Thursday, November 23, 2006

Flaherty considers tax cut for foreigners

Hi All,

I have had to deal with this issue many times during my time as a realtor. This tax harkens back to the days rigid currency controls and has a big impact on otherwise straightforward investment decisions.

HEATHER SCOFFIELD AND STEVEN CHASE

Globe and Mail Update

Finance Minister Jim Flaherty is contemplating elimination of a key tax on foreign investors as a way to ease access to capital and assuage the energy sector after his move to tax income trusts.

Withholding-tax rates vary according to the type of investment and the country, but the 10-per-cent tax on Canadian interest that U.S. investors pay is in Mr. Flaherty's sights, several sources say.

Negotiations with the United States have been on-again-off-again to have both countries lower their withholding tax on cross-border investments for years, but Mr. Flaherty is looking for ways to revive the talks, three well-connected Bay Street sources say.

“I know for some time the minister has been looking to get the job done,” one source said.

The federal government's attempts kicked in to high gear this month, after complaints from the energy sector that the tax on income trusts would drive away foreign investment.

There is no evidence that an announcement is imminent, but Bay Street has been cheering him along.

“These withholding taxes are probably an impediment to investment flows,” says Finn Poschmann, director of research at the C.D. Howe Institute.

In the short term, Ottawa gives up some tax revenue, but in the long term, improved investment flows and better access to financing for Canadian companies make up for the loss, he argues. Access to venture capital in particular could be improved, he says, mainly because Americans would bring capital and managerial skills by taking larger stakes in Canadian companies.

While it's unclear whether withholding taxes will show up in Mr. Flaherty's long-term economic plan Thursday, it would make sense to include a reference, Mr. Poschmann said.

“It would be natural to see a move on withholding taxes as part of a prosperity agenda.”

As a general rule, Canada slaps a 25-per-cent tax on disbursements to foreigners — dividends, interest and royalties. But like many other countries, Canada has bilateral treaties that lower that tax for individual countries.

With the United States, Canada generally levies a 15-per-cent withholding tax on dividends and a 10-per-cent tax on interest payments of various kinds. In turn, the United States taxes interest paid to Canadians at a rate of 10 per cent. Although taxpayers on both sides of the border get tax credits from their own country for tax withheld by other countries, the credits don't come close to making up investors' losses.

As a result, the withholding taxes have acted as a deterrent to Americans investing in Canada and to U.S. financiers underwriting Canadian firms and projects, analysts say.

Canada's share of the world's foreign direct investment has slowly declined over the past year, and the elimination of withholding taxes could help reverse the trend, analysts argue. The move would make it easier for Canadian companies to expand beyond Canada, and encourage foreign firms to invest here.

The private sector has estimated that the short-term net loss to government revenue is small, about $100-million a year. However, federal government estimates suggest the number could be more than double that.

Ottawa will probably not move to reduce or eliminate any withholding tax until the Americans agree to reciprocate, several insiders said, but that's not beyond the realm of possibility.

“It would only be done in the context of a bilateral treaty,” one source said. “You'd also have to have agreement with the Americans, which I don't think would be a problem because the United States has eliminated withholding taxes on every treaty it has signed in recent years.”

A coalition of dozens of companies on both sides of the border has long lobbied for action on withholding taxes. And in a recent submission to Mr. Flaherty, the Canadian Chamber of Commerce put the issue near the top of its list of things the federal government should tackle to improve capital flows and investment.

It called on Ottawa to negotiate with major tax treaty partners the elimination of withholding taxes on dividends, royalties and interest payments.

It also asked Ottawa to immediately revive negotiations for tax changes under bilateral treaties with the United States and other major trading partners.

“The imposition of withholding taxes on interest, dividends and royalties has an immediate, negative impact on productivity,” the chamber argues.

The taxes impede cross-border capital flows, act as a tariff on the importation of capital and knowledge, and raise the cost to Canadian business of accessing foreign technology, the submission says.

“It's not a good tax, and it's not bringing in billions, so you should get rid of it,” said one Bay Street source.

He believes that the country's economy as a whole would benefit from the elimination of the withholding tax, with or without reciprocity from the United States, since Canadian companies would benefit from lower borrowing costs through more foreign competition to finance Canadian business.

Canadian lenders, such as the chartered banks, may not immediately appreciate the foreign competition, he conceded.

“But if you look at it broadly, it would be beneficial to Canada.”

The downside of the elimination of withholding taxes is mainly political.

The move would likely prompt critics to say Canada is giving away money to foreign companies and foreign governments.

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