Tax Expenditures 2000:
Notes to the Estimates/Projections:  3
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Chapter 3 - Description of Corporate Income Tax Provisions

The descriptions of the specific tax measures contained in this chapter are intended as a simplified reference and are not detailed descriptions of specific tax measures.

Tax Rate Reductions

The following items are measures that reduce the statutory tax rate faced by a corporation. They are considered to be tax expenditures because income is taxed at a rate other than the generally applicable tax rate.

Low Tax Rate for Small Businesses

Objective: This lower tax rate is intended to provide small corporations with more after-tax income for reinvestment and expansion. (Tax Measures: Supplementary Information, February 22, 1994.)

Corporations that are Canadian-controlled private corporations (CCPCs) are eligible for a lower federal tax rate of 13.12 per cent (12 per cent plus surtax) on the first $200,000 of active business income.

Effective July 1, 1994, CCPCs with more than $15 million of taxable capital employed in Canada are no longer eligible for this rate reduction. In addition, CCPCs with between $10 million and $15 million of taxable capital employed in Canada have reduced access to the small business deduction.

Low Tax Rate for Manufacturing and Processing

Objective: This lower tax rate is intended to enhance the international competitiveness of the manufacturing industry. (Income Tax Reform, June 18, 1987.)

Canadian manufacturing and processing income not eligible for the small business deduction is subject to a lower federal tax rate of 22.12 per cent (21 per cent plus surtax).

The 1999 budget proposed a phased-in extension of this lower tax rate to corporations that produce electrical energy or steam for sale.

The 2000 budget proposed a phased-in extension of this lower tax rate to corporations that produce, for sale, steam for uses other than the generation of electricity.

Low Tax Rate on General Income of Small Businesses

Objective: This lower tax rate is intended to ensure that small businesses benefit from lower corporate tax rates more rapidly. (The Budget Plan 2000, February 28, 2000.)

The 2000 budget proposed that, effective January 1, 2001, the federal corporate income tax rate on income between $200,000 and $300,000 earned by a Canadian-controlled private corporation from an active business carried on in Canada be reduced to 22.12 per cent (21 per cent plus surtax). Income eligible for this lower rate will be reduced to the extent that the corporation has manufacturing and processing (M&P) income subject to the reduced M&P tax rate or income from resource activities.

Low Tax Rate for Credit Unions

Objective: The purpose of the low tax rate for credit unions is to permit a credit union to accumulate capital on a tax-preferred basis up to a maximum of 5 per cent of deposits and capital.

Although not a private corporation for most purposes, a credit union is eligible for the lower federal tax rate of 13.12 per cent (12 per cent plus surtax) provided to small businesses. A credit union with more than $200,000 of active business income may be eligible for this lower rate on income in excess of the $200,000 limit where the total income of the corporation since 1971 is less than the corporation's "maximum cumulative reserve," which is equal to 5 per cent of amounts owing to members (including members' deposits and share capital).

Exemption From Branch Tax for Transportation, Communications, Banking and Iron Ore Mining Corporations

Objective: Exemptions from branch tax are in recognition of the fact that certain foreign companies sometimes have no real alternative to the branch office form of organization when operating in other jurisdictions. For example, this is often the case for Canadian mining ventures that are jointly financed by Canadian and foreign interests and require large amounts of capital investment. (Budget Speech, April 10, 1962.)

The branch tax is imposed on that portion of the income of non-resident corporations derived from the carrying on of business in Canada through a branch. If a Canadian branch has ceased active business operations, non-residents are liable for tax on capital gains on dispositions of taxable Canadian property. The rate is 25 per cent, but is frequently reduced by bilateral tax treaties to 15 per cent, 10 per cent or 5 per cent.

A corporation is exempt from the branch tax if it is:

• a bank;
• a corporation whose principal business is:
  – the transportation of persons or goods;
  – communications; or
  – mining iron ore in Canada; or
• an exempt corporation such as a registered charity.

Legislation will be introduced in Parliament to make foreign bank branches subject to the branch tax effective as of June 28, 1999.

No data are available.

Exemption From Tax for International Banking Centres

Objective: In order to broaden our trade and business interests in Europe and the Pacific Rim, this measure exempts international banking centres established in Montréal and Vancouver. This measure is also intended to return to Canada some banking activities previously conducted abroad and to attract business that normally wouldn't be conducted in Canada. (Department of Finance Release 87-16, January 28, 1987.)

A prescribed financial institution's branch or office carrying on certain business in the cities of Montréal or Vancouver may qualify as an international banking centre (IBC) and therefore be exempt from tax on its income. To qualify as an IBC under the Income Tax Act, the branch's income must be derived from accepting deposits and making loans to non-residents. This measure, introduced in 1987, is considered a tax expenditure because a financial institution can undertake business with non-residents through a Canadian permanent establishment without being subject to Canadian income taxes.

No data are available.

Tax Credits

Investment Tax Credits

The following measures are credits against federal income taxes otherwise payable. They are considered to be tax expenditures because they provide incentives to taxpayers that invest in certain activities, such as scientific research and experimental development (SR&ED), or in certain capital assets in designated regions of the country.

The amount of an investment tax credit (ITC) is calculated as a percentage of the cost of eligible expenditures. ITCs can reduce federal income tax revenues in one of two ways. They may be:

• used to offset federal income taxes otherwise payable; or
• fully or partially refunded in the year they are incurred in the case of smaller Canadian-controlled private corporations (CCPCs).

Certain ITCs earned in a year may be refunded to individuals and qualifying corporations that cannot use them to reduce federal income taxes otherwise payable. The rate of refundability for these ITCs is generally 40 per cent. However, a qualifying CCPC may receive a refund of 100 per cent on SR&ED ITCs earned at the 35-per-cent rate in respect of up to $2 million of eligible current expenditures.

For the purposes of the refund, a qualifying corporation is generally a CCPC with taxable income not exceeding $200,000 in the preceding year. However, in the case of the SR&ED ITC, refundability phases out as the prior-year taxable income of a CCPC (or associated corporate group) rises above $200,000 and is eliminated entirely at $400,000. In order to focus ITC benefits on smaller CCPCs, the 1994 budget introduced a change to phase out refundability after 1995 for CCPCs with taxable capital employed in Canada exceeding $10 million and to fully eliminate refundability for CCPCs with taxable capital employed in Canada exceeding $15 million.

All refunds reduce the amount of ITC for carry-over purposes. Unused ITCs may be carried forward 10 years or back 3 years.

ITCs utilized or refunded in a year reduce either the undepreciated capital cost of the asset for capital cost allowance purposes or, in the case of SR&ED, the SR&ED pool. Credits earned in respect of a property acquired after 1989 and not immediately available for use may not become claimable or refundable until the property is available for use or has been held by the taxpayer for 2 years.

Issues in Calculating the Value of ITCs

To maintain consistency with the other tax expenditures estimates, the amounts estimate the forgone revenue for the year in question from each ITC. In other words, the estimates show how much additional revenue would have been collected by the Government in the year if the ITC had been eliminated in that particular year. To do this, the amount of ITCs used in the year are separated into three components: ITCs that were both earned and used in the year, ITCs that were earned in the current year but were carried back and applied to reduce tax of a previous year, and ITCs that were earned in prior years but were carried forward and used in the year. The first represents credits in respect of current year expenditures. The costs of any applicable refunds of ITCs earned are included in these estimates. The latter two items – ITCs carried over to other years – are itemized separately as an aggregate for all ITCs.

Another perspective on the revenue cost of each ITC may be obtained by looking at the amount of ITCs earned in a specific year. This information is provided in the following table for 1995 and 1996. However, it should be recognized that ITCs earned in the year are not necessarily used in the year – they may be used in a subsequent or previous year, subject to the carry-over rules. As a result, had the ITCs been eliminated, government revenues for the year would not have been higher by the amounts shown in the following table since it may take a number of years for ITCs earned in a year to be used by the taxpayer to reduce federal taxes.

Investment Tax Credits Earned in the Year

	19951	1996
	($ millions)
SR&ED ITC	1,619	1,676
Atlantic ITC	307	330
Special ITC	33	n.a.
1 The 1995 figures are based on final data and differ from the figures in last year's edition of the tax expenditures document, which were based on preliminary data.

Scientific Research and Experimental Development Investment Tax Credit

Objective: The federal income tax incentives for scientific research and experimental development (SR&ED) provide broadly based support for all types of SR&ED performed in every industrial sector in Canada. The rationale for this tax support is that the benefits of SR&ED extend beyond the performers themselves to other firms and sectors of the economy. The existence of these spillovers or externalities mean that, in the absence of government support, firms would likely perform less SR&ED than desirable from the economy's point of view. Federal tax policy objectives in supporting SR&ED are to: encourage SR&ED to be performed in Canada by the private sector through broadly based support; assist small businesses to perform SR&ED; provide incentives that are, as much as possible, of immediate benefit; provide incentives that are as simple to understand and comply with and as certain in application as possible; and promote SR&ED that conforms to sound business practices. Federal income tax incentives for SR&ED assist the private sector in developing new products and processes, improving productivity, enhancing competitiveness and growth, and creating jobs for the benefit of all Canadians. (Budget Plan, March 6, 1996.)

There were three rates of SR&ED ITCs prior to 1995: a general rate of 20 per cent; an enhanced rate of 35 per cent for CCPCs with prior-year taxable income of less than $200,000; and a rate of 30 per cent for the Atlantic provinces and the Gaspé region. The latter rate was eliminated in the 1994 budget effective after 1994. The maximum amount of SR&ED expenditures that can earn ITCs at the 35-per-cent rate in a year is $2 million.

The SR&ED ITC is earned on eligible current and capital expenditures in respect of SR&ED in Canada performed by, or on behalf of, a taxpayer and related to a business of the taxpayer.

Atlantic Investment Tax Credit

Objective: The objective of the Atlantic investment tax credit (AITC) is to promote economic development (i.e., investment, thereby increasing productivity and employment) in the Atlantic provinces and the Gaspé region. (Budget Plan, March 1977)

Prior to 1995, the AITC was available at a rate of 15 per cent in respect of eligible expenditures in the Atlantic region – i.e., Newfoundland, New Brunswick, Nova Scotia, Prince Edward Island, the Gaspé region and their associated offshore areas. The 1994 budget reduced the AITC rate to 10 per cent for eligible expenditures incurred after 1994.

The AITC is earned on eligible expenditures on new buildings, machinery and equipment employed in the following qualifying activities: farming, fishing, logging, mining, oil and gas, and manufacturing and processing.

The AITC is refundable at a rate of 40 per cent for qualifying CCPCs and individuals.

Special Investment Tax Credit

Objective: The objective of the special investment tax credit (SITC) was to promote regional development by encouraging foot-loose manufacturing activities to locate within qualifying regions of low growth and high unemployment across Canada. (Budget Plan, 1980)

Prior to 1995, the SITC was provided at a rate of 30 per cent for eligible expenditures on new buildings, machinery and equipment used in qualifying activities in qualifying regions of Canada. The SITC was eliminated in the 1994 budget, effective January 1, 1995. However, certain activities in the Atlantic region continue to be eligible for the AITC.

Qualifying activities were defined under the Regional Development Incentives Act and its regulations, and generally included manufacturing and processing facilities located in a qualifying region, with the exception of certain primary processing of natural resources.

Qualifying regions included northeastern British Columbia, northwestern Alberta, northern Saskatchewan, most of Manitoba, northern Ontario, northern Quebec and the Gaspé region, and areas of Atlantic Canada.

Investment Tax Credits Carried Back

These are tax credits that were earned by corporations in the current taxation year and were carried back to the three previous taxation years to reduce federal taxes otherwise payable in those years.

Investment Tax Credits Claimed in Current Year but Earned in Prior Years

These are tax credits that were earned by corporations in previous years but not claimed until the current year. There is a revenue cost to the Government when the credits are used by corporations to reduce federal taxes payable. While the aggregate amount of these credits is known with some confidence, there is not enough information available to identify separately the amounts for each credit.

Political Contribution Tax Credit

Objective: This provision is intended to ensure that registered political parties have a broad base of financial support. (Report of the Royal Commission on Taxation, 1966, vol. 3.)

A non-refundable tax credit is available for contributions to registered federal political parties or candidates. The credit is earned at a rate of 75 per cent on the first $100 contributed, 50 per cent on the next $450 contributed and 33¹/₃ per cent on the next $600 contributed. The maximum credit is $500 and is available when the taxpayer has contributed $1,150.

This measure constitutes a tax expenditure because political contributions are not incurred to earn income.

Canadian Film or Video Production Tax Credit

Objective: The film tax credit is intended to subsidize the Canadian film and video production industry. (Budget Speech, February 27, 1995, and Budget Plan, February 27, 1995.)

The Canadian film or video production tax credit was introduced in the 1995 budget for certified Canadian film productions produced by qualified corporations. It provides a refundable investment tax credit of 25 per cent of the cost of eligible salaries and wages expended after 1994, except where the financing of the film is eligible for transitional relief from the termination of the capital cost allowance (CCA) film incentive. Eligible salaries and wages are limited to 48 per cent of the cost of production, so that the credit provides assistance of up to 12 per cent of the cost of the production. Canadian film or video productions are certified by the Minister of Canadian Heritage.

This tax credit was intended to retarget government assistance available to Canadian film productions in order to maximize the benefit to such productions. It replaced a tax shelter of accelerated CCA deductions used principally by higher-income individuals, with a refundable tax credit for eligible films produced by qualified taxable Canadian corporations.

Film or Video Production Services Tax Credit

Objective: The film or video production services tax credit makes Canada a more attractive place for film production by complementing the existing Canadian film or video production tax credit and by allowing a greater range of productions (usually foreign-owned) to qualify for assistance. The tax credit provides economic development assistance to film and video productions produced in Canada. The tax credit was effective beginning November 1, 1997, to coincide with the elimination of film production services tax shelters.

The production services tax credit applies to film or video production services that are provided in Canada for films that do not have sufficient Canadian content to qualify for the Canadian film or video production tax credit. It is a refundable credit of 11 per cent of salaries and wages paid to Canadian residents for services performed in Canada after October 31, 1997. The Canadian Audio-Visual Certification Office of Canadian Heritage provides certificates of eligibility.

The tax credit is designed to retarget government assistance by making the benefit available directly to the production services provider. Previously, this assistance was provided through syndicated tax shelters for such productions.

Exemptions and Deductions

The following exemptions and deductions are considered tax expenditures because they deviate from the benchmark tax system.

Partial Inclusion of Capital Gains

Objective: The reduced rate of inclusion for capital gains provides incentives to Canadians to save and invest, and to ensure that Canada's treatment of capital gains is broadly comparable to that of other countries. (Proposals for Tax Reform, 1969. Tax Reform 1987: The White Paper, 1987.)

Only a portion of net realized capital gains are included in income. The amount of the tax expenditure is the additional tax that would have been collected had the full amount of the capital gains been included in income. However, this amount is likely an overestimate of the true amount of this tax expenditure. To the extent that the capital gains are from shares that have increased in value due to retained earnings, and which have already been taxed at the corporate level, the partial inclusion of the capital gains provides some relief from double taxation and, therefore, should be part of the benchmark tax system. The 2000 budget proposed to reduce the capital gains inclusion rate from three-quarters to two-thirds effective February 28, 2000.

The 1997 budget reduced the inclusion rate on capital gains arising from certain donations to charities (other than private charitable foundations) to one-half of the regular inclusion rate. Donations eligible are those of securities that are listed publicly on a recognized stock exchange in Canada, where the donation is made between February 18, 1997, and the end of the year 2001. The 2000 budget proposed that the inclusion rate also be reduced by one-half in respect of capital gains arising from gifts of ecologically sensitive land to qualified donees other than private foundations.

Royalties and Mining Taxes

Non-Deductibility of Crown Royalties and Mining Taxes

Objective: Prior to 1974, royalties in respect of the production of natural resources had traditionally been deductible as a business expense. On May 6, 1974, the federal government announced that it would deny the deduction of Crown royalties and provincial mining taxes. This action was taken in order to ensure that provincial royalties, provincial mining taxes and other arrangements having similar effects do not unreasonably erode the corporate income tax base. (Budget Speech, May 6, 1974.)

The current tax system does not permit a deduction for Crown royalties or mining taxes. The deduction has been denied since May 6, 1974. From that time to the end of 1975, oil and gas and mining companies were eligible for a resource tax abatement of 10 and subsequently 12 percentage points for petroleum profits and 15 percentage points for mining income. This provided a lower rate of tax on oil and gas and mining income. A resource allowance (discussed below) was proposed in the June 1975 budget and replaced the resource tax abatement after 1975.

A negative tax expenditure is calculated for the non-deductibility of Crown royalties and mining taxes. A negative tax expenditure implies that the Government collects more income taxes than would have otherwise occurred in the benchmark system. The issue arises as to whether the benchmark tax system would include a deduction for all Crown royalties and mining taxes. Two generic types of non-deductible Crown charges are levied on the extraction of natural resources. One type is a simple royalty system where the Crown charge is based only on gross revenues. There are also more complex systems of Crown charges that are based on net resource profits – i.e., resource profits after the deduction of numerous costs, including capital, operating costs and sometimes a return on capital employed.

In the case of Crown charges based on gross revenues, the benchmark system would include a deduction for these royalties since they are analogous to costs of production. However, the benchmark tax system would not include a deduction for the latter type of profit-related Crown royalties and mining taxes because they are structured more like income taxes. Provincial income taxes are not considered to be a deductible expense in the benchmark system. Provincial payroll and capital taxes, on the other hand, are deductible and they are not treated as tax expenditures.

The calculations shown in Tax Expenditures and Evaluations represent the federal corporate income tax revenues generated by the current rules, which deny the deductibility of all Crown royalties and mining taxes. No attempt has been made to divide the disallowed royalties into the two categories described above. This is in part due to the fact that many royalty systems include characteristics of both a gross and net calculation. Thus, the calculation represents an overestimate of the actual negative tax expenditure.

Resource Allowance

Objective: The resource allowance came into effect in 1976. It replaced the resource tax abatements noted above. It was viewed as a better way of recognizing that provinces impose mining taxes and/or royalties and to take that fact into account, within reasonable limits, in determining taxable income. In addition, the resource allowance was designed to offer more incentives to those who explore and develop in Canada and to impose a greater tax liability on those who do not. (Budget Speech, June 23, 1975.)

Since 1976, the income tax system has provided a resource allowance deduction equal to 25 per cent of a taxpayer's annual resource profits, computed after operating costs and capital cost allowances, but before the deduction of exploration expenses, development expenses, earned depletion and interest expenses. These latter expenses were excluded from the resource profit calculation primarily to encourage companies to undertake exploration and development activities in Canada. The resource allowance is provided in lieu of the deductibility of Crown royalties, mining taxes and other charges related to oil and gas or mining production. The measure allows the provinces room to impose royalties or mining taxes on the production of natural resources while maintaining the federal income tax base. For analytical purposes, the value of the tax expenditure for the royalties and mining taxes is broken down into two components:

• the federal tax revenue earned by disallowing royalty deductibility (a negative tax expenditure, described above); and
• the federal tax revenue forgone resulting from the resource allowance deduction (a positive tax expenditure).

An approximation of the overall impact of the resource allowance measure (compared to the benchmark tax system) can be obtained by netting the two above effects.

Earned Depletion

Objective: The earned depletion incentive was designed to encourage taxpayers to undertake more exploration and development than they otherwise would. As part of the Government's 1987 tax reform initiative, the ability to earn new earned depletion allowance deductions was phased out. (Proposals for Tax Reform, 1969; Summary of 1971 Tax Reform Legislation; Budget Speech, May 6, 1974; Budget Speech, November 18, 1974; and The White Paper, Tax Reform 1987.)

Earned depletion is an additional deduction from taxable income of certain exploration and development expenditures and other resource investments. Prior to 1990, taxpayers were entitled to earn an extra deduction of up to 33¹/₃ per cent of most exploration and development expenses or the costs of assets related to new mines or major expansions. The deductions for earned depletion are generally limited to 25 per cent of the taxpayer's annual resource profits, although mining exploration depletion can be deducted against non-resource income. As in the case of a Canadian exploration expense or a Canadian development expense, earned depletion could be pooled (i.e., placed in a special account, and any remaining balance could be carried forward indefinitely for use in later years).

Additions to the depletion pools for earned depletion and mining exploration depletion were eliminated as of January 1, 1990. Deductions can still be made on the basis of existing depletion pools.

Under the benchmark tax system, a deduction for earned depletion would not be available.

Deductibility of Charitable Donations

Objective: This incentive is designed to support the important work of the charitable sector in meeting the needs of Canadians. (Report of the Royal Commission on Taxation, 1966, vol. 3. Budget Plan, 1996. Budget Plan, 1997.)

Donations made by corporations to registered charities are deductible in computing taxable income within certain limits. Unused deductions may be carried forward for up to five years.

For years prior to 1996, this deduction was limited to 20 per cent of net income. The 1996 budget announced that the deduction limit would be raised to 50 per cent of net income plus 50 per cent of taxable capital gains resulting from the donation of property. The 1997 budget announced a further increase in the limit to 75 per cent of net income plus 25 per cent of the amount of taxable capital gains arising from the donation of appreciated capital property and 25 per cent of any capital cost allowance recapture arising from the donation of depreciable capital property. The percentage of income restrictions do not apply to gifts of ecologically sensitive land and certain gifts of cultural property.

This deduction would not be permitted under the benchmark tax system because these expenditures are not incurred to earn income.

Deductibility of Gifts to the Crown

Objective: Gifts made to Canada or to a province are deductible, within certain limits, to encourage such contributions. Note: The Income War Tax Act, 1917, permitted the deduction of contributions to the Patriotic and Canadian Red Cross Funds and any other patriotic fund approved by the Minister.

Gifts made by corporations to Canada or a province are deductible in computing taxable income, within certain limits. Unused deductions may be carried forward for up to five years.

Prior to 1997 the amount deductible was limited only to the amount of income in a particular year. The 1997 budget restricted the deductible amount to 75 per cent of net income plus 25 per cent of the amount of taxable capital gains arising from the donation of appreciated capital property and 25 per cent of any capital cost allowance recapture arising from the donation of depreciable capital property. The percentage of income restrictions does not apply to gifts of ecologically sensitive land and certain gifts of cultural property.

This deduction would not be permitted under the benchmark tax system because these expenditures are not incurred to earn income.

Interest on Small Business Financing Loans

Objective: This measure was intended to help small businesses in financial difficulty, including farmers, to obtain loans at lower interest rates. (Budget 1992: Budget Speech, February 25, 1992.)

Small businesses in financial difficulty are able to treat interest paid on small business financing (SBF) loans entered into between February 25, 1992, and the end of 1994 as a non-deductible payment, and SBF lenders are permitted to treat the interest received as a dividend – resulting in such interest being non-taxable to corporate lenders and individual lenders being eligible for a dividend tax credit. This tax treatment permitted lenders to reduce the interest charges to such small businesses while maintaining their after-tax rates of return.

Non-Deductibility of Advertising Expenses in Foreign Media

Objective: This measure ensures that control of periodicals and newspapers will remain in the hands of Canadians and supports the continued existence of a viable and original Canadian magazine industry. (House of Commons Debates, vol. 3, 1965. Finance Canada News Release 95-050, June 15, 1995.)

Expenses for advertising in non-Canadian newspapers or periodicals or on non-Canadian broadcast media cannot generally be deducted for income tax purposes if they are directed primarily to a market in Canada. Deducting the cost of advertising in foreign periodicals or on television stations is not restricted if the advertising is to promote sales in foreign markets.

This treatment results in a negative tax expenditure since the deduction of an expense incurred to earn income is denied. Under the benchmark tax system, advertising expenses in foreign media incurred to gain or produce income from a business or property would be deductible whether targeted at foreign or domestic markets.

No data are available.

Non-Taxation of Provincial Assistance for Venture Investments in Small Business

Objective: Provinces have established venture capital corporations to provide investment capital for small businesses. The non-taxation of provincial assistance for venture investments in small business assists the successful working of such provincial plans. (Budget Papers, December 11, 1979.)

Government assistance received by a corporation is normally either included in the corporation's income or reduces the cost basis of the assets to which the assistance relates for capital cost allowance purposes. There are a number of exceptions to this rule, including provincial assistance provided for venture capital investment under specified provincial programs. Under the benchmark tax system, this type of assistance would be included in the corporation's income or would reduce the cost basis of the related assets.

No data are available.

Deferrals

The tax expenditures in this section provide for a deferral of income taxes from the current to a later taxation year. They have been valued on a cash-flow basis (i.e., the forgone tax revenue associated with the additional net deferral in the year). The alternative way of valuing deferrals would be to calculate the value of the interest-free loan that is provided to the taxpayer when taxes are deferred to a later year.

Accelerated Write-off of Capital Assets and Resource-Related Expenditures

Objective: Accelerated capital cost allowances (CCAs) are provided for capital assets since faster write-offs are one way in which incentives can be given for investment. Accelerated CCAs are also provided for certain energy conservation and electrical generating equipment. Initially, this acceleration was provided as a temporary incentive during the mid-1970s in response to the international escalation of oil prices and partly to promote "off-oil" initiatives.

It is recognized that the exploration for and development of mines and oil and gas deposits involve more than the usual industrial risks and that the scale of these risks is quite uncertain in most cases. As a result, accelerated write-offs are provided for certain exploration and development and capital costs expenses so that these costs can be deducted for tax purposes early enough so that taxes will be applied only when it is clear that a project will be profitable. (The Corporate Income Tax System: A Direction for Change, May 1985. Tax Measures: Supplementary Information, February 22, 1994. Proposals for Tax Reform, 1969.)

Under the benchmark tax system, corporations would be permitted an annual deduction for their use of capital assets based on their anticipated economic life. Using the cash-flow approach, the tax expenditure in any particular year would be calculated as the forgone tax revenue resulting from the difference between the deduction taken for tax purposes, usually CCA, and the true economic depreciation based upon the asset's useful economic life. These annual calculations of the impact on cash flow can provide some indication of the tax expenditures resulting from the accelerated deductions for capital assets, but they could also be very misleading.

Tax expenditure amounts are not provided because:

• differences between the deductions for tax purposes and economic depreciation may not accurately reflect the tax expenditure; and
• adequate data are not available to calculate with any degree of accuracy this tax expenditure.

There are instances when differences between the deductions for tax purposes and economic depreciation would not accurately reflect the tax expenditure. First, it should be noted that the accelerated deductions for tax purposes lead only to a deferral, not a permanent reduction, of tax payable. If CCA rates are higher than actual depreciation rates, then during the initial years, the CCA claim would exceed economic depreciation. However, in later taxation years, the reverse would occur (i.e., actual depreciation would exceed the amount allowed for tax purposes). These differences between CCA and actual depreciation would lead to a positive tax expenditure in the early years of asset ownership since higher CCA rates in the initial years are a tax incentive. However, in later years, the CCA claim would be less than actual depreciation, resulting in a negative tax expenditure, thus offsetting the previous tax expenditure to some extent. For the corporate sector in total, the aggregate tax expenditure in any particular year could be positive or negative depending upon the level of investment in the current and previous years. As a result, the tax expenditure depends critically on the growth rate of investments. If the growth rate were zero, then, in the long run, one would expect no tax expenditure amount since the positive tax expenditures resulting from more recent asset acquisitions would be offset by the negative tax expenditures resulting from older assets – that is, in total, the annual tax depreciation claimed would be equal to the economic depreciation.

In addition, because CCA is a discretionary deduction, the cash-flow method could result in a tax expenditure being reported even if there is no acceleration of CCA rates (i.e., the CCA rates correspond with economic depreciation rates). A company has discretion to claim less than the maximum amount in a particular year. As a result, in that year, the cash-flow method would result in a negative tax expenditure. Because the company would now have a larger undepreciated balance for tax purposes, future CCA write-offs would be larger than the corresponding economic depreciation, thereby resulting in a positive tax expenditure in future years.

Finally, differences between CCA and economic depreciation may also result from the treatment of dispositions. For tax purposes, assets are generally grouped in pools with gains or losses on disposition adjusting the undepreciated balance, while gains and losses for economic depreciation purposes are recognized on an asset-by-asset basis.

Also, the asset cost for tax purposes may differ from the cost for economic depreciation purposes in that, for economic depreciation purposes, interest costs are often capitalized while, for tax purposes, such costs are generally expensed in the year incurred.

Because economic depreciation is difficult to determine, the deductions for capital assets reported by companies in their financial statements are often used as a substitute. However, financial statement depreciation may differ from economic depreciation. Furthermore, not all companies classify the capital asset deductions as depreciation or some other readily identifiable expense. For example, in the leasing industry, a lease may be classified as an operating lease for tax purposes with CCA being claimed, while for accounting purposes, it may be classified as a capital lease, in which case the corresponding accounting deduction may not be specifically identifiable. Since the costs written off for financial statement purposes for this sector cannot be precisely determined, it is not possible to estimate the related tax expenditure. More generally, adequate data are not available to calculate with any degree of accuracy this tax expenditure.

Although it may not be possible to estimate with any degree of accuracy the expenditure using the cash-flow approach, some indication of the magnitude of the tax expenditure relating to a particular accelerated write-off provision can be calculated by comparing the estimated discounted present value of the tax benefits resulting from acquisitions in a particular year under each of the two depreciation methods. For example, if the CCA rate is higher than the actual depreciation rate, the discounted present value of the benefit of being able to claim CCA would exceed the discounted present value of the benefit of the financial statement depreciation, thereby resulting in a measure of the positive tax expenditure or tax incentive that has been provided.

The number of asset classes with accelerated depreciation rates was reduced significantly when changes were introduced in 1988. As a result, many CCA rates now approximate the rate of economic or financial statement depreciation, and the associated tax expenditure related to accelerated depreciation provisions has been reduced. However, a few instances remain where the CCA rates are clearly accelerated – that is, the tax system allows a larger deduction from income for the first few years after the property is acquired than is applied for financial statement purposes. Some of the more significant of these accelerated CCA provisions are described below. Illustrations of the net present value of the benefit of some of the remaining accelerated CCA provisions are also provided.

Vessels (Class 7)

Vessels are generally included in class 7 and are subject to a maximum CCA rate of 15 per cent on a declining-balance basis. Accelerated CCA on a straight-line basis at a maximum rate of 33¹/₃ per cent of the capital cost of the property is available in respect of a vessel, including furniture, fittings, radio communication equipment and other equipment if it was (a) constructed in Canada, (b) registered in Canada, and (c) not used for any purpose whatever before acquisition by the owner. These assets are depreciated over a four-year period, with 16²/₃  per cent written off in the first and fourth years, and 33¹/₃ per cent written off in the second and third years.

Energy-Efficient Equipment (Class 43.1)

Class 43.1 was introduced in 1994. Eligibility for class 43.1 is described in regulations to the Income Tax Act. In general, the following types of equipment may qualify for inclusion in class 43.1: certain electrical generating equipment including co-generation and specified waste-fuelled electrical generation systems; active solar systems; small-scale hydroelectric installations; heat recovery systems; wind energy conversion systems; photovoltaic electrical generation systems above a minimum threshold level; geothermal electrical generation systems; and specified waste-fuelled heat production equipment. Assets included in class 43.1 are eligible for an accelerated CCA rate of 30 per cent on the decline-balance basis rather than the 8-per-cent rate provided to most electrical generating equipment (4 per cent provided for equipment acquired prior to February 28, 2000). Active solar systems, heat recovery systems and waste-fuelled heat production equipment must be used directly in connection with an industrial process to qualify as class 43.1 equipment. The 1999 budget included in class 43.1 equipment for the generation of electricity from gas that would otherwise be flared during the production of crude oil.

Class 43.1 is also subject to the "specified energy property" rules, which may reduce the amounts that can be deducted to less than 30 per cent of the unclaimed capital cost.

Canadian Renewable and Conservation Expenses

Objective: The renewable energy and energy conservation sector faces difficulties in financing intangible costs. The Canadian Renewable and Conservation Expenses (CRCEs) address this concern by providing them with improved access to financing in the early stages of their operations when they may have little or no income to utilize the income tax deductions related to these expenses. The 1996 budget made the tax treatments of renewable and non-renewable energy sectors more similar by: introducing a new category of expenditures (namely CRCEs) in respect of intangible costs that are analogous to those expenses that are renounced as Canadian exploration expenses, and are associated with the development of projects, the equipment for which is eligible for class 43.1 treatment; allowing this new class of expenditures to be fully deductible; and allowing these expenditures to be renounced to shareholders who have entered into a flow-through share agreement. (Budget 1996: Budget Plan.)

This category of expenses was introduced to provide for full deductibility of certain costs associated with the development of renewable energy projects and other projects for which the equipment is eligible for accelerated deductions under class 43.1. The cost of test wind turbines is also eligible to be claimed as a CRCE expense.

CRCE can be flowed out pursuant to a flow-through share agreement. It was introduced to provide a more equitable tax treatment for the financing of renewable and non-renewable energy projects.

Mining Assets

Certain mining buildings, machinery and equipment acquired for use at a new mine or a major expansion of an existing mine may qualify for an accelerated CCA rate of up to 100 per cent. A 25-per-cent increase in a mine's capacity is generally considered to be a major expansion.

These mining assets were previously included in class 28 and depreciated at a rate of 30 per cent. Acquisitions after 1987 are included in class 41 and depreciated at a rate of 25 per cent. In addition to the 25-per-cent allowance provided in class 41, a taxpayer owning such property and operating the mine may claim an additional allowance equal to the lesser of (1) the remaining undepreciated capital cost of property of the class, or (2) the income for the year from the new or expanded mine.

The 1996 budget announced income tax changes for oil sands projects. The objective of the changes was to provide a more equitable tax treatment for the two different oil sands extraction methods (mining and in situ). Mining methods involve the removal of overburden and the transportation of bituminous sands to a central processing facility where the oil (bitumen) is separated from the sand using hot water. With in situ operations, the oil is recovered from an underground reservoir by the application of heat or other techniques, which make the oil more mobile and capable of flowing from a well or wells.

The 1996 budget extended the accelerated CCA rules to the eligible depreciable capital costs for in situ projects. The tax treatment that previously had been available only for new mines (both mineral and oil sands) and major mine expansions was also extended to other capital investments, including large incremental capital costs that might not otherwise qualify as a major expansion (e.g., efficiency improvements and environmental protection). In the latter circumstance, all tangible capital expenditures incurred for all types of mines, including both types of oil sands projects, would qualify for accelerated CCA to the extent that, in a year, these capital costs exceeded 5 per cent of gross revenue from that mine or oil sands project in that year.

Capital Equipment Used for Scientific Research and Experimental Development

Eligible capital expenditures for the provision of premises, facilities or equipment used for scientific research and experimental development in Canada may be fully deducted in the year they are incurred. In the absence of this provision, these amounts would have been depreciable over several years. Under the benchmark tax system, expenditures that are capital in nature and designed to produce income in the future are depreciated over a period approximating that during which the income is expected to arise.

Exploration Costs and Pre-Production Development Expenses

Expenditures incurred in determining the existence, location, extent or quality of mineral resources and oil or gas, or incurred to develop mineral resources prior to commercial production in Canada, are classified as a Canadian exploration expense (CEE) and can be deducted for tax purposes at a rate of up to 100 per cent.

Generally accepted accounting principles allow companies to depreciate exploration expenditures on either a "full cost" or a "successful efforts" basis. The full cost method requires that all exploration costs, whether they result in new production or not, be capitalized and amortized as the reserves are depleted. The successful efforts method requires that only those costs that result in the discovery of reserves and have a benefit in terms of future revenues are capitalized; other costs are expensed as incurred. Most Canadian-controlled companies follow the full cost method, while foreign-controlled companies in Canada usually follow the successful efforts method.

The 100-per-cent write-off of CEEs for tax purposes is more rapid than the amounts used for financial statement purposes, especially for successful exploration. The fast write-off for CEEs provides a deferral of tax.

Under the benchmark tax system, corporations would be permitted an immediate deduction only for unsuccessful exploration expenditures. However, those costs associated with successful exploratory activities (i.e., those costs that result in producing assets for both the mining and oil and gas sectors) would be permitted a deduction based on an amortization over the life of the asset.

Under certain conditions, corporations entering into flow-through share agreements are entitled to reclassify limited amounts of a Canadian development expense (normally a 30-per-cent deduction on a declining-balance basis) into a CEE. The tax expenditure associated with this provision appears as a personal tax expenditure item since these deductions are taken by the purchasers of the flow-through shares, who are generally individuals.

Illustration

Assuming a taxable corporation makes a $100,000 investment in an eligible asset, the net present value of the income tax reduction resulting from accelerated CCA is presented in the following table. This illustration is based upon the federal corporate income tax rate that will generally apply to the related income in 2001 (unless otherwise indicated) and uses a discount rate of 8 per cent. The actual net present value of the reduced federal tax resulting from accelerated CCA will vary depending upon the tax status of the corporation, its effective tax rate and the amount of CCA actually claimed in future years. The following table presents the maximum value of the incentive assuming that firms can fully benefit from the accelerated CCA. The one exception is for the analysis of mining assets (see footnotes 2 and 3 below).

	CCA Class	Accelerated Rate	Baseline Tax Depreciation Rate	Net Present Value of Reduced Federal Tax Resulting From Accelerated CCA
Vessels	7	331/3% straight-line	15% declining balance	$5,600
Electrical generating equipment using wind, solar and geothermal energy	43.1	30% declining balance	8% declining balance	$6,2001
Canadian Renewable and Conservation Expenses	Full write- off in year	Full write-off in year	30% declining balance	$3,7001
Mining assets
Oil sands and   in situ oil	41(a)	100% (subject to income restriction)	25% declining balance	$500 to $4,0002
Conventional mines	41(a)	100% (subject to income restriction)	25% declining balance	$500 to $1,3003
Scientific research and experimental development equipment4	Full write- off in year	Full write-off in year	30% declining balance	$4,700
Exploration costs for non renewable resources and pre-production development expenses for mines	Full write- off in year	Full write-off in year	30% declining balance	$4,800
1 These amounts reflect the fully phased-in value of the 1999 budget proposal to provide, by 2002, the manufacturing and processing profits deduction for the production of electrical energy for sale. 2 Accelerated CCA can be claimed only against income earned by the related project, not against total corporate income. The income of the project, in turn, depends inter alia on prices for oil/minerals. Therefore, the net present value of the federal tax reduction resulting from claiming accelerated CCA varies depending upon the amount of project income against which CCA may be claimed. The estimates in this table were based on the operating results of a range of existing and proposed oil sands mining and in situ oil sands projects as obtained from industry sources. The calculations result in a range of $500 to $4,000 per $100,000 investment; however, most oil sands projects would generally fall between $1,000 and $3,500. 3 For conventional mines, the analysis was based on hypothetical mine models developed by Natural Resources Canada. These models include a range of low and high profitability metal mines. 4 This is the value of the accelerated CCA deduction and doesn't include the benefit of scientific research and experimental development tax credits provided.

Allowable Business Investment Losses

Objective: Small businesses often have difficulty obtaining adequate financing. The allowable business investment loss rules provide special assistance for risky investments in small business. (Budget Papers, May 23, 1985.)

Capital losses arising from the disposition of shares and debts are generally deductible only against capital gains. However, under the allowable business investment loss rules, a portion of capital losses in respect of shares or debts of a small business corporation may be used to offset other income. The 2000 budget proposed that this portion be reduced from three-quarters to two-thirds, effective February 28, 2000, as a consequence of the reduction in the capital gains inclusion rate.

Unused allowable business investment losses may be carried back three years and forward seven years. After seven years, the loss reverts to a capital loss and may be carried forward indefinitely.

The value of the tax expenditure is the amount of tax relief provided by allowing these losses to be deducted from other income in the year rather than being deducted against uncertain taxable capital gains in the future.

Holdback on Progress Payments to Contractors

Objective: In the construction industry, holdbacks are considered to become receivable by contractors or payable to subcontractors only upon satisfactory completion of the project in order to alleviate potential cash-flow difficulties for this sector.

In the construction industry, contractors are typically given progress payments as construction proceeds. However, a portion of these progress payments (e.g., 10 per cent to 15 per cent) is often held back until the entire project is completed satisfactorily. The amount held back need not be brought into the income of the contractor until the project to which it applies is certified as complete, rather than when earned, as would be required in the benchmark tax structure. Where a contractor, in turn, withholds an amount from a subcontractor, costs equal to the amount of the holdback are not considered to have been incurred by the contractor and are not deductible until paid. The net impact of these two measures on a given contractor's tax liability depends on the ratio of holdbacks payable to holdbacks receivable. If holdbacks receivable are greater than holdbacks payable, there is a deferral of tax. If holdbacks payable exceed holdbacks receivable, there is a prepayment of taxes.

Increases in net holdbacks receivable or decreases in net holdbacks payable result in a positive estimate of the amount of the tax expenditure. Increases in net holdbacks payable or decreases in net holdbacks receivable result in a negative estimate.

Available for Use

Objective: Permitting capital cost allowance (CCA) and tax credits to be claimed in the second taxation year following the year of acquisition, even though the property may not have been put into use, is intended to reduce the potential impact upon projects with long construction periods. (Supplementary Information Relating to Tax Reform Measures, December 16, 1987.)

Taxpayers may claim CCA and investment tax credits (ITCs) on eligible property at the earlier of the time it is put in use or in the second taxation year following the year of acquisition. Property that becomes eligible for CCA and ITCs by virtue of the two-year deferral rule could result in a significant mismatch of revenues and expenses that give rise to a tax deferral. This is a tax expenditure because taxpayers are allowed to claim deductions and tax credits on property before it is put in use.

No data are available as assets are pooled into classes and are not accounted for separately. Furthermore, assets are not identified as being "available for use" or "not available for use."

Capital Gains Taxation on Realization Basis

Objective: This treatment recognizes that, in many cases, it is difficult to estimate with accuracy the value of unsold assets, and that taxing the accrued gains on assets that have not been sold would be administratively complex and could create significant liquidity problems for taxpayers. (Report of the Royal Commission on Taxation, 1966, vol. 3.)

Capital gains are taxed upon the disposition of property and not on an accrual basis. This treatment results in a tax deferral. Under the benchmark tax system, capital gains would be fully included in income as they accrue.

However, since 1994, financial institutions and investment dealers have been required to report gains and losses on certain securities on an accrual basis (i.e., mark to market).

No data are available.

Expensing of Advertising Costs

Objective: It is often difficult to identify specific costs with specific revenue. Moreover, there is no certainty that any revenue will result from many types of expenditures. As a result, for tax and accounting purposes, it is usual to write off against income most of these expenditures when incurred. Therefore, advertising expenses are deductible on a current basis even though some of these expenditures provide a benefit in the future. (Report of the Royal Commission on Taxation, 1966, vol. 4.)

Advertising expenses are deductible on a current basis even though some of these expenditures provide a benefit in the future. Under the benchmark tax system, the expenses would be amortized over the benefit period.

The estimates provided are based upon the assumption that 25 per cent of advertising costs incurred in a particular year provide a benefit in the following two years. Since tax expenditures are estimated on a cash-flow basis, an increase in annual advertising costs would result in a positive estimate of the tax expenditure. Decreases in annual advertising costs would result in a negative estimate of the tax expenditure.

Deductibility of Contributions to Mine Reclamation and Environmental Trusts

Objective: Contributions to mine reclamation and environmental trusts have been made deductible in order to assist firms that are required to make such contributions. Prior to this change, the mandatory contributions, in combination with previous income tax rules, led to two problems for companies. First, they could give rise to cash-flow problems and second, some companies, particularly single-mine companies, may have been unable to fully utilize the deduction of actual reclamation expenses, since the majority of these expenses occur at the end of the life of the mine, when it no longer produces income. This measure also assists companies subject to environmental regulations to meet their obligations under the relevant federal or provincial statutes without distorting governments' choices of instrument used to provide assurance that adequate funds are available to conduct restoration activities at the end of operations. (Tax Measures: Supplementary Information, February 22, 1994. Budget Plan, February 18, 1997.)

Certain environmentally sensitive activities can disturb the natural environment in the area where the activity takes place, and measures may need to be taken to repair the environmental damage after operations have terminated. In these situations, governments may require companies to set aside funds in advance in trust funds to ensure that adequate amounts are available to conduct restoration activities at the end of operations.

The 1994 budget permitted a deduction of government-mandated contributions to mine reclamation trusts in the year in which they are made rather than permitting a deduction only when the mine reclamation costs are actually incurred. Income earned in such trusts is subject to tax each year under special Part XII.4 rules. The same income taxed in the trust is considered taxable income of the beneficiary, but the beneficiary also receives a refundable tax credit on its share of the tax paid by the trust. When actual reclamation costs are incurred, any withdrawal of funds from the trust will be included in income subject to tax and the actual reclamation costs incurred will be deductible. The 1997 budget extended this treatment to similar funds established for waste disposal sites and quarries for the extraction of aggregate and other similar substances.

The overall effect is to provide cash-flow assistance to companies as they set funds aside but to recover the income forgone plus interest when the actual reclamation work is done. The value of the tax expenditure over the life of the project is, therefore, nil. However, in any given year the value of the tax expenditure is the amount of tax relief that is effectively provided by allowing payments to be deducted from income when contributions are made to the trust. This tax expenditure could be positive or negative depending upon the amount of contributions to and withdrawals from these trusts in a particular year.

Deductibility of Countervailing and Anti-Dumping Duties

Objective: The deduction of these duties when paid, rather than waiting to deduct the exact amounts upon final resolution of the dispute, assists firms. This assistance recognizes that these firms are required to pay amounts that are not under the control of the taxpayer, and although these amounts may be subsequently refunded, in whole or in part, this process can take several years. (Budget Plan, February 24, 1998.)

In accordance with the rules established under the World Trade Organization, countervailing and anti-dumping duties may be imposed by countries to offset the injurious effects of imports that are subsidized or dumped. These actions may result in Canadian taxpayers paying such amounts in order to export their products. The 1998 budget made cash outlays for duties deductible in computing income subject to tax in the year they are paid even though these amounts may be refunded, in whole or in part, in a subsequent year. Any refunds or additional amounts subsequently received, such as interest, would have to be included in income in the year of receipt.

The value of the tax expenditure is the amount of tax relief provided by allowing these contingent costs to be deducted from income when paid rather than when the exact amount, if any, of the duty is determined. This tax expenditure could be positive or negative depending upon the amount of countervailing duties paid and recovered by firms in a particular year.

No forecasts have been made of the future tax expenditure amounts since it is not possible to determine the cost of future trade actions affecting Canadian taxpayers.

Deductibility of Earthquake Reserves

Objective: In 1997, the Office of the Superintendent of Financial Institutions introduced new guidelines that require federally regulated insurance companies selling earthquake protection to meet target levels of preparedness to ensure they have sufficient financial capacity to pay insured earthquake losses when they occur. This measure helps to ensure that sufficient capacity is achieved in a timely fashion. (Budget Plan, February 24, 1998.)

An earthquake reserve is composed of two parts: the first element, the "earthquake premium reserve," is based on a percentage of net earthquake premiums written; the second element, the "earthquake reserve complement," takes into account the earthquake exposure reinsured with another insurance company and a proportion of the capital and surplus of the company. The 1998 budget made the "earthquake premium reserve" deductible for income tax purposes. Under the benchmark system, such reserves would not be deductible.

Cash Basis Accounting

Objective: It would create some hardship to require farmers and fishers to adopt the accrual method because of the accounting and liquidity problems which this might involve for those with relatively small incomes. As a result, farming and fishing corporations are permitted to use the cash basis of accounting. (Report of the Royal Commission on Taxation, 1966, vol. 4.)

Farming and fishing corporations may elect to include revenues as received, rather than when earned, and deduct expenses when paid rather than when the related revenue is reported. This treatment allows a deferral of income and a current deduction for prepaid expenses. Under the benchmark tax structure, income is taxable when it accrues and expenses are deductible in the period to which they relate.

No data are available.

Flexibility in Inventory Accounting

Objective: This measure ensures that farmers operating on a cash basis are able to avoid creating losses that would be subject to the time limitation if carried forward. (Budget Supplementary Information, 1973.)

Farm corporations using the cash basis method of accounting are allowed to depart from it with regard to their inventory. A discretionary amount, not exceeding the fair market value of farm inventory on hand at year-end, may be added back to income each year. This amount must then be deducted from income in the following year. The effect of this provision is to allow farm corporations to avoid creating losses which, if carried forward, would be subject to the time limitation. Thus, the tax expenditure provides tax relief to the extent that the losses would otherwise have been subject to the time limitations.

No data are available.

Deferral of Income From Grain Sold Through Cash Purchase Tickets

Objective: By permitting the deferral of the reporting of income on grain sales, this measure facilitates the orderly delivery of grain to elevators, ensuring that Canada meets its grain export commitments. (Budget Papers, 1974.)

Farmers may make deliveries of grain before the year-end and be paid with a ticket that may be cashed only in the following year. The payment for deliveries of grain is included in income only when the ticket is cashed, thereby providing a deferral of taxes. Under the benchmark tax system, income would be taxed on an accrual basis.

The estimates are based on data provided by the Canadian Wheat Board. Since tax expenditures are estimated on a cash-flow basis, an increase in the balance of uncashed grain tickets represents additional income that is being deferred and results in a positive estimate of the tax expenditure. A decrease in the balance of uncashed grain tickets indicates that less income is being deferred and results in a negative tax expenditure.

Deferral of Income From Destruction of Livestock

Objective: This deferral was introduced to allow farmers operating on a cash basis adequate time to replace their herds, destroyed under statutory authority, without imposing a tax burden in the year of livestock destruction. (Budget Papers, 1976.)

If the taxpayer elects, when there has been a statutory forced destruction of livestock, the income received from the forced destruction can be deemed to be income in the following year. The deferral is also available when the herd has been reduced by at least 15 per cent in a drought year. This provision allows for a deferral of income to the following year when the livestock is replaced. Under the benchmark tax system, income is taxed on an accrual basis.

Deferral Through Use of Billed-Basis Accounting by Professionals

Objective: This treatment recognizes the inherent difficulty in valuing unbilled time and work in progress. (Summary of 1971 Tax Reform Legislation, 1971.)

Under accrual accounting, costs must be matched with their associated revenues. In computing their income for tax purposes, however, professionals are allowed to elect either an accrual or a billed-basis accounting method. Under the latter method, the costs of work in progress can be written off as incurred even though the associated revenues are not brought into income until the bill is paid or becomes receivable. This treatment gives rise to a deferral of tax.

No data are available.

International

Non-Taxation of Life Insurance Companies' World Income

Objective: To ensure that life insurance companies can compete in foreign markets, foreign income is exempted from tax in Canada. Canadian insurers could not compete in other countries if Canada imposed the normal tax rules on profits earned in a country that taxes on the basis of premiums or investment revenue only. (Supplementary Budget Papers, March 31, 1977.)

All Canadian corporations except Canadian multinational life insurers are taxed on their worldwide income. Canadian multinational life insurers are taxed only on their profits from carrying on a life insurance business in Canada using special rules in the income tax regulations.

Prior to 1993, the cost of this tax expenditure was estimated from tax returns and information available from the Office of the Superintendent of Financial Institutions. However, information required to estimate this tax expenditure is not available after 1992.

Exemptions From Non-Resident Withholding Tax

Objective: Over time, as the benefits of freer trade in capital, goods and services have been increasingly recognized, countries including Canada have adjusted their tariff and tax structures to remove impediments to international transactions. Part of this adjustment has been the reduction in non-resident withholding tax on certain payments. Lower withholding taxes can reduce the cost to Canadian business of accessing capital and other business inputs from abroad. For example, a lower Canadian withholding tax on interest payments to non-residents can reduce the cost of accessing foreign capital in certain situations. Similarly, a reduced withholding tax on royalty payments can reduce the cost of accessing foreign technology and other property and services, and thereby enhance the competitiveness of Canadian businesses requiring these inputs.

Canada, like other countries, imposes a withholding tax on various types of income paid to non-residents. The basis for this tax rests on the internationally accepted principle that a country has the right to tax income that arises or has its source in that country. The types of income subject to non-resident withholding tax include: certain interest, dividends, rents, royalties and similar payments; management fees; estate and trust income, alimony and support payments; and certain pension, annuity and other payments.

Canada's statutory non-resident withholding tax rate is 25 per cent. However, the rate is lowered and exemptions are provided for certain payments through an extensive network of bilateral tax treaties. These rate reductions, which apply on a reciprocal basis, differ depending on the type of income and the tax treaty country.

The Income Tax Act also provides for a number of unilateral exemptions from withholding tax, including exemptions for the following: interest payments on government debt; interest payments to arm's-length persons on long-term corporate debt; interest payments to arm's-length persons on foreign currency deposits with branches of Schedule I banks; and royalty payments for the use of copyright.

The estimates of the tax expenditures associated with withholding tax exemptions for certain royalties, interest, dividends and management fees paid to non-residents were derived from a detailed analysis of payments to non-residents and withholding tax collections on those payments for 1992, 1993 and 1994, and projections of payments to non-residents over the post-1994 period. The cost estimates were derived by applying treaty withholding tax rates (in the case of payments to a country with which Canada had a tax treaty in the year considered) or the statutory 25-per-cent withholding tax rate (in the case of payments to non-treaty countries) that would otherwise apply, in the absence of an exemption, to observed and projected payments data under the benchmark assumption used throughout this publication of no behavioural response to the hypothetical removal of existing withholding tax exemptions.

This benchmark assumption of no behavioural response is particularly difficult to sustain for this type of tax. Foreign providers of capital, technology and other property and services, in most cases, are unwilling to bear the withholding tax given that they do not pay such a tax when supplying other markets. If a withholding tax was to be imposed, foreign providers would either require that the tax be shifted back to the Canadian borrower or user of property or services in the form of higher charges (which in many cases could not be absorbed), or they would bypass Canada in favour of other foreign markets where such a tax does not exist, again implying increased financing and other business costs for Canadians. Indeed, these same competitiveness considerations have led to the introduction of a number of withholding tax exemptions both in Canada and in other countries.

Thus, these particular tax expenditure estimates cannot be interpreted as additional revenues that could be collected from non-residents if the withholding tax exemptions were removed, since the removal of the exemptions would generally involve the elimination of the tax base.

Exemption From Canadian Income Tax of Income Earned by Non-Residents From the Operation of a Ship or Aircraft in International Traffic

Objective: The international shipping tax exemption is a reciprocal tax exemption provided for income earned by a non-resident person in Canada from the operation of a ship or aircraft in international traffic. This exemption, whose purpose is the avoidance of international double taxation, was first introduced in the Income War Tax Act at a time when Canada had few bilateral double taxation agreements.

Non-resident persons operating a ship in international traffic are exempted from Canadian income tax, as is done in other countries. Similarly, non-resident persons operating an airline in international traffic are exempted from Canadian income tax. In both cases, the exemption applies only if the non-resident's home country gives Canadian residents substantially similar tax relief. The amount of the tax expenditure is the tax that would otherwise be payable on profits related to the Canadian business of the non-resident persons, net of the tax collected on the non-Canadian income of the resident persons.

No data are available.

Other Items

Transfer of Income Tax Room to Provinces in Respect of Shared Programs

Objective: One percentage point of corporate tax is transferred to the provinces as part of the federal contribution under the Canada Health and Social Transfer. This transfer assists provinces in providing services in the areas of health, post-secondary education and social assistance.

In 1967, federal-provincial fiscal arrangements were altered. The federal government substituted a transfer of corporate income tax points for direct transfers to provinces under the cost-shared program for post-secondary education. The tax change involved an increase in the corporate income tax abatement rate from 9 to 10 percentage points, effectively reducing the federal corporate income tax rate at that time from 37 per cent to 36 per cent (the rate before the abatement was 46 per cent). This transfer of tax room has been included as a tax expenditure because it is a substitute for direct spending programs.

Interest Credited to Life Insurance Policies

Objective: Not requiring the reporting of income of exempt policies on an accrual basis reduces complexity for policyholders and insurance companies.

Life insurance companies are taxed under the investment income tax (IIT) at a rate of 15 per cent on net investment earnings attributable to life insurance policies.

The IIT interacts with the taxation of policyholders. The Income Tax Act divides life insurance policies into two categories: savings-oriented policies and protection-oriented policies.

Savings-oriented policies are those where the amount of money invested in the policy is large relative to the death benefit. A holder of a savings-oriented policy is subject to annual accrual taxation in respect of the net investment earnings credited to the policy. Net investment earnings reported by these holders are subtracted from the IIT base in order to avoid double taxation of net investment earnings.

In contrast, a holder of a protection-oriented policy is not subject to annual accrual taxation. Net investment earnings are taxed when the policy is sold or surrendered, terminated (other than by death), or when paid out as policy dividends once the cumulative dividends exceed the total premiums paid under the policy. Net investment earnings that are taxable to holders of protection-oriented policies are also deductible from the IIT base.

Most of the cost of the tax expenditure relates to protection-oriented policies. This cost has three basic elements:

• differences between personal and IIT rates;
• timing differences (i.e., policies that are eventually taxed in the hands of policyholders); and
• permanent differences (i.e., policies that are held until the death of the insured).

Non-Taxation of Registered Charities and Other Non-Profit Organizations

Objective: Charities play a useful and important role in our national life. They are significant in the fields of education, medicine, scientific research, culture, religion and athletics, to name just a few major areas. Their role is to fill in gaps of service and financial support where governments should not or cannot play a significant part. To support these charities, the Government exempts registered charities from income tax. (Discussion Paper: The Tax Treatment of Charities, June 23, 1975.)

Registered charities and other non-profit organizations, both incorporated and unincorporated, are exempt from income tax. This is a tax preference to the extent that the charity or organization has taxable income, mainly investment income or profits from certain commercial activities.

No data are available.

Income Tax Exemption for Provincial and Municipal Corporations

Objective: The Constitution Act states that no lands or property belonging to Canada or any province shall be liable for taxation. This provision means that Crown corporations created at one level of government are exempt from paying taxes imposed by the other level of government, or by governments at the same level. This immunity from taxation extends to all agents of Canada or a province. (Section 125 of the Constitution Act.)

Provincial Crown corporations and municipal corporations are exempt from income tax. Under the benchmark tax structure, such corporations would be taxable to the extent that they had taxable income.

No data are available.

Non-Taxation of Certain Federal Crown Corporations

Objective: Federal Crown corporations that carry on significant commercial activities are subject to federal income tax, which ensures that they compete on a level playing field with similar businesses in the private sector. Other federal Crown corporations are exempt from taxation. Their exempt status avoids the compliance and administration costs associated with filing an income tax return. Furthermore, the net financial position of the federal government would be unchanged if these Crown corporations were required to pay income taxes – the payment of taxes would merely be a transfer of funds from the Crown corporation to consolidated revenues.

While federal Crown corporations are generally not subject to income tax, those Crown corporations that carry on significant commercial activities are taxable. It is possible, however, that some exempt corporations have income that would be taxable under the benchmark tax system.

No data are available.

Aviation Fuel Excise Tax Rebate

Objective: The aviation fuel excise tax rebate is designed to provide airlines with an immediate cash-flow benefit in exchange for a reduction in accumulated losses that would otherwise be available to reduce income taxes in future years.

The aviation fuel excise tax rebate, which is effective for the calendar years 1997 to 2000 inclusive, provides excise tax rebates on the aviation fuel used by airline companies. Rebates are limited to $20 million per year per associated group of companies. In order to receive a rebate, a company must agree to reduce its income tax losses by 10 dollars for every 1 dollar of rebate.

Surtax on the Profits of Tobacco Manufacturers

Objective: The surtax on the profits of tobacco manufacturers is intended to maintain federal revenues in the tobacco sector. (Department of Finance Canada News Release 96-086, November 28, 1996.)

Tobacco manufacturers are subject to a special surtax on their profits. The surtax is levied at a rate of 40 per cent of the Part I tax on tobacco manufacturing profits. The surtax was originally announced as part of the National Action Plan to Combat Smuggling in February 1994 for a three-year period, and was extended for another three years from February 1997. In November 1999, the Government announced that, effective February 2000, the surtax would be made permanent. The surtax is considered a tax expenditure because it constitutes a departure from the benchmark system. Because the surtax results in more revenues than would otherwise be raised under the benchmark tax system, it is a negative tax expenditure.

Resource Sector Tax Rate

Objective: Canada must ensure that its business income tax system is internationally competitive. The resource sector (crude oil, natural gas and mining) benefits from special deductions, such as the resource allowance when it exceeds royalties, accelerated exploration and development expenses and fast write-offs for certain capital assets, all of which serve to reduce its effective tax rate. (The Budget Plan 2000, February 28, 2000.)

The 2000 budget proposed a 7-per-cent reduction in the general corporate income tax rate applicable to most businesses in Canada. The first proposed reduction will be from 29.12 per cent to 28.12 per cent for income that does not qualify for special tax treatment. Special tax treatment is provided to small businesses, manufacturing operations and the non-renewable natural resource sectors (i.e., oil and gas production and mining). The 2000 budget proposed that these latter sectors will continue to be subject to the 29.12 per cent rate (i.e., the statutory rate of 28 per cent plus the 4-per-cent surtax), given that they qualify for a number of special tax provisions that lower their taxable income base and therefore lower their effective tax rate. The Department has initiated consultations with resource industries associations and provinces to determine whether adjustments can be made to the existing resource tax structure so as to extend the proposed lower rates to the non-renewable natural resource sector.

In accordance with the definition of a standard benchmark, which has been set for 28.12 per cent in 2001, the higher tax rate of 29.12 per cent that will continue to apply to the resource sectors constitutes a negative tax expenditure (i.e., it results in more corporate income tax being paid than what would be the case if the benchmark tax rate were to be applied). This negative tax expenditure will offset a portion of the various positive tax expenditures available only to these sectors (i.e., the resource allowance when it exceeds royalties, accelerated exploration and development expenses and fast write-offs for certain capital assets).

The negative tax expenditure set out in the document for 2001 and 2002 is calculated as the extra federal corporate income tax payable by the sectors because of the introduction of the 1-per-cent lower general rate effective January 1, 2001.

Temporary Tax on the Capital of Large Deposit-Taking Institutions

Objective: The temporary tax on the capital of large deposit-taking institutions was adopted to help achieve deficit reduction targets. (Budget Plan, February 27, 1995.)

The temporary surcharge is levied at a rate of 12 per cent of the financial institution capital tax imposed under Part VI of the Income Tax Act calculated before any credit for income taxes and as if there was a capital deduction of $400 million. The surcharge applies to financial institutions as defined under Part VI, but not to life insurance companies. The surcharge is not eligible to be offset by tax payable under Part I.

The surcharge was introduced in the 1995 budget for a period of 18 months and extended for one year in the 1996, 1997, 1998 and 1999 budgets. The 2000 budget proposed to extend the surcharge to October 31, 2001, pending completion of the review of the application of this surcharge as announced by the Government in its June 25, 1999, paper Reforming Canada's Financial Services Sector: A Framework for the Future.

The surcharge is considered a tax expenditure because it constitutes a departure from the benchmark system. Because the surcharge results in more revenues than would otherwise be raised under the benchmark tax system, it represents a negative tax expenditure.

Memorandum Items

Refundable Taxes on Investment Income of Private Corporations

Objective: A refundable Part I tax levied on the investment income of private corporations is intended to reduce the deferral advantage to individuals of earning investment income through these private corporations instead of earning such income directly. The deferral advantage arises when the corporate tax rate applied to this income is lower than the marginal tax rate of the individual shareholder. (Budget Plan, February 27, 1995.)

Refundable tax provisions of the corporate income tax system provide some integration of the corporate and personal income tax regimes. These provisions include:

• a refundable tax (Part IV tax) of 33¹/₃ per cent on intercorporate dividends received by private corporations (25 per cent on dividends received prior to July 1, 1995); and
• an additional Part I tax of 6²/₃ per cent on the investment income (excluding deductible intercorporate dividends) received after June 30, 1995, by Canadian-controlled private corporations (CCPCs).

These additional taxes, as well as 20 percentage points of the Part I tax paid by CCPCs on investment income (excluding deductible intercorporate dividends), are refundable to the corporation at a rate of one dollar for every three dollars of taxable dividends paid (prior to July 1, 1995, the refund was one dollar for every four dollars of taxable dividends paid).

The additional Part I tax on the investment income of CCPCs, the Part IV tax on intercorporate dividends and the amount of refundable taxes refunded upon the payment of dividends are considered to be tax expenditures because they constitute a departure from the benchmark system. In addition, because investment income of CCPCs is subject to Part I tax at a rate of 29.12 per cent rather than at the benchmark rate, this additional tax also represents a departure from the benchmark system and is included as part of the "Additional Part I taxes." Because the additional Part I taxes and the Part IV tax result in more revenues than would otherwise be raised under the benchmark system, they are negative expenditures. To the extent that, in a particular year, the amount of refundable taxes refunded upon the payment of dividends exceeds the total of the additional Part I tax on the investment income of CCPCs and the Part IV tax on intercorporate dividends, there is a net tax expenditure.

Refundable Capital Gains for Investment Corporations and Mutual Fund Corporations

Objective: This item is part of an integrated system of measures that ensures that the treatment of capital gains earned by investment corporations or mutual fund corporations and subsequently distributed is generally comparable to the treatment of capital gains earned directly by an individual. The rationale for this integrated system is that investments made through these kinds of corporations are comparable to investments made by an individual since these special investment corporations must hold only passive investments.

Capital gains realized by an investment corporation and a mutual fund corporation are taxed at the corporation level, and the tax is accumulated in the "refundable capital gains tax on hand" account. The corporation uses this account to claim a capital gains refund when it distributes capital gains dividends to its shareholders or through share redemptions by a mutual fund corporation. Since these dividends are capital gains distributions, they are taxed as capital gains in the hands of the shareholder and not as dividends.

This measure is considered a tax expenditure because it constitutes a departure from the benchmark system by allowing a public corporation (that qualifies as an investment corporation or a mutual fund corporation) to flow out its capital gains to shareholders. The result is that the distributed capital gains will be taxed at the same rate as if the corporation were a private corporation.

Loss Carry-overs

Objective: Loss carry-overs are provided to support business operations and investment in a number of ways. Permitting the carry-over of losses provides certainty to firms that they can benefit from tax losses sustained and that they can obtain immediate tax relief by deducting losses against prior years' income, thus reducing the risks faced by investors. (Budget Papers: Supplementary Information and Notice of Ways and Means Motions on the Budget, April 19, 1983.)

The cyclical nature of business and investment income suggests that the impact of such income should be viewed over a longer period of time rather than on an annual basis. As a result, carry-overs of losses are treated as part of the benchmark tax system. The loss carry-over rules permit taxpayers to apply their losses against past or future income. The estimates provided indicate approximately how much tax revenue the Government forgoes by allowing current-year losses to be carried back (i.e., applied to reduce tax paid in previous years) and by allowing losses of previous years to be carried forward and applied to reduce tax otherwise payable for the current year. There are four types of losses that can be carried over, and specific provisions apply to each.

Non-Capital Losses

A non-capital loss is a company's loss from business operations. Non-capital losses may be carried back three years and forward seven years to reduce or offset the corporation's taxable income.

Estimates reflecting the impact of the carry-forward of prior years' losses (i.e., non-capital losses applied to the current year) include the revenue impact of allowing non-capital losses of previous years to be applied to reduce Part I tax and the refundable Part IV tax otherwise payable for the current year. Estimates reflecting the impact of allowing current-year losses to be applied to reduce income tax paid in previous years (i.e., non-capital losses carried back) include the impact on both Part I tax and refundable Part IV tax.

Net Capital Losses

A net capital loss can arise from the disposition of capital property. This type of loss may be carried back three years and forward indefinitely but can only be applied against net taxable capital gains.

Estimates are provided for both the revenue impact of allowing net capital losses of previous years to be applied to reduce income tax otherwise payable for the current year (i.e., net capital losses applied to the current year) and the impact of allowing current-year net capital losses to be applied to reduce income tax paid in previous years (i.e., net capital losses carried back).

Farm Losses and Restricted Farm Losses

A corporation can deduct, in the calculation of net income, a loss incurred from a farming or fishing business. The unused losses of this business may be carried back 3 years and forward 10 years.

When the corporation's major source of income is not farming, the amount of farming losses deductible in the year is restricted to a maximum of $8,750. The unused losses, defined as the excess of the net farm losses over the farm losses deductible in the year, are considered restricted farm losses. Restricted farm losses may also be carried back 3 years and forward 10 years but can only be applied against farm income.

Estimates consist primarily of the revenue impact of allowing farming losses of previous years to be applied to reduce income tax otherwise payable for the current year.

The revenue impact of applying restricted farm losses is minimal.

Deduction of Meals and Entertainment Expenses

Objective: To reflect the existence of the personal consumption element of meal and entertainment expenses, only 50 per cent of these costs are deductible (80 per cent before March 1, 1994). (Income Tax Reform, June 18, 1987; Budget Papers, 1994.)

Meals and entertainment expenses are considered to be a memorandum item because the amount that should be deductible under a benchmark tax system is debatable. While a portion of these expenditures is incurred in order to earn income, there is an element of personal consumption associated with these expenditures. Consequently, only a partial deduction for these expenses would be permitted under the benchmark tax system.

Generally, the deduction is limited to 50 per cent of the cost of food, beverages and entertainment (80 per cent before March 1, 1994) in order to reflect the personal consumption portion of these costs. The estimates provided reflect the additional tax revenue that would be received if no deduction were allowed (i.e., that there is no business purpose to the expenditure).

Large Corporations Tax

Objective: This tax ensures that all large corporations, and groups of related corporations, with more than $10 million of taxable capital employed in Canada pay some federal tax. (Budget Papers, April 27, 1989.)

The large corporations tax (LCT) was introduced on July 1, 1989, as a tax on the Canadian capital of large corporations. The rate of tax in 1993 and 1994 was 0.2 per cent. The 1995 budget increased the LCT rate to 0.225 per cent effective budget day 1995.

Companies can reduce their LCT liability to the extent of the Canadian portion of their corporate surtax. The rate of corporate surtax was increased from 3 per cent to 4 per cent in the 1995 budget.

Threshold

Objective: The objective of the LCT threshold is to ensure that smaller businesses will not be subject to the tax. (Budget Papers, April 27, 1989.)

The $10-million capital deduction effectively exempts smaller corporations from the LCT as long as these corporations are not related to other corporations subject to the LCT – that is, the $10-million deduction must be shared among related corporations. This capital deduction is not considered to be a tax expenditure because it is generally available to all corporations.

Exempt Corporations

Objective: Because the corporate surtax is creditable against the LCT liability, corporations are effectively subject to the greater of the LCT and the corporate surtax. If corporations exempt from paying Part I tax and its related corporate surtax were subject to the LCT, they would have no way of reducing the LCT. As a result, certain corporations such as non-resident investment corporations, deposit insurance corporations and corporations exempt from paying Part I income tax are also exempted from paying the LCT.

Certain corporations such as non-resident investment corporations, deposit insurance corporations and corporations exempt from paying Part I income tax are exempt from paying the LCT. This exemption is a tax expenditure, but data are not available to estimate its value.

Patronage Dividend Deduction

Objective: The purpose of this tax expenditure is to place co-operatives in a position of tax equality with other forms of business enterprise considering that obligated patronage dividend payments reduce the ability to pay tax. To avoid discrimination, similar treatment is provided for patronage dividends distributed by ordinary companies, partnerships or individual business enterprises. (Budget Speech, 1946.)

In computing income for a taxation year, a taxpayer is allowed to deduct patronage dividend payments made to customers. Patronage dividends are payments made to customers in proportion to their volume of business. The taxpayer is required to withhold 15 per cent of all patronage dividends in excess of $100 paid to each customer who is resident in Canada.

The appropriate benchmark tax treatment of patronage dividends is uncertain. These dividends could be considered to be analogous to the payment of a volume discount or the return of excess payments. With this view of the benchmark system, this would not be a tax expenditure.

Alternatively, these payments could be perceived as the distribution to members (or shareholders) of earnings that would not be deductible under the benchmark system. The amount shown, reflecting this view of the benchmark system, is the revenue impact of allowing patronage dividends to be deductible from income.

Logging Tax Credit

Objective: The logging tax credit was introduced as a means of relieving the tax burden on the forest industry. (Budget Speech, April 10, 1962.)

The logging tax credit reduces federal taxes payable by the lesser of two-thirds of any logging tax paid to a province and 6²/₃ per cent of income from logging operations in that province. This reduction in federal taxes can be argued to be a tax expenditure for the reasons similar to those discussed with reference to the resource allowance deduction.

Deductibility of Provincial Royalties (Joint Venture Payments) for the Syncrude Project (Remission Order)

Objective: The Syncrude project was initiated in the early 1970s when all provincial Crown royalty charges were fully deductible in the computation of income taxes. After a joint venture agreement with the province of Alberta was signed, the project participants received assurances from the federal government that the joint venture payments to the province would be treated as royalties. In May 1976, the Government granted a remission order to Syncrude participants by Order in Council. The remission order permits participants to deduct joint venture payments to the province of Alberta. Income tax regulations provide a resource allowance on the net amount when calculating federal corporate income taxes. The remission order provides for the deduction of joint venture payments for production from Leases 17 and 22 until the earlier of December 31, 2003, or when cumulative production reaches 2.1 billion barrels.

Taxpaying participants in the Syncrude project are permitted to deduct both a resource allowance and "joint venture payments" made to the province of Alberta in lieu of a royalty in computing income subject to tax. This is accomplished through a remission order. Under the benchmark tax system, these joint venture payments, which are profit sensitive, would not be deductible.

Deductibility of Royalties Paid to Indian Bands

Objective: Royalties paid to Indian bands were deductible prior to the 1974 budget. The Government allowed these royalties to continue to be deductible after 1974 to encourage further development of non-renewable natural resources on Indian lands.

Royalties and lease rentals paid to Indian bands in respect of oil and gas and mining activities on Indian reservations are paid to Her Majesty in Right of Canada in trust for the Indian band. Unlike non-deductible Crown charges, amounts paid to the benefit of an Indian band are generally deductible for federal income tax purposes. In addition to the deductible Crown charges, a resource allowance is earned on the resource profits net of the deductible Crown charges.

The amounts paid to the Government of Canada in the form of mining and oil and gas royalties/lease rentals paid to Indian bands are provided below:

Oil and Gas and Mining Royalties/Lease Rentals Paid to Indian Bands

	1995-96	1996-97	1997-98	1998-99
	($ millions)
Oil and gas	58.0	92.0	89.0	99.0
Mining	0.5	1.0	2.0	0.9
Source: Indian and Northern Affairs Canada.

Non-Resident-Owned Investment Corporation Refund

Objective: The general rationale for the refund provided to non-resident-owned investment corporations is to encourage the investment of foreign funds in Canadian corporations at little tax cost to the Government. (Report of the Royal Commission on Taxation, vol. 4, 1966.)

A non-resident-owned investment corporation must pay income tax at a rate of 25 per cent. However, except for capital gains realized on taxable Canadian property, this tax is refundable when the surplus is distributed as taxable dividends to the shareholders, and the applicable rate of withholding tax then applies. As a result, the corporation is essentially treated as a conduit for the flow-through of income to the non-resident shareholders. The amounts reported estimate the tax revenues that would be generated if the non-resident-owned investment corporation refund was not available, under the no-behavioural assumption used throughout this publication.

The 2000 budget proposed to eliminate the status of non-resident-owned investment corporations. Unlike the estimates presented in the present publication, the budget estimates take into account the behavioural considerations of the proposed policy.

Investment Corporation Deduction

Objective: Investment corporations provide an important flow of individual savings available for investment in the ownership of Canadian industry because qualifying investment corporations must invest in Canadian properties. The purpose of this measure is to induce investment of these savings in Canada rather than abroad. (Budget Speech, December 20, 1960.)

Investment income is taxed at the corporation level and in the hands of the individual who receives it as dividend payments. In order to achieve a certain degree of integration between the personal and corporate tax systems, the current rules allow an investment corporation to deduct from its Part I tax otherwise payable 20 per cent of the amount by which its taxable income exceeds its taxed capital gains.

This measure constitutes a tax expenditure because it allows a public corporation that qualifies as an investment corporation to benefit from elements of the integration system, which are usually available only to private corporations. The tax expenditure is estimated as the additional revenue that would have been collected by the Government if investment income (except capital gains) had been taxed at the general income tax rate applicable to public corporations. In addition, because investment corporations are subject to Part I tax at a rate of 29.12 per cent rather than at the benchmark rate, this additional tax represents a departure from the benchmark system and is included as part of this expenditure.

Deferral Through Capital Gains Rollovers

Objective: Rollover provisions are provided in some situations in which it would be unfair to collect a capital gains tax even though the taxpayer has sold or otherwise disposed of an asset at a profit. (Proposals for Tax Reform, 1969.)

The taxation of capital gains is affected by provisions that permit taxpayers to defer realization for tax purposes through various rollover provisions. Since the benchmark tax structure includes various rollover provisions that permit the deferral of capital gains when a corporate structure is changed, this item is identified separately for information purposes.

No data are available.

Deduction for Intangible Assets

Objective: Three-quarters of eligible capital expenditures can be written off at 7 per cent per annum on a declining-balance basis. Prior to 1972, taxpayers could not deduct such expenditures on intangible assets in the year incurred (because they were capital in nature) or over a number of years by way of depreciation (because no asset was acquired on which depreciation could be claimed). (Summary of 1971 Tax Reform Legislation.)

Three-quarters of eligible capital expenditures on intangible assets are added to the cumulative eligible capital of a taxpayer. A deduction of up to 7 per cent of cumulative eligible capital at the end of the year is allowed. Examples of intangible assets include goodwill, customer lists and franchises.

The deduction for intangible assets could give rise to positive or negative tax expenditure estimates depending on the actual rate of depreciation of these assets relative to the amount that is permitted for tax purposes.

No data are available.

Tax Exemption on Income of Foreign Affiliates
of Canadian Corporations

Objective: The Canadian exemption system for taxing the income of foreign affiliates is based on the objective of eliminating double taxation while at the same time encouraging the international competitiveness of Canadian multinationals.

The Canadian system for taxing the income of foreign affiliates of Canadian shareholders or the dividend income of the Canadian shareholders derived from foreign affiliates is based on the objectives of encouraging international competitiveness, protecting the tax base and eliminating double taxation.

Where the foreign affiliate earns active business income, Canada defers any recognition of that income until it is paid to the Canadian shareholders as a dividend on shares of the affiliate. In cases where the business income has been earned in a country with which Canada has a double taxation treaty, the dividend paid out of that income to Canadian

corporate shareholders is not subject to additional Canadian tax. Where the business income is earned in non-treaty countries, the dividend is taxed in Canada but a tax deduction is provided to Canadian corporate shareholders based on the underlying foreign tax paid.

Where the foreign affiliate earns passive income and the affiliate is a controlled foreign affiliate of a person resident in Canada, the passive income is taxed in the Canadian shareholder's hands on an accrual basis. The Canadian shareholder can deduct taxes paid in the foreign jurisdiction in determining net additional Canadian tax liability. When the income earned in the foreign affiliate is actually paid to the shareholder in the form of a dividend, a deduction from income subject to tax is provided to the extent that the income was included in income subject to tax in a previous year.

Questions arise as to what should be the appropriate benchmark system to measure the value of the tax expenditure, if any, in this case. Basically, three different benchmarks could be contemplated:

• Canada should tax only Canadian-source income.
• 
  This is the territorial approach. Under this approach, foreign subsidiaries of Canadian companies would face the same tax burden on foreign-sourced business income as locally owned enterprises in the foreign jurisdiction. This approach is consistent with the concept of capital-import neutrality. Capital-import neutrality results when the shareholders of subsidiaries do not face additional taxes in Canada with respect to the foreign business income earned by their subsidiaries. This is the effect of Canada's decision not to tax dividends arising from affiliates in countries with which Canada has entered into a double taxation agreement as a way to relieve double taxation. If this exempt dividend approach were to be considered as the benchmark, then no preference would be associated with the foreign dividend exemption.
• Income earned by a foreign affiliate should be taxable in Canada when dividends are paid to the Canadian shareholder and double taxation alleviated with a foreign tax credit. This is the approach used by a number of countries since it allows for additional taxes to be collected in the country of residence of the shareholder of a foreign affiliate at the time a dividend is paid to the shareholder by the affiliate out of foreign business income. These additional taxes would be levied when domestic tax payable exceeds the amount of foreign taxes paid both on the dividend itself and on the underlying foreign corporate profits out of which the dividend was paid. In Canada, dividends from foreign affiliates that do not qualify as exempt dividends are taxed on this basis. If this were to be considered the benchmark system, then the exempt dividend system would provide a preference measured as the additional tax, net of the foreign tax credit, that would have been payable had the dividend been taxable in Canada.
• Income earned by foreign affiliates should be taxable in Canada as it accrues to the Canadian shareholder (i.e., on a current basis). This system is consistent with the concept of capital-export neutrality, which states that income of foreign affiliates should be subject to the same tax in the hands of its shareholders on a current basis regardless of whether the income is earned domestically or in a foreign affiliate. Certain passive income earned by controlled foreign affiliates is taxable on this basis in Canada. If this system was to be viewed as the benchmark, both the exempt dividend and the foreign tax credit approaches would be said to provide a preference measured as the deferral of incremental Canadian tax from the time the income is earned until the time the dividend is paid out.

Each of these three possible benchmarks has a policy justification. Data required to compute the amount of tax preference associated with any of the benchmarks are currently unavailable.

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