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1993 Report of the Auditor General of Canada

1993 Report

Appendix C—Reports of the Standing Committee on Public Accounts to the House of Commons

REPORT TO THE HOUSE

Wednesday, September 16, 1992

The Standing Committee on Public Accounts has the honour to present its

EIGHTH REPORT

It is generally agreed that parliamentarians and Canadians have the right to require the federal government to publish, at such time as prescribed by law, information on the expenditures, objectives, effectiveness and efficiency of government programs. This information, which shall be concise as well as exhaustive, must be published regularly, at the appropriate time, and in accordance with the laws of Parliament.

It is up to Parliament to make decisions on behalf of all Canadians. For instance, it is incumbent on Parliament to pass and amend legislation, to vote on appropriations, to decide how they should be spent and to set certain limits on funding for various programs. Under this system, accountability and the obligation to inform Parliament are fundamental.

Background

The lack of information on CAP is not a new development. In fact, it has been going on for some time. In 1978, the Breau report, Fiscal federalism in Canada , recommended improving the statistical and financial information available on CAP. In 1985, the Study Team Report to the Task Force on Program Review (the Nielsen Task Force) mentioned a number of shortcomings with respect to the collection of CAP data. More recently, in 1987, the National Welfare Council recommended that statistical information be published on a more regular basis.

CAP annual reports

After discussing the problem with senior officials from Health and Welfare Canada invited to appear before your Committee, members were puzzled about the current practice of not publishing information on CAP within a reasonable timeframe. The federal government spends $6 billion on CAP without reporting to Parliament. This means the government is violating the Canada Assistance Plan , which is an Act of Parliament. Since these are statutory expenditures which Parliament does not have to approve, it is your Committee's opinion that this is one more reason why the Department should follow the letter of the law by publishing on time its annual report on CAP, so that parliamentarians and Canadians be well informed.

Considering its broad financial responsibility and the size of this assistance program designed for Canadians who are most in need, the Public Accounts Committee considers that CAP management should improve its reporting on the billions of dollars for which it is responsible.

The time has come to correct a situation that has gone on far too long already. The delays in publishing CAP annual reports are not an isolated incident. Annual reports on major programs such as Old Age Security, the Canada Pension Plan and family allowances are all late. Your Committee wonders whether Health and Welfare Canada has demonstrated the will to produce its statutory reports on time by putting in place the appropriate mechanisms.

The Public Accounts Committee therefore recommends:

that the Department of National Health and Welfare table its annual report on time, as required under section 18 of the Canada Assistance Plan . If the Department is unable to table a complete report, it should provide an interim report, pending final compilation of information provided by the provinces.

Your Committee realizes that the Department is, to a certain extent, dependent on the provinces and that it is not easy to reconcile statistical information based on definitions that vary. After the federal government has given the provinces $20 million to help them update their equipment and simplify data collection, the Committee wondered whether Canadians have gotten their money's worth. In fact, it is your Committee's opinion that the Department is being somewhat lax by not requiring the provinces to submit their information on time.

Your Committee therefore recommends:

that, if the situation does not improve significantly within the next year, the Department of National Health and Welfare should seriously consider imposing monetary sanctions on provinces whose timeframes are unacceptable and which persist in late reporting of the information required to prepare the CAP annual report. Those sanctions could be effected by holding back transfer payments provided for under the CAP.

Estimates Part III

The Estimates for 1992-93 do not mention the impact of the current economic recession on the number of welfare recipients in Canada in future years. Nor do the Estimates indicate the effects of the Government Expenditures Restraint Plan Act on CAP (Bill C-69, which received royal assent in February 1991).

The Department should also be more specific in its analysis of CAP financial requirements. It should avoid the use of vague statements and should include an analysis of past and future trends, for instance. The Department should also provide in the Estimates better disclosure of key findings of program evaluations, including CAP.

Your Committee therefore recommends:

that the Department of National Health and Welfare improve the reporting of CAP information in the Estimates, so that parliamentarians and all Canadians be well informed.

Pursuant to Standing Order 109, the Committee requests that the Government table a comprehensive response to this Report.

A copy of the relevant Minutes of Proceedings and Evidence (Issues No. 28 and No. 33 which includes this Report) is tabled.

Respectfully submitted,

JEAN-ROBERT GAUTHIER

Chairman.

REPORT TO THE HOUSE

Wednesday, September 16, 1992

The Standing Committee on Public Accounts has the honour to present its

NINTH REPORT

The Department of Finance decides from time to time to amend the Income Tax Act pursuant to explanations requested by taxpayers. The latter, seeking a technical interpretation of tax matters in unusual circumstances for which no provision is made in the Act, wish to ensure that their interpretation of the Act is clearly consistent with Parliament's intention. In response to their requests, these taxpayers receive a letter of comfort informing them that the Department will recommend amendments to the Income Tax Act .

In 1990, the Department issued 20 comfort letters to taxpayers or their representatives. By confirming the application of certain future legislative provisions, these letters facilitate interpretation of the Income Tax Act . It has not been the practice of the Department of Finance to make a public announcement when it sends a letter of comfort to a taxpayer.

According to the Auditor General, this practice enables some taxpayers to manage their business affairs with greater certainty, but places those who are unable to examine the letters of comfort at a disadvantage. Some taxpayers are thus placed in a privileged position since the information contained in those letters is not forwarded to other taxpayers in similar situations. According to the Auditor General, many of the latter would adjust their tax planning if they knew the content of those letters. The Auditor General goes even further to say that this practice constitutes a breach of one of the Department of National Revenue's commitments in its Declaration of Taxpayer Rights, according to which the government must make every reasonable effort to transmit tax information to taxpayers. When the Committee examined this question, the Auditor General's representative expressed the hope that the government would ensure all taxpayers have access to complete and accurate information concerning the Income Tax Act. According to him, the Department of Finance should "amend its practice... and at the time it issues a letter of comfort, it will advise the public of its intention to recommend amendments to the Income Tax Act " (Minutes of Proceedings and Evidence, Issue No. 23, p. 6) .

Furthermore, the Department of Finance claims that the letters of comfort merely confirm Parliament's well-known intention to amend the Act in response to a particular situation. They thus enable taxpayers to avoid being trapped by an improper literal interpretation of the existing Act. The Senior Assistant Deputy Minister contended before the Committee that it was not the overall policy that was in question, but rather the Act's application to specific situations. In his view, the letters of comfort "deal with very narrow technical interpretations of the law in the context of a specific fact situation". (Minutes of Proceedings and Evidence, Issue No. 23, p. 17) Lastly, the Department of Finance also believes that the letters of comfort are so specific and technical that it is highly unlikely any other taxpayer could use the information they contain.

To help clarify the entire question, the Committee invited a number of accounting firms to express their views. The firms Peat Marwick Thorne and Ernst & Young appeared before the Committee, and the firm Samson Bélair Deloitte & Touche submitted a brief in which it stated, "If the purpose of such amendments is to change the Act to do away with certain irregularities or consequences that the legislator may not have foreseen initially, then all taxpayers should be informed." The representative of Peat Marwick Thorne, for his part, said he was convinced that "these comfort letters rarely, if ever, grant any advantage to the taxpayer receiving them". (Minutes of Proceedings and Evidence, Issue No. 30, p. 5) Consequently, he saw little need to make them public immediately on their issuance. In any case, as he emphasized further on, "Rarely are other taxpayers as interested in a Department of Finance comfort letter, because the facts they deal with are typically so technical and so narrow that they often only affect one company". (Minutes of Proceedings and Evidence, Issue No. 30, p. 8) Lastly, the accountants believe that the letters of comfort are necessary since certain major business transactions would otherwise not be conducted for lack of certainty. Without these letters, taxpayers would be obliged to request remission orders or retroactive tax relief. These consultations also show that the accountants agree with the Auditor General's view that all taxpayers should be treated equally and notified of Parliament's intention to amend the Act.

It is the Committee's view that economic decisions that have tax effects are necessarily influenced when certain taxpayers are in exclusive possession of information. Furthermore, in any business, tax information is a key factor in every major decision and is supremely useful if it is also exclusive. Since information plays a fundamental role in the competitiveness of businesses, it is essential that the government ensure that this information is made public in an equitable manner.

The Committee is of the view that, by virtue of the principle of fairness, these letters of comfort should be made public in order to assist all taxpayers in better managing their affairs. However, it recognizes the existence of three problems associated with the publication of such letters. The Committee admits that there is some danger in publishing, on a broad scale, information based solely on the Department's interpretation, but which does not yet have force of law. Furthermore, publication of these letters could prove costly. Considerable human resources would thus have to be allocated in order to respond to taxpayers' requests. Lastly, the Committee believes that increasing the frequency and distribution of letters of comfort could reduce their number, something that goes against the opinions of the accounting firms. The representative of Peat Marwick Thorne stated that it "would be regrettable if any mandatory form of publication caused the Department of Finance to curtail the activity. I can see many officials concluding that we cannot proceed; we simply will not be able to issue the comfort letter at this point in time" (Minutes of Proceedings and Evidence, Issue No. 30, p. 19) The Committee would find this situation regrettable because it is of the view that these letters are undeniably useful in certain cases.

The Department of Finance proposes to publish a set of technical amendments associated with the letters of comfort once a year, but the Committee believes that this would still provide a certain benefit to the recipients of those letters.

The Committee therefore recommends:

A) that the Department of Finance publish copies of the letters of comfort sent to taxpayers in the Canada Gazette every three months (taking care to protect the identity of their recipients);

B) that, for each letter of comfort, the Department append a brief technical paper explaining the context and objectives of the amendments which it intends to make to the Income Tax Act.

Pursuant to Standing Order 109, the Committee requests that the Government table a comprehensive response to this Report.

A copy of the relevant Minutes of Proceedings and Evidence (Issues Nos. 23, 30 and 33 which includes this Report) is tabled.

Respectfully submitted,

JEAN-ROBERT GAUTHIER

Chairman.

REPORT TO THE HOUSE

Thursday, November 26, 1992

The Standing Committee on Public Accounts has the honour to present its

TENTH REPORT

that the Department of Finance and the Auditor General meet as soon as possible in order to clarify their positions and seek common ground on the nature and extent of the issue of tax arrangements for foreign affiliates of Canadian companies that may result in considerable erosion of the tax base.

Pursuant to Standing Order 109, the Committee requests that the Government table a comprehensive response to this Report.

A copy of the relevant Minutes of Proceedings and Evidence (Issue No. 35 which includes this Report) is tabled.

Respectfully submitted,

JEAN-ROBERT GAUTHIER

Chairman.

REPORT TO THE HOUSE

Wednesday, February 24, 1993

The Standing Committee on Public Accounts has the honour to present its

ELEVENTH REPORT

In travelling to London, the Committee had a number of objectives, one of which was to obtain a better understanding of the reform of the British civil service and to learn from it. The Committee also wanted to discuss such issues as information for Parliament, program evaluation, tax measures and financial control in connection with aid to developing countries. The Committee also wanted to find out more about the Public Accounts Committee, the Public Accounts Commission, the Comptroller and Auditor General of the United Kingdom, and about relations between these groups. Finally, the Committee considered it important to discuss the particular role of the Accounting Officer and its potential relevance to the Canadian context.

A. The Reform of the Civil Service in the United Kingdom

In December 1990, in an attempt to reduce the costs of the public service and at the same time breathe new life into it, the Canadian government announced a new reform package. Called ``Public Service 2000'', its aim is to stimulate creativity among public employees. The government is moving towards partial deregulation of the bureaucratic environment, in the hope of promoting excellence among public employees.

The Canadian Standing Committee on Public Accounts has pointed out on a number of occasions that it will be difficult for managers to report to Parliament, once Public Service 2000 has been implemented. In his opening remarks to the Standing Committee on Public Accounts on May 14, 1992, the Chairman of the Committee and Member of Parliament for Ottawa-Vanier clearly summarized this concern:

There is a problem, however. Public Service 2000 fails to provide an accountability system for public employees and does not indicate how Parliament and members of Parliament would exercise control over public employees' innovative ideas on behalf of Canadians. In fact, the two major elements still lacking in Public Service 2000 are an efficient accountability system and parliamentary control mechanisms. ( Minutes of Proceedings and Evidence, Issue No. 27, p. 5)

In order to find out more about how the British government overhauled its civil service and, in particular, how it managed to reconcile an extraordinary delegation of authority with the requirement to report to Parliament, the Standing Committee on Public Accounts met with British managers involved in implementing the reforms, public employees working within the framework of the new management model, and a union of professionals. Since 1982, the British government has made three attempts at reorganizing the civil service.

The Financial Management Initiative

The Next Steps Initiative

...first, that... the executive functions of Government... should be carried out by units clearly designated within Departments, referred to in the report as ``agencies''. Responsibility for the day-to-day operations of each agency should be delegated to a chief executive. He would be responsible for management within a framework of policy objectives and resources set by the responsible Minister, in consultation with the Treasury... secondly, that the Government should commit themselves to a progressive programme for attaining this objective; thirdly, that staff should be properly trained and prepared for management of the delivery of services... and, fourthly, that a ``project manager'' at a senior level should ensure that the programme of change takes place. (House of Commons Debates, February 18, 1988)

Delegation of Broader Authority and Flexibility

At the outset, the agency and the responsible department sign a framework document which defines the agency's objectives, determines the means of measuring its achievements, describes anticipated performance, outlines the duties and responsibilities of the Chief Executive Officer, and sets out the obligation and the method of reporting, the financial and accounting structure, the degree of delegated authority and personnel management. Furthermore, the framework document clearly establishes the line between the responsibilities of the department, charged as it is with policy development, and those of the agency, which is responsible solely for the delivery of public goods or services.

Usually funded out of the votes allocated to the department, the agency negotiates with the department a package of powers and financial regulations that are tailored to its needs. It has total control over its budget and may use its funds as it sees fit. Finances are therefore managed with the sole aim of improving the agency's performance.

Agencies that generate sufficient income through the sale of public goods or services are authorized to use ``trading funds''. There are currently eight agencies which have received such authorization. This financial framework, which has existed since 1973 and whose use has now been extended to the agencies, allows greater flexibility and permits agencies to be self-financing. For instance, operations, capital expenditures and loans can be financed with trading funds and surplus funds from one year may be carried over to the next. Agencies are not required to turn their income or budget surpluses over to the British government's Consolidated Revenue Fund. The corporate discipline imposed by trading funds means that the agencies are more aware of their performance, which is measured not only in terms of costs, but also in terms of expenditures and the quality of services rendered. In fact, the use of trading funds must be seen as one of the cornerstones of the reform of the British civil service, since they increase managers' financial responsibilities considerably.

Accountability

The framework document described above is the key and the guarantee that the accountability system will be effective, since it sets out explicitly the expectations, the objectives, and the desired level of performance, as negotiated with the Department, including performance indicators. With regard to accountability, the document also sets out control mechanisms and the structure linking the agency, the Minister responsible and Parliament. According to officials, it increases the openness of the accountability requirement, which is supposed to make the financial management of the agencies and the quality of performance information all the more accessible. It is likely that this will have repercussions throughout the entire machinery of government. On January 8, 1990, the Minister for the Civil Service said in the House of Commons:

There will be much more scope for Parliament to scrutinize the activities of the agencies than there has been hitherto... Agencies' objectives and performance will be more open to scrutiny than ever before, by Parliament and by others with an interest, including their customers. (Debates of the House of Commons, January 8, 1990)

Agencies are also required to prepare annual corporate accounts which must be audited by the Comptroller and Auditor General. These reports must not only contain information of a general and financial nature, but must also describe performance, measured in terms of the objectives. It is interesting to note that the agencies are not required to follow a pre-established format. Even though the Treasury has the authority to impose the content, the principles to be followed and the format of accounts, it is the minister responsible and the Chief Executive Officer who decide what is appropriate in light of the agency's objectives. It is interesting to note that Price Waterhouse recently set up a jury that awarded a short time ago the first annual prize for the best agency report.

The Citizen's Charter

In January 1991, Prime Minister Major announced the creation of the Charter Mark Award for agencies that have had excellent performance and met the commitments made in the Citizen's Charter. The assumption is that the winning agencies will have found ways of innovating without increasing costs.

In May 1991, the Efficiency Unit published a report entitled ``Making the Most of Next Steps: the Management of Ministers' Departments and their Executive Agencies'' (the Fraser Report). Prime Minister Major accepted the recommendations of this report aiming at enhancing even further the agencies' freedom of movement and managerial flexibility. One of the recommendations was for eliminating various limitations so that agencies could ``shop around'' to obtain services from the private sector at a better price; it was also proposed that Chief Executive Officers should have greater authority and responsibility for performance and that agency employees should have vocational training to acquire the tools to deliver services of higher quality.

In November 1991, in a report entitled ``Competing for Quality'', the government announced its intention of using market testing, that is, including the private sector in tendering to compete with the public sector in the delivery of services. It is already anticipated that public services with a total worth of about a quarter of a billion pounds sterling will have been tested by next year. Some Whitehall officials are even aiming at the figure of 1 billion pounds sterling.

The Next Steps Initiative and the Citizen's Charter have changed the British civil service considerably. At first glance, it appears that there is still a major challenge to reconcile delegation of authority with the need for control. According to officials we met in London, now that managers are aware of the clients' needs, they have managed to improve the quality of service provided and to excel, without undermining the accountability requirement. In July 1992, almost half of all public employees (nearly 300,000 people) were working in 81 government agencies as diverse as the Weather Office, the Motor Vehicle Office and the Passport Office. The largest of these, the Social Security Benefits Agency, employs more than 63,000 people, while the smallest, the Wilton Park Conference Agency, has 30 employees. Fifty-four of the 81 Chief Executive Officers had been recruited through an open competition process and, of these fifty-four, 30 came from outside the civil service. The government has identified 28 other services that are likely to become agencies, adding an additional 68,000 public employees, and plans to have nearly three-quarters of its public employees working in agencies by 1995. This achievement can be attributed to the deep-rooted political will to reform the bureaucracy that has been evident over the past ten years, but were preceded by 20 years of vain attempts at reform and fruitless discussions.

Observations

According to a representative of the National Audit Office, the British government has in fact managed to improve the quality of service while at the same time paying more attention to the clients. In addition to delegating considerable authority to officials, the British government implemented a pay system based on performance and attainment of objectives, and made hiring and dismissal of personnel more flexible. The Canadian delegation was shown concrete examples of success, such as the Driver and Vehicle Licensing Agency and the United Kingdom Passport Agency, and met with an official of the Social Security Office--an office made up of five agencies which had considerable success in reducing the time required to process ever greater numbers of files. This improved performance, according to government representatives, could only be to the benefit of taxpayers and clients. Thanks to significant changes in attitude, public employees now understand the importance of providing high quality services to the clients. Although the Public Accounts Committee saw a number of changes in London that would be desirable in Canada, we are unable to rate the overall success of the British initiative. While a number of encouraging signs were brought out in our discussions, it is too early to assess the impact of the Citizen's Charter on clients, managers and taxpayers. We can, however, draw up a list of observations and lessons learned that will surely be useful in the reform of the Canadian public service.

1) The Public Accounts Committee observed that the unions had not been adequately consulted in the British reform. It is not surprising that the unions would oppose market testing, for example, since they felt that the Next Steps Initiative was the last stage before privatization. A representative from the First Division Civil Service Association told the Committee that private sector tenderers would always have an advantage over their public sector counterparts because of their lower fixed costs. This association of professionals also pointed out that pay and benefits would probably be reduced, that stability and the continuity required for certain functions would suffer, that long-term planning would be very difficult, that there would be conflicts of interest with the tenderers, and that the security of certain information would be endangered. Even though the union admitted that the Next Steps Initiative worked in terms of making public employees more aware of operating costs, it felt that market testing would prove to be a disaster.

The Public Accounts Committee does not want to pass judgment on the ever-increasing use of the private sector by the British government. We would, however, like to issue a warning and stress the importance of consultations with unions and professional associations before embarking on the process of reform. It would probably be worthwhile developing a new type of partnership between public employees, senior managers and politicians before even thinking of undertaking such far-reaching reforms in Canada.

2) The Public Accounts Committee would also like to point out that market testing carried out too aggressively entails considerable risks for management. First, if the private sector is to be called on more and more, we should try to ensure the neutrality of ``private'' public employees and that the tendering process is managed fairly and without interference. Second, since the position of those in senior agency positions (such as Chief Executive Officers) will be continually jeopardized by market testing, one might wonder whether they might not be tempted to make unacceptable innovations (for instance, by reducing the quality of the service their agency provides). We might also ask how qualified employees will be recruited to fill senior level positions if managerial positions are constantly being called into question.

3) Since the senior executive of an agency has close relations with the Minister responsible, there is a danger that, when the time comes to report to Parliament, the Minister may hide behind the Chief Executive Officer. Moreover, the proliferation of administrative units will make it more difficult to verify that maximum benefit has been derived from resources. Finally, more contracting out and privatization will gradually make accountability the responsibility of the private sector. Accountability and openness may not be guaranteed as fully as those in London believe them to be; only time and experience will tell.

4) In order to make such significant changes to a bureaucracy, it is necessary to have powerful political support and a firm commitment to change. It cannot be left up to senior officials to implement drastic changes to the public service in which they themselves work. Without the support of the last two British Prime Ministers, the successes seen in various quarters would probably not have been as marked. It might be asked whether the reform would have been possible without major shock treatment. If the new organizational culture based on client satisfaction and performance had not been imposed so forcefully, the British civil service would very likely have resisted any attempt at reform. If the reforms had not been so well structured, without the delegation of authority and responsibilities, and without the major innovations resulting in freedom to make decisions, change would probably have been impossible and the British government would have been unable to counter the normal tendency towards centralization. The Next Steps Initiative can therefore be seen as the catalyst that brought about change.

5) In conclusion, the Committee wishes to stress that we must be careful that we do not produce a public service which is overly concerned with financial results and employment security and pays scant attention to the needs of its clients.

B. Information for Parliament

In order to find out British views on this issue, the Public Accounts Committee discussed information to Parliament with a number of senior officials, politicians and a professor from the London Business School. For departments, government information is not as uniform as it is in Canada; within the guidelines issued by the Treasury Office, the departments are more or less free to choose the format. The 81 government agencies, as mentioned above, have even more flexibility. The subject of information for Parliament arouses little interest in the United Kingdom, but parliamentarians do not seem to complain about it. The Chairman of Britain's Public Accounts Committee said that the members are quite indifferent to the information submitted to them. Estimates are concurred in as tabled, without the possibility of any amendments. The House Select Committees review neither the reports nor the expenditure plans. It is not surprising, since they have so little influence, that members are not interested in the information they receive. In any case, at the London Business School, the Canadian delegation was told that, although the volume of information has increased exponentially over the last few years, it is not understood, being all too often too technical and irrelevant. The British government has no electronic method of transmitting information. The situation is strangely similar to the Canadian experience, where parliamentarians do not need more information, but rather information that is more accurate and more relevant. Unless this change comes about, they will continue to be uninterested in the information they are given.

Observations

C. Program Evaluation

Whoever wishes to optimize resource use must be accurately informed about the way programs perform. Program evaluation makes it possible to know whether the raison d'être , goals, anticipated and actual results and program design are satisfactory. When such evaluations... are made public, they increase the accountability of the government and its officials... Program evaluation is all the more important in the current context of budgetary restraint... The government must continually improve the allocation of ever-scarcer resources. (Minutes of Proceedings and Evidence, Issue No. 9, p. 4)

In order to find out more about the United Kingdom's policy on program evaluation, the Public Accounts Committee met with managers in the Treasury Office. To its great surprise, the Committee learned that the British government has no clear and specific orders requiring regular and independent program evaluation; only new large-scale programs are evaluated the year following their implementation. There is no official evaluation of tax measures, nor does the government publish accounts of fiscal expenditures. There was a clear interest in the issue, but nothing more. In fact, one manager told us that the current state of affairs was ``patchy''. Those at more senior levels appeared to rely on audits by the Comptroller and Auditor General for the evaluation of program performance.

Our discussions in London convinced the Committee of the importance of program evaluation. With reform of the public service, the Canadian government is preparing to delegate further decision-making authority to its managers. The many raisons d'être and degree to which objectives were attained must be reviewed and evaluated periodically, and adapted when necessary; fiscal measures must not escape this fundamental rule.

Consequently, the Public Accounts Committee recommends

that all programs be evaluated regularly and independently.

D. Management of Financial Aid to Developing Countries

The Agency claims that, if full feasibility studies had to be conducted for all transactions of this type, their administrative cost would be high and they would monopolize scarce resources. (Minutes of Proceedings and Evidence, Issue No. 13, p. 4)

The Committee recommended:

that CIDA undertake, as required by Treasury Board, full risk assessments of all projects... The extent of these assessments should obviously be directly proportional to the level of CIDA funding. (Minutes of Proceedings and Evidence, Issue No. 13, p.6)

In order to find out how the British government manages risk and shares responsibility for financial aid to developing countries, the Public Accounts Committee visited the Overseas Development Administration (ODA) which is part of the Foreign and Commonwealth Office and is responsible for managing and supervising financial aid to developing countries. In 1991-92, British aid to developing countries amounted to approximately 1.8 billion pounds sterling. In light of our discussions with an ODA manager, the Committee feels it would be in CIDA's interests to emulate the ODA's management practices. In fact, while the ODA's role is essentially that of money-lender, it ensures that the risks and feasibility of all the projects in which it participates have been properly assessed ex ante , regardless of the method of financing and the amount involved. Beneficiary countries are responsible for conducting feasibility studies and risk assessments, and the ODA provides the resources to do the analyses if the need arises. The ODA representative mentioned that this was not ODA's preferred option, and that it hoped to see beneficiary countries developing their own expertise in project evaluation. The ODA also prepares, independently and systematically, ex post evaluation reports five to ten years after the start-up of each project, in which its performance is assessed in light of its initial objectives. These assessments make it possible to learn from the errors made. All aid is credited in the form of partnerships and the ODA expects that the beneficiary country will manage the project effectively. Like CIDA, however, it operates in a high risk environment. Unlike the situation in Canada, the ODA's accountability is shared in the event of failure, since the participants sign an agreement in principle covering the division of responsibilities. Furthermore, ODA managers oversee the interests of the British government and the beneficiary country in the field. While helping to ensure that the project runs smoothly, these managers can also warn the British authorities should difficulties arise.

It should be noted that, while ODA funds projects in more than 150 countries, its aid goes primarily to only about 30, thus making the risks easier to manage. One of the comments the Committee made in the Fourth Report to the House was that ``CIDA should perhaps do less, but do it better''. (Minutes of Proceedings and Evidence, Issue No. 13, p. 6)

Observations

E. Operating Relationships between the National Audit Office, the Public Accounts Committee and the Public Accounts Commission

The National Audit Office

Observations

In light of the British experience, the Public Accounts Committee believes that the future Auditor General of Canada should be appointed following consultations with the Chairman of the Public Accounts Committee. This procedure would enhance the independence of the Auditor General.

The Committee is of the view that the Office of the Auditor General of Canada should be able to table reports as soon as they are completed or as it considers appropriate. The British experience has confirmed to the Public Accounts Committee that regular tabling of reports and the constant media attention would encourage senior managers to manage public funds more efficiently and to react more rapidly to the observations of the Auditor General and the Committee.

Consequently, the Public Accounts Committee recommends

that Canada's Auditor General Act be amended to allow the Auditor General's comprehensive audits to be tabled, on a timely and appropriate basis, rather than waiting for their publication in the form of chapters in an annual report.

The Public Accounts Committee

Observations

The Public Accounts Commission

Observations

The Role of the Accounting Officer

Observations

Pursuant to Standing Order 109, the Committee requests that the Government table a comprehensive response to this Report.

A copy of the relevant Minutes of Proceedings and Evidence (Issue No. 41 which includes this Report) is tabled.

Respectfully submitted,

JEAN-ROBERT GAUTHIER

Chairman.

REPORT TO THE HOUSE

Friday, April 23, 1993

The Standing Committee on Public Accounts has the honour to present its

TWELFTH REPORT

Introduction

On the strength of this mandate, the Auditor General considered it important to call attention to the fact that, because of the tax arrangements for foreign affiliates, Canada has likely lost hundreds of millions of dollars in tax revenue.

The ingenuity of the several hundred taxpayers involved seems limitless, and the Committee is concerned that a number of businesses are succeeding in obtaining undue tax benefits.

It is also important to point out that it is not so much the Auditor General's observations, which are disturbing to say the least, that led the Committee to study this question in greater depth, but rather the tone of the long commentary by the Department of Finance in response to the Report of the Auditor General. The almost arrogant self-assurance with which the Department of Finance rejected the Auditor General's comments encouraged the Committee to fully explore the question of the taxing of foreign subsidiaries and consult some expert witnesses.

Background

In his annual report, he shows that Canadian corporations have received nearly $600 million in the form of tax-exempt dividends from Barbados, Cyprus, Ireland, Liberia, the Netherlands and Switzerland. These observations are based on Revenue Canada's T106 data base. According to the Auditor General, that represents a loss of about $240 million in tax revenue for Canada, since the other countries have not collected any tax on those amounts. On March 11, 1993, the Department of Finance sent the Committee a letter pointing out an error in the T106 data base. This correction affects only the estimate of dividends received from the designated countries where tax is collected at rates similar to Canadian rates. The estimate of dividends received from certain designated countries where the tax rates are low therefore remains unchanged. Discovery of this error in the Revenue Canada data does not change the substance of the Auditor General's comments. Actually, the error seems to increase his concerns, since the dividends received from certain designated countries that have low tax rates now represent 23 per cent of total dividends received rather than 14 per cent.

There is no doubt that the system for taxing foreign subsidiaries is essentially equitable and appropriate. Brian Arnold, of the University of Western Ontario, stated that "... I think the fundamental structure of our tax system for taxing foreign source income of Canadian multinationals is correct, fundamentally sound." (Minutes of Proceedings and Evidence, Issue No. 40, p. 22) He had previously stated that the "... current system for taxing foreign affiliates... is satisfactory and working reasonably well." ( ibid ., p. 6) The Committee also admits that many international transactions involving foreign subsidiaries do not undermine the current provisions of the Income Tax Act .

In the Committee's view, however, the fact that many of these transactions comply with the provisions of the Act, and hence are completely legal, does not mean that the rules should not be changed. Brian Arnold added that, even though the tax system was working well, that "does not mean that there aren't some things that can be done to improve it." ( ibid ., p. 6) The Committee feels that a number of tax avoidance schemes are not justifiable and run counter to Parliament's intention and the objectives of the Income Tax Act . In this report, the Committee therefore recommends certain amendments with respect to the taxing of foreign subsidiaries that would make the Act consistent with the intention of Parliament and would in all likelihood put an end to much of the fiscal erosion.

Significance of the tax losses

In response to the Committee's request, the Auditor General indicated on December 8, 1992, that his Office and the Department of Finance had agreed that the tax arrangements for foreign affiliates could erode the tax base. He did mention that they still could not agree on the amount of tax revenue already lost.

According to the Department of Finance, in a dynamic universe, any change to the tax regime would result in significant changes in the behaviour of taxpayers, who would find other ways of avoiding tax. As a result, there would not be any additional income to tax.

A number of witnesses said that we should not expect to collect any additional revenue from taxing the foreign activities of Canadian multinationals.

First, the Committee considers that the integrity of Canada's tax base must be protected. Brian Arnold said: "It is ... protecting the domestic tax base. It is not trying to raise revenue from these foreign-source activities of Canadian-based multinationals, because you will have enormous difficulty in collecting any significant revenue from that activity." ( ibid ., p. 9)

Second, the Committee thinks that care must also be taken to keep the tax system fair and equitable, and that there is no reason, in our tax regime, why income earned in a tax haven should be given preferential treatment over income earned in Canada and subject to Canadian tax. The Department of Finance has pointed out several times that the tax system must protect the competitiveness of Canadian firms. However, the Committee considers that offering Canadian multinationals a double deduction of interest costs, in order to maintain a degree of competitiveness, makes the tax system unfair. Offering multinationals a subsidy disguised as preferential tax treatment, without doing the same for other Canadian firms that do not have operations abroad, makes the tax system unfair.

List of designated countries and tax havens

However, the Auditor General points out that it often happens that certain multinationals abuse the rules that permit a Canadian firm to repatriate, on a tax-exempt basis, income from an active business, by using the tax havens mentioned in the list of designated countries. This means that we are allowing into Canada earned income that is not taxed or is taxed at a lower rate.

The Deputy Minister of Finance, David Dodge, told the Committee: "All countries with which Canada has concluded tax treaties impose corporate taxes at significant rates." (Minutes of Proceedings and Evidence, Issue No. 37, p. 13) However, an exception is made in the case of developing countries: "Canada, as a matter of policy, has long maintained the habit of accommodating such concessions provided by Third World countries and not frustrating them by taxing income that has benefited from their fiscal incentives." ( ibid , p. 13) The Deputy Minister continued by stating:

As part of our general policy toward economic development in lesser developed countries, ... we have undertaken, along with most OECD countries, to not offset through our tax system fiscal incentives they provide to try to increase incomes in very low-income economies. ( ibid , p. 23)

The Committee does not accept the words of the Department of Finance when it questions the good faith of a number of foreign subsidiaries of Canadian corporations working in these developing countries that are considered tax havens. Brian Arnold contradicted the Department of Finance when he told the Committee the following:

There is no real business being done in most of these tax havens... generally... we are talking about banking services. The banks and the local professional community will benefit to a certain extent, but for the most part there are not real activities. These companies are conduits. The money is actually being invested elsewhere. (Minutes of Proceedings and Evidence, Issue No. 40, p. 20)

Thus the list of designated countries must be reviewed regularly. Brian Arnold suggested removing all countries that do not have tax treaties. Even the Department of Finance seems to agree with this proposal: one of its representatives told the Committee: "When it becomes obvious that we will not be in a position to conclude negotiations [with those countries], clearly consideration should be given to taking them off the list." (Minutes of Proceedings and Evidence, Issue No. 38, p. 35) Robert Brown of Price Waterhouse supported the view of Brian Arnold when he said: "[The list] is not quite meeting that challenge, and it would be appropriate to review it and to consider whether some of the countries on it should be on it." (Minutes of Proceedings and Evidence, Issue No. 43, p. 10) This review of the list of designated countries would have little effect on the competitiveness of Canadian multinationals. In this connection Robert Brown said: "So while taking a few islands off the list might be something that could be considered, it will not alter the position of Canadian corporations, and it will also not change the fact that there are differences between the Canadian tax system and other systems". ( ibid . p. 10)

The Public Accounts Committee accordingly recommends

A) that the Department of Finance immediately, and regularly thereafter, review the list of designated countries given in Regulation 5907(11) made under the Income Tax Act to remove all countries with which Canada has not signed a tax treaty or with which the negotiations will likely be impossible to conclude;

B) that the Department of Finance assess the merits of being able to bring back to Canada tax-exempt all income from subsidiaries operating in these tax havens.

Foreign Accrual Property Income (FAPI) and active foreign business income

The difficulty in administering these rules lies in the fact that the Department of Finance has not yet defined the term "active business income". However, Revenue Canada has pointed the problem out to the Department of Finance a number of times.

The lack of a precise definition is a matter for concern. The Committee wonders how the General Anti-Avoidance Rule can be applied when the term "active income" has never been defined. The Committee considers that something that is implicitly permitted by the Income Tax Act cannot be prohibited. Amending the Act to clarify what is meant by active income would not weaken the rule of taxing income from foreign sources, and it would put an end to the tax avoidance schemes that are eroding the Canadian tax base. Brian Arnold also stated on this subject that "those rules [FAPI] need to be modified, strengthened, expanded in order to make them work more effectively. I think those changes would mean you would raise more revenue or you would not lose as much revenue elsewhere in your system." ( Minutes of Proceedings and Evidence, Issue No. 40, p. 10)

Contrary to what some witnesses have said, the Committee also considers that the responsibility for finding the right definition should not be left to the courts. It is time to act. Since there is no question of changing the basic structure of the rules, the Committee thinks that definitions can be developed. Even the Department of Finance agrees on the nature of the problem, since it stated: "the essential problem is one of finding out what the definition should be." (Minutes of Proceedings and Evidence, Issue No. 37, p. 28)

The Committee accordingly recommends

A) that the Department of Finance immediately clarify what constitutes active business income in the context of the rules on foreign accrual property income;

B) that the necessary amendments be made to the Income Tax Act to protect the integrity of Canada's tax base.

The FAPI rules and transferring foreign losses to Canada

Besides, Brian Arnold said the following on this subject: "I know of no other country that permits active business losses in a foreign affiliate to be offset against passive investment income of the foreign affiliate." (Minutes of Proceedings and Evidence, Issue No. 40, p. 11) Robert Brown also stated that "there would certainly be some questions about the appropriateness [of such measures]." (Minutes of Proceedings and Evidence, Issue No. 43, p. 6) He also indicated that this change would not harm Canada's competitive position or encourage Canadian firms to leave the country. He did not think that "it would lead to any massive outflow of Canadian corporations." (ibid., p. 16) According to Allan R. Lanthier of the Canadian Institute of Chartered Accountants, the General Anti-Avoidance Rule could not prevent the transfer of foreign losses to Canada.

The Committee considers that amending the Income Tax Act would protect our tax base without affecting the competitiveness of Canadian corporations in any way.

The Committee accordingly recommends

that the Income Tax Act be amended to prevent Canadian corporations operating subsidiaries abroad from using the tax losses of those subsidiaries to reduce their taxable income in Canada.

Interest deductibility and transfer prices

The Committee accordingly recommends

A) that the Department of Finance study in depth the problem of interest deductibility before making changes to the Income Tax Act

B) that the Department send the Committee on Public Accounts the results of this study.

The question of interest deductibility is closely linked to that of transfer pricing. Capital is "property" with a price, for which the costs may be deducted for income tax purposes. The Department of Finance and Revenue Canada should therefore study in greater depth the question of transfer pricing (fair selling price for goods and services, including capital invested, to Canadian businesses by foreign affiliates). On this subject, Robert Brown stated: "Developments now occurring in other countries relating to transfer prices could undermine the Canadian revenue base if not successfully resisted by Canadian authorities." ( ibid ., p. 6)

The Committee accordingly recommends

A) that the Department of Finance carefully study the problems associated with setting transfer prices;

B) that Revenue Canada strengthen its efforts on monitoring transfer prices.

Problems of communication between Revenue Canada and the Department of Finance

Tax arrangements for foreign affiliates are a concern for the Department of National Revenue-Taxation (NRT). On a number of occasions, NRT has advised the Department of Finance about concerns it has with existing legislation.

In its evidence before the Committee, Revenue Canada indicated that it had become more interested in this question, and the officials of the Department said they had reported some of their concerns to the Department of Finance.

Apparently, Revenue Canada several times made suggestions to the Department of Finance for amendments to the Income Tax Act in the area of foreign-source income. Also, on January 25, 1993, the senior advisor to the Deputy Minister of National Revenue, Robert Beith, sent the Committee a list of the changes that had been suggested to the Department of Finance.

The first recommendation reads as follows:

Consider interim budget amendments to the foreign affiliate rules, before reactivating and completing their in-depth study and review, to address the more obviously abusive tax practices in this area...

The Department of Finance seems to be simply ignoring the alarm when it is sounded. Obviously, there are communication problems between the two departments. If Revenue Canada is to be stricter in applying the foreign accrual property income rules, for example, the Department of Finance will have to be more receptive to its comments and give it the necessary tools.

In this respect Robert Brown said it was necessary to

[strengthen]... the communication between the Department of Finance and Revenue Canada on avoidance issues or issues which appear to result in anomalies or unfairnesses in the taxation of foreign-source income. I think it's important that this communication should be as direct and as continuous as possible. ( ibid . p. 5)

Alan M. Schwartz, of the Canadian Bar Association, said that "there would be that internal tension between a tax collector and somebody who is standing back and looking at it from the point of view of the overall scheme." ( ibid ., p. 30)

Also, Revenue Canada should have more and better qualified resources in order to be stricter in applying the Income Tax Act . Allan R. Lanthier said the following in that connection: "I fully endorse strong assessing policies on the part of Revenue Canada". (ibid., p. 31). As Robert Brown pointed out: "You have to have effective legislation and you have to have an effective enforcement effort. The two of those will produce results". ( ibid . p. 18)

The Committee therefore recommends:

A) that the Department of Finance and Revenue Canada jointly develop a specific policy for better communication and to fully take into account the observations and comments by Revenue Canada. The Committee on Public Accounts will request Revenue Canada to advise the Committee on any occasions on which observations or suggestions are rejected arbitrarily by the Department of Finance.

B) that Revenue Canada apply more aggressively the provisions of the Income Tax Act and its regulations (like the General Anti-Avoidance Rule). If necessary, the Department should hire additional qualified and experienced staff.

The General Anti-Avoidance Rule

to the extent the rules in the foreign affiliate area are abused by taxpayers, we believe the general anti-avoidance rule, introduced in 1988, will assist Revenue Canada in protecting against abusive transactions in the future. (Minutes of Proceedings and Evidence, Issue No. 37, p. 15)

However, the Auditor General, some expert witnesses and a number of tax experts doubt that this rule can in fact curb the abuses raised in the audit note. Brian Arnold had this to say on the subject: "I don't think the general anti-avoidance rule is a panacea for Revenue Canada in terms of dealing with abusive tax avoidance arrangements." (Minutes of Proceedings and Evidence, Issue No. 40, p. 28) Robert Brown supported Brian Arnold's statement in a way when he said: "I think in the general foreign affiliate area the GAAR rule would have only limited application ... I think in some areas it could have application, but it requires an aggressive enforcement action by Revenue Canada and some interpretation by the courts." (Minutes of Proceedings and Evidence, Issue No. 43, p. 17) It is important to note that the GAAR has never been applied.

The Committee therefore recommends

that the Department of Finance and Revenue Canada annually submit to the Committee on Public Accounts a report on the effectiveness of the General Anti-Avoidance Rule in thwarting the tax avoidance schemes used in connection with foreign affiliates.

Conclusion

As Robert Brown said: "It is important that the Canadian system for taxing international income should be fair, that it should provide a competitive environment for Canadian corporations to operate abroad, and that it should not create opportunities for the avoidance of Canadian tax on Canadian-source income." (Minutes of Proceedings and Evidence, Issue No. 43, p. 5) For example, we must avoid double taxation and facilitate the return of the income to Canada.

However, the Committee does not believe that the competitive position of Canadian businesses should be based on an unfair tax system that threatens to undermine Canada's tax base, as is the case now. On this subject, Brian Arnold stated the following:

We also want to have rules in place that stop Canadian-based multinationals, Canadian taxpayers generally, from trying to abuse that fundamental proposition, which is sound. But there needs to be limits on it. What we are really talking about here is how we should frame those limits. .... Right now there are some instances where the limits aren't working as well as they should, and we should fix those things up. (Minutes of Proceedings and Evidence, Issue No. 40, p. 22)

The Committee on Public Accounts is convinced that Parliament's intention was not to promote the international competitiveness of Canadian corporations through abusive or inappropriate tax avoidance practices. A number of tax arrangements for foreign corporations, which are currently tolerated, run counter to that intention.

The Department of Finance must therefore undertake to eliminate the abusive tax arrangements for foreign affiliates so as to protect the government's revenues and ensure that certain taxpayers will not be disadvantaged.

Though they are provisional in nature, these major amendments would finally give Revenue Canada the tools it needs to have Parliament's intention respected and protect the tax base. This is all the more important in a context of budget constraints and rationalization of public finances like the present one. The Committee on Public Accounts does not think that amendments to the current rules to stop the erosion of the tax base will cause a large number of Canadian businesses to move abroad, as the Department of Finance claims. According to the experts consulted, the necessary changes, with the exception of interest deductibility and transfer pricing, are relatively simple and will have no negative consequences. Brian Arnold said that it is not easy for a company to move its operations to another jurisdiction. The Committee also thinks that the changes suggested in this report would put an end to much of the erosion of the tax base without hampering the legal trade operations carried on abroad by Canadian taxpayers.

The Committee accordingly recommends

A) that the Department of Finance, even before completing the studies begun in 1987, undertake to amend the Income Tax Act provisionally to end the tax avoidance schemes used by Canadian corporations operating foreign subsidiaries, as recommended in this report;

B) that once the provisional measures are in place, the Department of Finance undertake to complete the studies begun in 1987 in order to develop specific amendments to the Income Tax Act designed to protect the integrity of the tax base in the long term;

C) that the Department of Finance continue to revise the legislative and regulatory measures, on an ongoing basis, to ensure that they are always adapted to the circumstances, to the evolution of tax laws in other countries and to the interpretations by the courts.

Finally, the government should ensure that all taxpayers and tax consultants have access to clear, complete, precise and accurate information concerning the taxation of foreign affiliates.

The Committee therefore recommends

that the Department of Finance commit itself to clarify the legal language relative to the Income Tax Act and to the taxation of foreign affiliates.

APPENDIX

Hon. Donald Frank Mazankowski
Minister of Finance
Room 209-S
Centre Block

Dear Minister:

In accordance with its mandate, the Standing Committee on Public Accounts examined paragraphs 2.28 to 2.61 of the Report of the Auditor General for 1992. At the meeting held on March 9, 1993, I asked the witnesses, Mr. Lanthier, Mr. Schwartz and Mr. Brown, whether they had had conversations or exchanges of views with your Department about their appearance before the Committee. In particular, I sought to know whether your Department had tried to influence the testimony of these experts in any way.

Although the witnesses stated that they had conversations with some officials in your Department, they all declared that they did not feel that the Department was trying to influence them. The Committee is concerned about this practice of communicating with witnesses before they appear at a Committee meeting.

Since much effort has been invested in its work, the Committee has no wish to see doubt cast on the relevance of the conclusions contained in its report because of such an intervention. In conclusion, the Committee would like to know what is the justification for this practice and how you explain proceeding in this manner.

I look forward to a prompt response.

Yours truly,

Jean-Robert Gauthier, M.P. Ottawa-Vanier

c.c.: Mr. David Dodge, Deputy Minister

Pursuant to Standing Order 109, the Committee requests the government to table an overall response to this report. However, given the extraordinary nature of the problem and the likelihood that Parliament will be dissolved before the expiry of the 150-day time limit prescribed in the Standing Orders, the Committee on Public Accounts would appreciate receiving a response from the government within 40 days of presentation of this report.

A copy of the relevant Minutes of Proceedings and Evidence (Issues Nos. 37, 38, 40, 43 and 48 which includes this report) is tabled.

Respectfully submitted,

JEAN-ROBERT GAUTHIER

Chairman.

REPORT TO THE HOUSE

Friday, April 23, 1993

The Standing Committee on Public Accounts has the honour to present its

THIRTEENTH REPORT

A copy of the relevant Minutes of Proceedings and Evidence (Issues No. 45 and No. 48 which includes this Report ) is tabled.

Respectfully submitted,

JEAN-ROBERT GAUTHIER

Chairman

REPORT TO THE HOUSE

Wednesday, June 9, 1993

The Standing Committee on Public Accounts has the honour to present its

FOURTEENTH REPORT

The Committee considers that the resources allocated to employment should, because of the pressures on today's labour market, increasingly be used for worker adjustment. In 1991-92, the Department of Employment and Immigration allocated $2.858 billion to its Employment Activity Programs. These have an impact on the employment rate and thus on the economy, and interest in how they are managed is intensifying accordingly. It was with this in mind that the Committee focused on the question of the effectiveness of the Department's employment programs and its ability to promote the efficient and effective functioning of the Canadian labour market.

The Committee was pleased with the commitments made by the Department of Employment and Immigration according to the statement by Mr. François Pouliot, Associate Deputy Minister, of the Department's intention of expanding the scope of its program evaluations.

To ensure that evaluation of the interdependency of program components will be undertaken within a reasonable period of time, the Committee recommends

that the Department of Employment and Immigration submit a detailed calendar of its work plan within 60 days.

The Committee is not, however, entirely convinced that the Department is in a position to carry out this program evaluation successfully, as it does not seem to have all the tools required for the exercise.

In the Committee's view, in order to carry out appropriate performance monitoring, the Department must have reliable information on the results of its efforts. The Auditor General notes that the Department has had longstanding difficulty in developing and selecting performance indicators for its employment programs and services.

The Committee realizes that in a constantly evolving labour market the Department must frequently rethink its performance indicators. Nevertheless, the Committee considers that the Department should ensure that it has the means to meet this challenge.

Therefore, with a view to making possible better project monitoring, the Committee recommends

that the Department of Employment and Immigration improve program performance measurement

- by making available in a timely manner the necessary data already on hand for establishing performance indicators; and

- by developing new performance indicators corresponding to the various objectives for different programs, as these are initiated or modified.

A copy of the relevant Minutes of Proceedings and Evidence (Issues No 53 and No 54 which includes this Report) is tabled.

Respectfully submitted,

JEAN-ROBERT GAUTHIER

Chairman.