Canadian Chamber Of Commerce Warns On Interest Deductibility

by Mike Godfrey, Tax-News.com, Washington

24 April 2007

The Canadian Chamber of Commerce has warned that a measure contained in Finance Minister James Flaherty's last budget to abolish the deductibility of interest incurred when investing abroad could cost the private sector billions of dollars per year.

In an open letter to Mr Flaherty, the 170,000 member organization announced that:

"On behalf of our members, we are writing to you to express our views and concerns on the recent proposal in Budget 2007 to effectively disallow an interest deduction for a Canadian resident corporation on money borrowed to acquire shares of a foreign affiliate."

"We believe this proposed shift in policy represents a dramatic and negative change from Canada’s existing system, which the Department of Finance has historically defended."

It went on to observe that:

"From a public policy perspective, and taxation policy in particular, the central issue is whether Canada’s taxation of outbound investment should be made more restrictive and what impact such restrictions may have on the competitiveness of our corporations and the economy as a whole."

"Current policy helps businesses in Canada to invest and expand globally. Canadian businesses use their foreign affiliates, established by foreign direct investment (FDI), to deliver more services internationally. According to Statistics Canada data, sales of Canadian foreign affiliates represent a significant and growing share of the business revenues generated by Canadian companies engaged in international business."

"In 2004 (the most recent data available), sales of goods and services of foreign affiliates of Canadian businesses reached $372 billion, almost as much as Canada’s total goods exports ($429 billion in 2004)."

"Outbound FDI also allows Canadian companies to be better plugged in to the global supply chain and distribution networks; get closer to foreign customers in order to provide better service; and establish partnerships and alliances around the world to maintain their competitive edge. Profits and dividends from foreign investments are transferred between countries and are reinvested generating more trade, jobs, investment and economic growth."

The industry body continued:

"The Canadian Chamber believes that the proposal in Budget 2007 will increase the after-tax cost of borrowing to invest in foreign affiliates, thus serving as a disincentive to invest abroad, thereby eroding the competitiveness of Canadian resident corporations. Moreover, in a small, open economy such as Canada’s, if a company has reached its capacity in the local market – i.e. reached a level where it cannot expand further in the Canadian marketplace – it will now be penalized for borrowing in Canada to expand abroad."

"This also assumes that Canadian companies will have the ability to borrow outside of Canada. This will not be the case for some companies, thereby crippling their ability to expand."

"In addition, companies that manufacture products in Canada whose principal inputs include imported raw materials from their foreign affiliates will be forced to source inputs elsewhere from more costly suppliers if they cannot acquire or finance production facilities in offshore locations. This will increase their cost of production."

"Particularly hard hit will be those companies that do not have the flexibility to restructure their debt or to use cash reserves for foreign investments. This will be a problem for smaller companies which may not have as much clout in negotiating with lenders. It will also be a problem for larger Canadian resident companies that have borrowed significant amounts in the past and are locked into committed borrowings such as long-term debentures."

"What is lacking in the government’s proposal is an adequate grandfathering or transitional provision. Although we strongly believe the government should maintain the existing system, the proposal should have included exemptions for firms to prevent the financial damage they could potentially face from this sudden policy change."

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