OTTAWA and TORONTO — Federal Finance Minister Jim Flaherty's office declared yesterday that it has no intention of backing away from a controversial budget move to scrap the tax deductibility of interest that companies incur to fund foreign operations.
Taxation experts have warned this measure – which Finance describes as eliminating an undesirable tax subsidy – could pose a major impediment to banks and other Canadian companies that want to make foreign acquisitions.
Mr. Flaherty's office spoke yesterday to clarify the Finance Minister's intent on the heels of reports suggesting he might reconsider the move.
“He's not backing down,” said Dan Miles, director of communications for the Finance Minister. “The policy is the policy.”
Mr. Flaherty said earlier this week that he would consult “stakeholders” – that could include affected companies and tax experts – so that Finance could design the implementing legislation “in the best way possible.”
But Mr. Flaherty was also clear that he was “satisfied” with the measure as proposed in the budget.
Under new measures outlined in the budget, Canadian companies borrowing money to finance foreign deals will no longer be able to deduct the interest costs against their Canadian income.
The 2007 budget document makes clear Finance considers the target of its action a subsidy that it says hurts Canada by encouraging the export of business operations.
Allan Lanthier, a retired senior partner of Ernst & Young and immediate past chairman of the Canadian Tax Foundation, warned yesterday that the budget move would hurt banks.
“I've been practising tax for 35 years – this is the single most misguided proposal I've seen out of Ottawa in 35 years, Mr. Lanthier said.
The proposal could also result in a number of large Canadian companies being put on the auction block, he said.
“A number of Canadian multinationals have become takeover targets,” he said. “You now have a Canadian multinational that's in a very tax-inefficient position, and that fact won't be lost on foreign purchasers. I think many of them may well become the subject of hostile takeover bids...
“This measure would put Canadian companies at a significant competitive disadvantage, and I think the economic fallout to the Canadian economy is potentially disastrous,” he said. “And I don't think the Finance Minister understands that, I don't think he was properly advised by his Finance officials.”
Compared with 10 years ago, “there are fewer Canadian multinationals now, they are more at risk, they are less robust, and other jurisdictions are creating fiscal climates to allow their domestic multinationals to expand,” he said.
Mr. Lanthier is suffering from a bit of guilt. He was one of the members of the Mintz committee, which recommended a similar measure a decade ago, although it had some differences, such as a grandfathering period.
Canadian banks are on high alert over the proposed change.
Royal Bank of Canada's Jim Westlake, head of Canadian retail banking, said yesterday: “Anything that would hurt growth and not support Canadian businesses abroad, we don't like. On the surface, it appears this tax may contain elements of that.”
Ogilvy Renault LLP tax expert Leonard Farber says the impact of the proposed measure is huge.
It “represents a major shift in long-standing policy affecting investment offshore but particularly Canadian multinationals,” said Mr. Farber, a former Finance official.
The budget – which only provides detailed fiscal data two years into the future – estimates that this will collect $10-million in 2007-08 and $40-million annually by 2009-10.
But experts warn the amount clawed back from Canadian companies each year by this measure would actually be hundreds of million of dollars. “Forty million dollars seems way low. It is probably much larger, to a magnitude of ten or twenty,” said one bank official who requested anonymity.
Finance watchers say the low official estimate is likely because the government is planning to grandfather some existing corporate activities. But over time, the extra taxes will climb, they predict.
© The Globe and Mail
