On December 10, 2008 the Report (the "Report") of the Advisory Panel on Canada's System of International Taxation (the "Panel") was released. It is fair to say that the Report is balanced, practical and reasonable.


The creation of the Panel was announced in May of 2007 in response to a fire-storm of criticism from business and tax professionals of an ill-conceived proposal included in the 2007 Federal Budget of Minister of Finance Jim Flaherty to significantly restrict the deductibility for Canadian tax purposes of interest on funds borrowed by a Canadian corporation to finance a "foreign affiliate", and as part of the Minister's rapid back-pedaling from that proposal. This proposal was a good example of how tax policy should not be made. It is interesting to note that one of the Panel's recommendations is that this very proposal be repealed.

The members of the Panel were a combination of business people and tax experts, and included as Chair Peter Godsoe, former CEO and Chairman of the Bank of Nova Scotia, and as Vice-Chair Kevin Dancey, President and CEO of the Canadian Institute of Chartered Accountants and former CEO and Canadian Senior Partner of PricewaterhouseCoopers. Mr. Dancey is also a former Assistant Deputy Minister of the Department of Finance and worked with the author at the Department in the 1980s, and from the author's experience is an insightful and contemplative individual.

The Panel's mandate was "to recommend ways to improve the competitiveness, efficiency and fairness of Canada's system of international taxation, minimize compliance costs, and facilitate administration and enforcement by the Canada Revenue Agency". The Panel reviewed Canadian tax rules applicable to both outbound and inbound investments and has recommended a number of broad ranging proposals, and has not been shy in this regard. The Panel consulted widely, conducted its own research (including a review of the tax systems of Canada's major economic competitors), and interviewed foreign tax officials.

The result is a set of recommendations for specific changes and of matters for further consideration and review. Following is a general overview of some of the more important or interesting recommendations.


While the Panel's report contains many recommendations, the Panel itself identified what it described as "two key directives" behind the recommendations, being:

  • The federal government should maintain the existing system for the taxation of foreign-source income of Canadian companies and extend the existing exemption system to all active business income earned outside of Canada by foreign affiliates.
  • The federal government should maintain the existing system for the taxation of inbound investment and adopt targeted measures to ensure that Canadian-source income is properly measured and taxed.
    Accordingly, the Report does not recommend radical changes to the Canadian tax system.

Broaden the existing exemption system to cover all foreign active business income earned by foreign affiliates - Canada's tax treatment of foreign-source income combines elements of the three basic approaches to such taxation, being the accrual or worldwide basis of taxation (applied to foreign accrual property income or "FAPI", and to foreign business income earned through a branch), the credit method (applied to so-called "taxable earnings" of a foreign affiliate) and the full exemption method (applied to so-called "exempt earnings" of a foreign affiliate). Currently, in general terms, Canadian tax rule distinguishes between active business income earned by a foreign affiliate in a country with which Canada has concluded a tax convention or a tax information exchange agreement.

Extend the exemption system to capital gains and losses realized on the disposition of shares of a foreign affiliate where the shares derive all or substantially all of their value from active business assets - This would be consistent with the recommendation above and a significant change to the existing treatment which taxes such gains when realized directly by a Canadian corporation, but defers such taxation when realized indirectly, thereby inducing corporations to create corporate structures that allow such gains to be realized and the proceeds maintained outside Canada, but which also result in the deferral of the remittance of such proceeds to Canada.

The current rules applicable to recharacterizing inter-affiliate payments and certain other items as "income from an active business" should be retained - The Panel saw this component of Canada's foreign affiliate taxation regime as important in maintaining international competitiveness of Canadian multi-national corporations.

The government should undertake a fresh review to coordinate the foreign accrual property income, foreign investment entity and non-resident trust regimes - The latter two still to be enacted regimes have been the subject of considerable criticism, since their original proposal in 1999, as being complex, convoluted and impossible to comply with.

Impose no additional rules to restrict the deductibility of interest expense of Canadian companies where the borrowed funds are used to invest in foreign affiliates and repeal the current rule - This is, perhaps, the most "interesting" recommendation, as it recommends a reversal of the very proposal that generated the fire-storm of criticism described above and that gave birth to the Panel.

Retain the current thin capitalization system, and reduce the maximum debt-to-equity ratio under the current thin capitalization rules from 2:1 to 1.5:1. As well, extend the scope of the thin capitalization rules to partnerships, trusts and Canadian branches of non-resident corporations. However, these rules should not be extended to third party debts that are guaranteed by related non-residents. The Panel was sensitive in its recommendations to basis erosion concerns. In this regard and interestingly, the Panel considered but rejected applying so-called earnings stripping rules to protect Canada's tax base. It is also interesting to see the Panel's recommendation that these rules be extended to partnerships, trusts and branches, something considered but rejected when the Canadian thin-capitalization rules were tightened in 2000.

Curtail tax-motivated debt-dumping transactions within related corporate groups involving the acquisition, directly or indirectly, by a foreign-controlled Canadian company of an equity interest in a related foreign corporation while ensuring bona fide business transactions are not affected - These types of transactions, probably the real source of concern at the Department of Finance behind the ill-conceived proposals that gave birth to the Panel, have been the subject of comment and concern for some time, including back in 1992 when commented on in the Auditor General's Report for that year. The significant challenge here will be in identifying transactions considered to be "bona fide business transactions", and coming up with a practical and workable set of rules.

Eliminate tax withholding requirements related to services performed and employment functions carried on in Canada where the non-resident certifies the income is exempt from Canadian tax because of a treaty - This recommendation addresses problems that arise from Canada's so-called "Reg 102" and "Reg 105" tax withholding requirements for services provided by non-residents. The Panel seems to have been influenced by legitimate concerns raised by Canadian business in respect of the compliance burden these rules impose and by the simpler US process applicable in similar circumstances.


The Report is a well crafted, considered document that takes a balanced approach to various competing concerns including competitive factors for Canadian business, economic efficiency, compliance burdens for taxpayers, similar burdens for the Canada Revenue Agency, and protection of Canada's tax base. In addition to the recommendations above are other also interesting recommendations for changes to the Canadian tax system, or simply for further review and study. One can only hope that the work of the Panel does not turn out to have been a purely political process intended to give the Minister of Finance an "out" from the poorly crafted proposals that gave rise to the creation of the Panel. Both the Report and the Panel deserve a better fate than that.