Release date: July 16, 2010
Guest: Wally Conway
Running time: 14:28 minutes
Canada’s tax system evolves to respond to changing economic realities, on the provincial, national and international levels, and is affected by other factors, including political ones. In this episode, Wally Conway taps into wisdom garnered in his 26 years at the Tax Legislation Division of the federal Department of Finance, and in his subsequent experience with PwC’s Canadian National Tax Service practice.
Learn about likely developments in corporate tax, personal tax and sales tax, as well as – perhaps most important – tax administration and enforcement over the next five years.
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You’re listening to another episode of PwC’s Tax Tracks at www.pwc.com/ca/taxtracks. This series looks at the most pressing technical and management issues affecting today’s busiest tax directors.
Gerry Lewandowski: Hi, I’m Gerry Lewandowski. Here with us today is Wally Conway, a senior member with PwC Canada’s Canadian National Tax Services practice (or CNTS). Wally is based in Toronto and Ottawa, and focuses on assisting PwC clients with matters relating to tax policy and administration, tax rulings, lobbying efforts and dispute resolution. He spent 26 years at the Tax Legislation Division of the Department of Finance where he was responsible for developing income tax policy and drafting legislation related to such matters as transfer pricing, corporate reorganizations, foreign affiliates, foreign investment entities, trusts, insurance and banking. Wally also represented the Department of Finance on the CRA’s GAAR and Transfer Pricing Review committee. Wally will share with us some of his thoughts on the direction of tax policy in Canada over the next few years.
Thanks for joining us Wally.
Wally: Well, thank you for having me.
Gerry: Let’s start off with a high-level question. Wally, what pressures do you think will drive Canadian economic and tax policy over the next five years?
Wally: By all reports, the world is now emerging from the global economic recession, the seriousness and breadth of which both surprised and shocked world leaders and their government advisors. Virtually no nation was untouched. It became readily apparent that the strength of the economy of a particular nation was directly related to the strength of the global economy. In fact, the governments of the G-20 group of countries came to the startling realization that independent action would be futile in stimulating their respective economies. They concluded that the only massive world wide effort to stimulate the global economy would meet with any success. Two important realizations emerged from the participations of the various levels of government of Canada in the stimulus actions to deal with the recession.
First, it reinforced their position that the relative competitiveness of Canadian and international business communities was a crucial factor in determining the economic and employment growth of their respective economies. Second, it became abundantly clear that the existing expenditure and debt levels of Canadian governments seriously hampered their ability to respond to economic crises.
Governments are now being forced to take decisions to deal with these realities. For example, the following observations can be made. The promotion of employment and economic growth through the support of Canadian business competitiveness has become the mainstay of government policy; Retirement of bloated government debt and control of government expenditures has become a primary focus of Canadian governments; Any increase in government expenditures will require more revenue which will have to be derived from the growth in the Canadian and provincial economies.
In absence of sufficient revenue growth acquired through economic growth, new and innovative means will have to be devised for paying for government services, including user fees, which are already being used extensively.
Governments will count heavily on Canadian business competitiveness to grow the economy. It is new business investment in Canada which is expected to produce the required sustainable economic and employment growth. New business investment will take place in Canada only if it will yield satisfactory returns. That will be the case only if Canadian business can be given adequate access to international markets and made competitive in those international markets.
The international competitiveness of Canadian business will be defined by:
It is clear that the government costs associated with the investment in Canadian competitiveness will be significant and ongoing.
Gerry: So what types of corporate tax measures can we expect to see over this five-year period?
Wally: One well publicized approach of the federal and provincial governments to promoting Canadian business competitiveness is corporate tax rate reductions. The goal is a planned federal and provincial corporate tax rate of 25% on new investment by 2012, which is purported to be the lowest corporate tax rate of all G-8 countries. In addition, provinces are reducing or eliminating capital taxes. Lowering tax rates has been the approach most often used by nations in their attempt to attract new business investment to their country. Reduced taxation of corporate profits enhances returns on business investment so as to encourage further investment and permit lower pricing so that Canadian companies can compete in the international market place. Lower tax jurisdictions have become satisfied in taxing the salaries and wages of the individuals that are employed by growing businesses. Such nations resort to sales taxes to raise additional revenue needed. Obviously, business growth will be promoted by a reduction in business income taxes. Employment growth is tied to economic growth and business growth.
While tax rates are a significant factor in business decision making, they are but one consideration. Canadian governments will be encouraged to implement tax base measures that would promote the competitiveness of Canadian business by reducing compliance costs and enhancing financial liquidity of a business. One such measure would be the adoption of a territorial system of taxation of business income. Under such a system, foreign source business income would be taxed only in the source country and not in Canada. Foreign source business income of Canadian business would then bare the same burden as the income of their international competitors. Canadian business would then be on a level playing field with those competitors.
In their most recent budgets, federal and provincial governments have agreed to study the prospects of implementing a tax consolidation system for groups of related companies. Such a measure would permit Canadian businesses to monetize tax attributes of the members of the related group on a timely and cost effective basis, thereby enhancing their liquidity and making them more competitive.
The beauty of such tax base measures is that they do not have significant long term costs associated with them. The measures would permit business to achieve in a timelier and more cost effective manner what they are able to achieve on a less timely and more costly manner. The goal would be the enhancement of business liquidity for the purpose of generating business and employment growth.
Gerry: What should we expect to see in terms of personal tax measures over the next five years?
Wally: One of the overriding objectives to enhancing the competiveness of Canadian business will be to make it possible for Canadian business to attract and retain talented and productive workers and leaders. Generally, Canadian governments have much work to do. Canadian personal tax rates are too high at the highest income tax bracket, the tax base is too tight and the retirement savings provisions are inadequate. To attract the best and brightest, it will be necessary to reduce the tax rates of the highest tax bracket which would attract the high wage earners. This has been politically unachievable up till now. Unfortunately, the fiscal capacity to enhance the tax assistance for retirement savings has not been there although there is some scope for loosening up on the tax base.
We cannot expect significant personal tax rate reductions over the medium term. The necessary fiscal capacity of the Canadian government does not exist.
That being said, Canadians are facing a retirement savings crisis which may force the Canadian governments to take some from of action. Many are entering into their normal retirement years with insufficient retirement savings. It would appear that Canadian governments will have to pick up the tab for supporting those retirees that may not be able to support themselves.
We should, therefore, expect to see retirement savings and pension reform designed to facilitate and support the retirement savings of Canadians. The emphasis will be on enhancing retirement savings by reducing administrative costs and maximizing investment yields.
By increasing tax assistance for retirement savings, retirement savings reform can be used to effect personal tax rate reductions while protecting the government from unwanted future welfare expenditures. Other than retirement savings reforms, there will be only tinkering with the personal tax system in order to appease the voters by loosening up a bit on the tax base.
Gerry: Wally, what types of sales tax measures can we expect to see over the next five years?
Wally: To be blunt, sales taxes are the “ace in the hole” of Canadian governments. Most provincial sales taxes have been or will eventually be harmonized with the federal GST. Harmonization has reduced the compliance cost of business and the administrative costs of governments. The amount of sales tax revenue collected is easy to alter by Canadian governments through a simple rate changes. In that way, the harmonized GST/HST is a cash cow of government taxes.
Manipulating sales tax rates can become the fall back position of governments in generating tax revenue. If Canadian governments cannot grow the economy sufficiently to offset budgetary deficits, expect to see an increase in the GST/HST rate by one or two percentage points. The GST/HST is a stroke of government genius. It is collected at source, remitted and forgotten. It is a tax that does not affect the international competitiveness of Canadian business. Export sales are not subject to GST/HST.
Gerry: And what about tax administration and enforcement…can we expect to see any trends over the next five years?
Wally: Until governments have eliminated budgetary deficits and effected sufficient amounts of government debt reductions, expect to see a concerted effort to collect every tax dollar of tax due by taxpayers. The low hanging fruit, such as easily disputable income versus capital transactions and other contentious transactions, will be the target of motivated tax collectors.
The prevailing view of tax administrators appears to be view that taxpayers are inappropriately avoiding significant amounts of tax. A significant amount of the tax administrators’ operating budgets has been devoted to hiring a large number of new aggressive tax planning auditors.
Canadian tax policy advisors also seem to be preoccupied with tax avoidance. The new disclosure rules proposed by the federal and provincial governments are evidence of this.
Unfortunately, the Canadian tax administration in Canada seems to be in disrepair. It is easy to observe that newly hired tax avoidance auditors are inexperienced in tax matters. The training that the CRA auditors are receiving does not offset their lack of experience. The decision making processes of the tax administrators appear to have been bogged down. The dispute resolution processes are producing too few dispute resolutions and too many unsupported tax re-assessments. There is an unsatisfactory build-up of unresolved tax disputes in the appeals sections. Increasing numbers of cases are going to the courts for decisions. The obvious conclusion is that something is terribly wrong with the tax administration and the fear is that no one is doing anything about it.
Tax transparency and administrative aggressiveness is in fashion with both the tax policy advisors and tax administrators in Canada. We can expect to see tax administrators to become increasingly aggressive in their approaches to auditing and getting information. We can only hope that those approaches will be reasonable and result in a fair administration of the Act. We can also expect to see the tax administrators to be increasingly aggressive in lobbying the tax policy advisors and legislatures for more legislative powers for the purpose of obtaining more taxpayer information.
It’s going to be a rocky road with dispute resolution rising in importance over the next few years.
Gerry: Thank you for sharing your insight and experience, Wally. For additional information on PwC’s Canadian National Tax Services Team, please visit pwc.com/ca/CNTS.
Thank you for tuning into Tax Tracks at www.pwc.com/ca/taxtracks.
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Through interviews with prominent PwC tax subject matter professionals, Tax Tracks is an audio podcast series that is designed to bring succinct commentary on tax technical, policy and administrative issues that provides busy tax directors information they require.