought forward, though this was not a surprise.
"Lower corporate rates are always better for business, I don't think there was a general expectation that they would accelerate that [the scheduled lowering of rates]" said Trossman.
The minister left hotly tipped announcements out of his budget..
Some professionals had expected an increase to the loss carry-back period, similar to that being pushed through in the US at the moment.
"There were rumours about that, but it didn't show up," said Trossman. "Certainly it would be helpful to clients of ours who are experiencing losses and are perhaps unable to make full use of them due to the carry-back period now being limited to three years."
