1985 Report of the Auditor General of Canada
Chapter 3—Audit Notes
Report Under Section 11 of the Auditor General Act on our Continuing Review of the Oil Pricing and Compensation Programs
3.1 This chapter contains matters of significance that we believe should be drawn to the attention of the House of Commons that have not been reported elsewhere in the Report, but have come to our attention during our audits of the accounts of Canada, Crown corporations and other entities.
Cash Management3.2 Chapter 4 of the 1984 Report, Review of Cash Management, reported a number of deficiencies identified in the course of carrying out our review of billing, collection, deposit and payment practices in 10 departments and agencies.
3.3 Actions have been undertaken recently by the Treasury Board Secretariat, the Office of the Comptroller General and the Receiver General to improve cash management practices of the government as outlined in their responses to observations made in paragraphs 4.26 to 4.41 of the 1984 Report. However, as a result of our current audit work in support of our opinion on the Public Accounts of Canada, we have a number of additional observations on cash management which are presented in the following cases.
Case 13.4 Ministry of Energy, Mines and Resources - Cash Provided to Petro-Canada in Advance of Need
In late March 1984, the Minister of Energy, Mines and Resources subscribed for $425 million in common shares of Petro-Canada. It appears that Petro-Canada did not need the funds obtained from this transaction for at least the next six months.3.5 The 1984 capital budget of Petro-Canada, which was approved by Order in Council in December 1983, had provided for $425 million in common shares, although the timing of the payment was not specified. Section 5(2) of the Petro-Canada Act says, in part: "each such subscription shall be paid out of the Consolidated Revenue Fund at such times as the Corporation may require and the Minister of Finance may approve..." The government was able to make use of funds authorized in the 1983-84 borrowing authority already approved by Parliament by completing the transaction before the end of March 1984, at a time when there was concern about upward pressure on the borrowing requirements for 1984-85.
3.6 According to quarterly and annual financial statements of Petro-Canada, the company's balance of cash and short-term deposits was as follows:
|31 December 1983||$55,584,000|
|31 March 1984||$494,863,000|
|30 June 1984||$681,995,000|
|30 September 1984||$653,938,000|
|31 December 1984||$32,819,000|
3.7 Based on the balances noted above, it can be deduced that Petro-Canada had excess funds that it was able to invest. A major portion of these excess funds appears to have been derived from the $425 million share subscription.
3.8 The effect of this transaction, which was legally and properly executed, was that funds were provided to Petro-Canada at least six months in advance of requirement. Based on the average yield for six month Treasury Bills, the cost for the government to borrow $425 million for that period of time would have exceeded $20 million. Since then, the government has taken steps to recover surplus cash from crown corporations including $50 million in the form of a dividend from Petro Canada in 1985-86.
Case 23.9 Department of External Affairs - Late Remittances by Export Development Corporation to the Consolidated Revenue Fund and Banking Delays by the Department of External Affairs Result in an Unintended Benefit to the Corporation of $775,500
The Export Development Corporation (EDC) remits to External Affairs funds it has received on accounts administered for Canada for deposit to the Consolidated Revenue Fund (CRF). Although the Receipt and Deposit of Public Money Regulations require that such funds be deposited to the CRF immediately on their receipt, EDC waits until the end of the month before remitting them to External Affairs. By waiting until the end of the month, the Corporation receives an economic benefit. Furthermore, External Affairs does not deposit the cheques on receipt but processes the documentation before depositing the funds, resulting in a further delay. We estimate, based on average yields on short-term investments, that for the 1984-85 fiscal year EDC received an economic benefit of $775,500 as a result of these delays in transferring funds to the CRF.3.10 The Corporation has explained that it is technically difficult to separate the amounts received by it for its own accounts from the accounts administered for Canada. This precludes the immediate segregation of funds between those for the Corporation and those for Canada. Occasionally, delays of several months may occur before the appropriate amount to be deposited in the CRF is finally determined and remitted. We estimated that, in 1984-85, EDC received an economic benefit of $626,400 on the accounts administered for Canada from the date it received the money until a cheque was sent to External Affairs.
3.11 The Corporation has also explained 1 July 1984 that it did not agree with the Commission's account receivable of $10 million since funds had been provided for payment to producers participating in the national milk marketing program and not for the purpose of financing the marketing of surplus dairy products. Our audit opinion on the financial statements of the Commission was qualified because of the overstatement of assets. If this amount had not been reported as an asset, the deficiency between cost of marketing operations and fade to EDC from the Consolidated Revenue Fund.
3.12 The Treasury Board Secretariat has been made aware of the issue and alternatives are being investigated. One option would be to have EDC pay interest from the day it received the funds until the day it transferred the funds to External Affairs. This may also apply to payments made to EDC from the Consolidated Revenue Fund.
3.13 There is a further delay from the time EDC sends the cheque, by hand, to External Affairs until the cheque is deposited in the CRF. We estimate the economic benefit received by EDC due to this second delay to be $149,100. The second delay could be avoided if External Affairs made arrangements to deposit the cheques immediately on receipt, completing the paper work later.
Case 33.14 Department of Fisheries and Oceans - Loss of Revenue from Loans to Crown Corporations
The Department of Fisheries and Oceans provides loans to the Canadian Saltfish Corporation and the Freshwater Fish Marketing Corporation to carry out their operations. Delays in collecting and depositing loan receipts have created an estimated loss of $190,000 in revenue to the government.3.15 In 1984-85, the Department of Fisheries and Oceans provided loans of $112 million to the Canadian Saltfish Corporation and the Freshwater Fish Marketing Corporation and received interest and loan repayments of $88 million.
3.16 The amounts of the loan repayments from the Corporations are large, often exceeding $1 million. These repayments are forwarded by regular mail to Fisheries and Oceans headquarters in Ottawa with the Corporations paying interest only up to the date cheques are mailed. This use of regular mail delays receipt by the Department from between 3 to 13 days. In addition, cheques received in the Department have not always been deposited on the date of receipt as required by government regulations. Delays in depositing cheques range from one to nine days.
3.17 In our opinion, permitting the Corporations to make their loan repayments in this fashion represents a lack of due regard for economy. Delayed receipt of loan repayments has resulted in $120,000 in foregone interest revenue in 1984-85, while delays in depositing receipts have resulted in an additional $70,000 loss in the same period.
3.18 Discussions with departmental officials have indicated that cash deposits are now being made in accordance with government regulations. In addition, the Department has negotiated procedures with officials of the Corporations to ensure that interest is paid to the date payment is received by the Department.
Case 43.19 Department of Fisheries and Oceans - Additional Cost for Purchase of Steveston Harbour
For the fiscal years 1983-84 and 1984-85, the Department made final payments for the purchase of Steveston Harbour in advance of need. By making these payments before their due dates, the Department saved $110,000 in interest payments. However, the government's cost of borrowing funds for these early payments has been estimated at $210,000. This lack of due regard for economy in cash management thus resulted in a net additional interest cost of $100,000 to the government.3.20 In August 1983, Treasury Board authorized the Department of Fisheries and Oceans to purchase property and harbour facilities at Steveston, B.C. from British Columbia Packers Limited for $9,860,000. Under the agreement of purchase and sale subsequently concluded, the purchase price was to be paid in three installments, with the first payment of $3,500,000 due on or before the closing date, the second payment of $3,360,000 on 1 June 1984 and the final payment of $3,000,000 on 1 June 1985. Interest at the rate of 5 per cent per annum was payable on the unpaid balance of the purchase price. The agreement also provided the government with the right to make payments in advance of due dates.
3.21 The first payment was made on the closing date as agreed. The second payment was made on 23 March 1984 and the final payment on 14 December 1984. These payments were made 69 and 168 days in advance of the respective due dates.
3.22 Although the financing cost of 5 per cent under the agreement with British Columbia Packers Limited was significantly lower than the government's overall cost of borrowing at the time, the Department did not take this into consideration in making the decision to prepay.
3.23 By making early payments, the Department was able to reduce the unspent portion of funds voted to it in both the 1983-84 and 1984-85 fiscal years. Because unspent department funds lapse at the end of a fiscal year, there was a clear incentive for the Department to make the payments early - even when it was uneconomical for the government as a whole.
Case 53.24 Department of Veterans Affairs and Canadian Pension Commission - Inadequate Control Over Veterans' Trust Accounts
At 31 March 1985, more than $53 million was being held in trust on behalf of veterans. We found there were inadequacies in the controls over veterans' trust accounts by the Department and the Canadian Pension Commission and in the policy guidance to those responsible for administering these trust accounts for veterans. We noted in the accounts examined that at least $412,000 had not been credited to individual veteran's trust accounts, and $264,000 had been incorrectly taken from veterans' accounts to pay for their treatment in foreign hospitals, notwithstanding that this was the Department's responsibility.3.25 The Veterans Affairs Act, the War Veterans Allowance Act and the Pension Act, together with the relevant regulations, provide for the administration of the affairs of veterans who are incapable of managing their own financial affairs. Individual trust accounts have been set up for this purpose. We noted that there were inadequacies in the policies and procedural guidelines for safeguarding the moneys being administered through these accounts. This has resulted in a poor accountability framework and substantial errors.
3.26 We observed that at least $412,000 had not been recorded in individual veteran's trust accounts, largely as a result of fund transfers between the various locations where such accounts are held. We have no assurance, because of the lack of controls, that the discrepancies were not larger than this amount.
3.27 On the death of a veteran for whom an account has been maintained, the Pension Act calls for a review of the account before the funds can be disbursed. The Canadian Pension Commission has not been consistently performing this review, and there were numerous accounts dating back to 1980 on which no action had been taken. A number of these accounts had individual balances in excess of $100,000.
3.28 Some veterans living outside Canada receive treatment in foreign health care institutions at the expense of the Department of Veterans Affairs. In the case of some of those for whom accounts were being administered by the Department, amounts totalling $264,000 had been incorrectly charged against the veterans' trust accounts rather than departmental appropriations.
3.29 Veterans Affairs has taken action to credit individual veterans' trust accounts where it has been able to identify amounts due to these veterans. While this action is commendable, controls over veterans' trust accounts that would ensure that such errors do not recur had not yet been instituted.
Observations on Crown Corporations3.30 Our Office is the appointed auditor of 44 Crown corporations, as required by the Financial Administration Act or the individual act incorporating the specific corporation. Details on significant reservations and other matters contained in reports to these corporations issued during the year are set out below. Most of these matters have already been raised in the public forum, but they are repeated here for emphasis, and for consideration by Parliament.
(Photo not available)
3.31 Canada Museums Construction Corporation Inc. - Unresolved Funding Requirement for the Construction of Two Museums
The Corporation was incorporated in 1982 with a mandate to recommend sites, architects and designs for the new National Gallery of Canada and the National Museum of Man in the National Capital Region, and to manage their construction. The projects are to be completed by 1987. In its planning documents, the Corporation estimated funding shortages of approximately $53 million. To date, Treasury Board has not accepted the Corporation's proposal regarding the additional funding needed for the two projects. In our opinion, it is unlikely that the two museums can be made fully operational in accordance with the building concepts and schedules as originally approved by Cabinet without resolution of the funding requirement. We also note that the Corporation did not include the cost of the sites in any of its funding proposals. Although construction is in progress, no final agreement or permission to occupy has been obtained for the National Museum of Man site. In addition, some portions of the sites for the two museums are not federally owned, and title to them has not been settled.3.32 In September 1981, the Cabinet allocated total funding of $185 million for the two projects. This ceiling has now been revised to $191.45 million ($98.15 million for the National Gallery of Canada and $93.30 million for the National Museum of Man). The Corporation presented to Cabinet a breakdown of the project expenditures into three broad elements: construction costs, fees, and corporate administration.
3.33 In November 1983, the Cabinet Committee on Priorities and Planning accepted the recommendations of the Corporation and approved the construction sites, architects, building concepts and long-term forecasts of the building schedules and funding requirements for each museum. However, the Corporation's funding proposals did not include the cost of the sites in any of the funding proposals. According to independent appraisals obtained by the National Capital Commission in 1983, the market values of these sites were approximately $14.1 million for the National Gallery and $5.4 million for the Museum of Man. In our opinion, the cost of the sites should have been stated to present fairly the total project cost.
3.34 In May 1984, the Corporation, subsequent to obtaining Cabinet approval, announced plans for a drive to raise funds from the private sector with a target of $24 million to cover funding shortages for the construction of the two museums. However, this plan did not proceed beyond seeking advice and collecting information.
3.35 As requested in December 1984 by the Deputy Minister of Communications and the Secretary to the Treasury Board, a task force was convened by the Minister of Communications to review costs and develop options for cost reduction. In its report in February 1985, the task force set out various options for reducing the costs of the projects. It concluded that further work would be required to identify a reasonable target figure for private sector fund raising.
3.36 In a proposal submitted to Treasury Board in March 1985, the Corporation estimated funding shortages of approximately $36 million (including $8.15 million for items not previously included in the scope of the project) to 31 March 1987, and indicated that new funding would be required for this amount to complete the two projects. A further $17.1 million was also estimated as a future requirement for construction contingencies, landscaping and furnishings for public areas, making a total funding shortfall of $53 million excluding accommodation planning, fit-ups and possible site costs. To date, Treasury Board has not accepted these proposals.
3.37 In April 1985, the Minister of Communications directed the Corporation to adopt certain recommendations of the task force report and authorized an additional amount of $14.1 million, subject to Treasury Board approval.
3.38 In May 1985, the Minister of Public Works, subsequent to being designated as the appropriate Minister with respect to the Corporation, directed that an immediate review of the budgets and construction schedules for the two projects be undertaken.
3.39 Although major portions of the sites for the two museums are federally owned, with the legal title to the lands currently belonging to the National Capital Commission, we note that certain parts of both sites are owned by other levels of government. Negotiations between the Commission and the parties concerned to resolve the issue of legal title to parts of the Museum of Man site that are not federally owned have been going on since 1973. In December 1983, an interim agreement was reached between the Commission and the Corporation for geological surveys, excavation and bringing in the required public utilities. Although construction is in progress, no final agreement has been reached with the Commission or the other owners.
3.40 On 14 June 1985, the Chairman and Chief Executive Officer of the Corporation requested the Auditor General to perform a value-for-money audit to assess the management of the Corporation's operations and affairs up to 16 May 1985. The results of the audit will be reported to the Corporation in the fall of 1985.
3.41 Canadian Dairy Commission - $10 Million Overstatement of Assets
Funds provided by Parliament for the payment of subsidies to producers have been redirected by the Canadian Dairy Commission to finance its export marketing operations, normally financed by levies against milk producers. This was done by the Commission as part of its response to the withdrawal of British Columbia from the national milk marketing program from August 1982 to October 1984. The Agriculture Stabilization Board disagreed with the Commission's use of funds and did not acknowledge liability for $10 million claimed by the Commission as of 31 July 1984.3.42 The Canadian Dairy Commission normally makes income subsidy payments to individual Canadian dairy producers out of funds provided by Parliament and transferred by the Agricultural Stabilization Board to the Commission. The Commission also undertakes export marketing operations, normally financed by producer levies, to dispose of dairy products surplus to Canadian requirements.
3.43 In 1982, the Province of British Columbia withdrew from the national milk marketing program. The Commission did not pay subsidies to producers in that province and, with the exception of $3.2 million, did not receive levies from them for the period of non-participation. However, the Commission continued to draw subsidy funds through the Board equivalent to levies that would have been received from British Columbia had that province remained in the program. Subsidy funds drawn and converted for the 1983 dairy year amounted to $8.5 million, $10 million for 1984, and $2.56 million for the dairy year ending in 1985. In total, $21.1 million of subsidy funds otherwise payable to British Columbia producers has been used by the Commission to finance export marketing operations for the benefit of milk producers in Canada.
3.44 This use of funds by the Commission was subsequently approved by the Treasury Board in March 1985 in the extraordinary circumstances of British Columbia's withdrawal from and re-entry into the program. This subsequent approval, however, does not alter the fact that the funds have been used for a purpose other than that authorized by Parliament in the Appropriations Acts and as set out in the Estimates.
3.45 The Agriculture Stabilization Board confirmed to us during our audit of the Commission's financial statements for the year ended 31 July 1984 that it did not agree with the Commission's account receivable of $10 million since funds had been provided for payment to producers participating in the national milk marketing program and not for the purpose of financing the marketing of surplus dairy products. Our audit opinion on the financial statements of the Commission was qualified because of the overstatement of assets. If this amount had not been reported as an asset, the deficiency between cost of marketing operations and financing and the deficit at 31 July 1984 would each have increased by $10 million.
3.46 Canadian Saltfish Corporation - Sales of Frozen Fish Products and Advance Payments to Frozen Fish Producers Beyond the Corporation's Statutory Powers
During the year ended 31 March 1985, the Canadian Saltfish Corporation sold $26.0 million of frozen fish products and made advance payments to frozen fish producers; in our opinion, both of these were beyond its statutory powers. This is the third year we have qualified our audit report with respect to the Corporation operating beyond its statutory powers.3.47 The Canadian Saltfish Corporation was established by the Saltfish Act in 1970 to improve the earnings of the primary producers of cured codfish. The Corporation's operations are restricted by its Act to trading and marketing cured codfish and its by-products in the Province of Newfoundland and the Lower North Shore of Quebec; it is required to buy all cured codfish of an acceptable standard of quality offered for sale by the fishermen.
(Exhibit 3.1 not available)
3.48 During the year ended 31 March 1985, the Corporation marketed frozen fish products under contracts with a number of producer companies. In accordance with certain of these contracts, the Corporation advanced up to 70 per cent of the projected market value of the fish products to the producer companies, with the balance payable determined by the ultimate selling price and any related expenses incurred.
3.49 In our opinion, because the Act specifies the Corporation's rights only in relation to cured codfish, sales of frozen fish products during the year and advance payments to frozen fish producers were not within the powers of the Corporation under the Saltfish Act. We have brought this issue to the attention of management by way of qualification in the auditor's report. This situation was also brought to the attention of management in the 1984 and 1983 auditor's reports.
Observations on Departmental Operations3.50 Under section 7 of the Auditor General Act, the Auditor General is required to call attention in his Report to anything resulting from his examination that he considers to be of significance and of a nature that should be brought to the attention of the House of Commons. In accordance with these reporting requirements, we believe the following matters should be brought to the attention of the House.
3.51 Department of External Affairs - Purchase of Memberships in the Aberdeen Marina Club, Hong Kong
To provide recreational facilities for employees and their families, the Department purchased 34 individual transferable debentures entitling the holders to memberships in the Aberdeen Marina Club in Hong Kong. The initial cost was $773,500, and annual membership fees, at the time of our audit, amounted to $27,000. The Department did not adequately analyse the need for the recreational facilities or investigate less costly alternatives. Furthermore, the Department exceeded its authority by not obtaining Treasury Board approval of the purchase and contravened government accounting practices by paying the initiation fees in three installments covering three fiscal years.(Photo not available)
3.52 As a result of the Royal Commission on Conditions of Foreign Service, the Department established a Recreational Hardship Support Program, approved by Treasury Board in April 1983. This program is designed to enhance recreational opportunities for employees and their dependants at specified hardship posts where access to the most basic facilities commonly available to all Canadians is non-existent or restricted. The total program is limited to $4,524,000 for the first four years plus $750,000 each year thereafter.
3.53 External Affairs uses a point system (100 point maximum) in evaluating the relative hardship of posts abroad. A rating between 25 and 40 is indicative of serious hardships, where at least one of the two main recreational outlets - opportunities for active sports or for social entertainment and recreation - is normally quite limited and there are attendant access difficulties. Posts with ratings of less than 25 points are deemed to be experiencing only moderate to slight recreational hardships. Hong Kong was rated at the bottom of the serious hardships category (25 points). It ranked 46th of 64 posts identified as having recreational hardship.
3.54 The Post proposed that club memberships be provided for all Canada-based staff, on the basis that active recreational facilities were not available and that overcrowding made it desirable to offer employees an escape from the tensions of life in that city. Less costly options were dismissed as not providing the best solution; however, in analysing the alternatives, neither the relative cost nor the projected use that would be made of such facilities was considered. Furthermore, the Post did not indicate how a recreational club in the city would provide an escape from the tensions of the city.
3.55 A Management Review report, prepared prior to the decision to purchase, recommended a more careful analysis to justify the large commitment of public funds. It pointed out that 7 of the 33 staff quarters were located in compounds that already had recreational facilities, 10 of the Canada-based staff had memberships in other clubs provided to meet operational needs, and all Canada-based staff had access to the swimming pool at the official residence. Less costly alternatives include renting a recreational condominium for $1,500 per month and purchasing memberships in fitness facilities for $600 each. Finally, a new chancery was being proposed that could include recreational facilities, and the Post had identified a program to upgrade staff quarters to include recreational facilities.
3.56 The Department had obtained Treasury Board approval for the overall Recreational Hardship Support Program. One of the conditions of the approval was that specific post initiatives be discussed with Treasury Board Secretariat. Hong Kong was identified as a post that would make use of club memberships. The cost was estimated to be somewhat less than $100,000. Given the discrepancy between the initial estimate and the final cost, we believe that Treasury Board Secretariat should have been informed and its advice sought prior to approval. In our opinion, the amount spent in Hong Kong exceeded the intent of the Recreational Hardship Support Program. It appears inconsistent with the program intent to spend 20 per cent of the first four years' budget on a marginally qualified hardship post.
3.57 Department of Finance - Income Tax Remission Order Confers After-tax Benefit of $1 Billion
On 5 February 1985, an income tax remission order was granted to Hudson's Bay Oil and Gas Company Limited, enabling it to deduct, for income tax purposes, financing costs that its parent incurred in acquiring it. The order may provide the company with an after-tax benefit of up to $1 billion, and permitted the use of a method of transferring losses for tax purposes that in May 1985 had only been proposed to Parliament.3.58 In July 1984, the government announced its intention to provide Hudson's Bay Oil and Gas Company Limited, a subsidiary of Dome Petroleum Limited, with an order remitting income taxes pursuant to section 17 of the Financial Administration Act. The remission order was granted on 5 February 1985.
3.59 The order enables Hudson's Bay Oil and Gas to deduct, for income tax purposes, the financing costs incurred by Dome in acquiring it. It is applicable to Hudson's Bay Oil and Gas's taxation years up to and including 1990, and the tax revenue that may ultimately be forgiven is only limited by the tax effect on the income to be offset by the financing costs.
3.60 The Department of Finance has advised us that if the remission were not provided, and as a consequence Dome were to be forced into bankruptcy, the federal government would suffer a substantial revenue loss. The government was also concerned that a failure of Dome could have a serious adverse effect on the Alberta economy. In these circumstances, the Department believes it cannot accurately determine costs or prepare meaningful cost figures.
3.61 We estimate that the revenue the Crown will forego may amount to $1 billion, assuming that Dome survives and that Hudson's Bay Oil and Gas maintains its 1982 and 1983 levels of taxable income before the deduction of the financing costs.
3.62 Remission orders are generally granted to provide relief. Although the remission order is in compliance with the law, we are concerned that a $1 billion after-tax benefit may ultimately be conferred on a particular taxpayer, without providing Parliament with the opportunity to review the matter.
3.63 The remission order also permitted Dome to make use of a method of allowing losses for tax purposes to be transferred within an ownership group before this method had been approved by Parliament. In May 1985, it was proposed as part of the Budget.
3.64 The remission order has significant cost implications and involves the application of a method of transferring losses for tax purposes that is currently before Parliament. In our opinion, Parliament's consent should have been sought.
3.65 Department of Indian Affairs and Northern Development - Potential Liability Resulting from Litigation Against the Crown
A recent Supreme Court of Canada decision has clarified the fiduciary responsibility of the Department in respect to surrendered Indian lands. Litigation now pending against the Department could result in substantial liability.3.66 The Reserves and Trusts Branch of the Department of Indian Affairs and Northern Development is responsible for administering Canada's statutory and treaty obligations to Indians and Inuit. A recent Supreme Court of Canada decision has clarified the fiduciary responsibility of the Department regarding surrendered Indian lands.
3.67 This decision could give rise to more litigation based on alleged irregularities in the past administration of surrendered Indian lands. Although this case did not deal with estates, membership, natural resources and trust funds, the same reasoning could be extended to them. It is also expected to revive many historical claims that were held in abeyance pending the Supreme Court of Canada decision.
3.68 A departmental report dated 30 June 1985 lists approximately 102 court cases now pending against the Crown. About 25 per cent of the Statements of Claim, on which the report is based, claim specific monetary amounts that could exceed $1 billion. Although the other 75 per cent do not stipulate amounts, the total amount of the liability could be substantial if the litigation is successful. The Department is now studying the full implications of the Supreme Court decision.
3.69 Department of Indian Affairs and Northern Development - Follow-up of the Administration of the Indian Economic Development Fund
The purpose of the Indian Economic Development Fund is to provide loan guarantees and direct loans to fund the development of viable Indian business enterprises. Direct loans under the Indian Economic Development Fund have an authorized capital lending ceiling of $70 million. We reviewed the progress made to improve the management of the Fund.3.70 The management of the Indian Economic Development Fund was a subject of criticism in our 1978 Report (paragraph 21.5) and our 1980 Report (paragraph 6.115). The Sixth Report of the Standing Committee on Public Accounts, tabled in the House of Commons on 23 June 1981, expressed concern that a number of weaknesses had not been adequately addressed and recommended that the Department immediately define and implement the goals of the Indian Economic Development Fund.
3.71 In its response, the Department stated that the definition and implementation of the goals would be blended in new policies, standards and procedures and would coincide with the implementation of the Loan Accounting System by April 1982.
3.72 Since then, the Department has developed and implemented the Loan Improvement Process. This has resulted in improved procedures and controls and has significantly enhanced the quality of Fund administration. Despite ongoing efforts, the Loan Accounting System is still not in place.
3.73 According to departmental estimates, $29.2 million or 63 per cent of the outstanding balances lent under the Fund as of 31 March 1985 was doubtful or uncollectible. In addition, $17.7 million in interest receivable on these loans was also doubtful or uncollectible. Most of the uncollectible and doubtful outstanding balances were loans made before our previous notes. In a continuing effort to improve the Fund's administration, the Department has set aside 15 person-years under a two-year timetable for following up and collecting these long outstanding loans.
3.74 Departments of National Revenue-Taxation and Finance - Income Tax Implications of Petro-Canada's Acquisition of Petrofina
Parliament, subject to approval by the Government, provided Petro-Canada with the funds to acquire Petrofina. The acquisition, however, was executed in a complex series of interrelated transactions involving two Petro-Canada subsidiaries and a partnership beginning with Petrofina exchanging its assets for shares of a Petro-Canada subsidiary. The assets were then transferred to a Petro-Canada-owned partnership; immediately after, another Petro-Canada subsidiary purchased 51 per cent of the Petrofina shares. Purchase of the balance of the shares took place over a 25-month period.
The original exchange ensured that the sale by Petrofina's non-resident parent would be exempted from Canadian income taxes. The transfer of assets to the partnership may have enabled Petro-Canada to reap tax benefits on winding up the partnership. The 25-month purchase was structured to allow a term purchase while eliminating Canadian withholding tax on the interest paid. It may also have exempted Petrofina's parent from Belgian income taxes.
Acquisition Structure3.75 Parliament, subject to approval by the Government, authorized the payment of moneys from the Canadian Ownership Fund to Petro-Canada for the purchase of shares and acquisition of property from Petrofina Canada Inc. The acquisition, however, was made by a wholly-owned subsidiary of Petro-Canada, Petro-Canada Explorations Inc. and its wholly-owned subsidiary, Petro-Canada Petroleum Inc., under the terms of a share-offer agreement supplemented by an asset-offer agreement.
3.76 Under these agreements, Petrofina would transfer its assets to Petro-Canada Petroleum in return for preferred shares. Petro-Canada Explorations would acquire at least 51 per cent of Petrofina shares initially, without any assurance that the remaining shares could be acquired. The initial share price was $120, and for subsequent purchases the price included adjustments for imputed interest and dividends paid.
Scope of Review3.77 We looked at the income tax consequences of the acquisition, focusing on a series of key transactions: the transfer of assets from Petrofina to Petro-Canada; the creation of a partnership for taxation purposes; and the share purchase arrangement. We also considered the related advance income tax rulings issued by the Department of National Revenue-Taxation.
Transfer of Assets3.78 Because Petro-Canada Explorations had no assurance that it would acquire more than 51 per cent of Petrofina's common shares, the exchange of assets for preferred shares ensured that the future growth of Petrofina would accrue to Petro-Canada Petroleum. It also converted Petrofina's immovable property to movable property. The conversion followed by the share purchase enabled National Revenue-Taxation to rule that Petrofina's Belgian parent would be exempted from Canadian tax on the sale of its Petrofina shares in accordance with the Canada-Belgium Income Tax Convention.
(Exhibit 3.2 not available)
Partnership Arrangement3.79 From the information made available to us relating to the partnership arrangement and its background, we made the observations that follow.
3.80 Ministers of the Crown were advised that the transfer of Petrofina's assets would involve a tax-free rollover that is allowed by the Income Tax Act. The parties agreed to comply with the existing provision in the Act that enabled Petrofina to defer tax on the asset transfer to Petro-Canada Petroleum, which inherited the potential tax liability by assuming Petrofina's tax value of the assets.
3.81 However, the Department of Finance was advised that the takeover was being structured in such a way that the tax basis of the underlying assets of Petrofina could be increased or "bumped up" to reflect the price paid for the shares, which was very much higher than their book value. This would result in eliminating some of the tax liability previously inherited from Petrofina. In the absence of this structuring, Petro-Canada would not be able to recognize for tax purposes the money expended for the assets it was acquiring from Petrofina. In our opinion, all the relevant information was not provided to ministers.
3.82 Ernst & Whinney, Chartered Accountants, in their review of the acquisition at the agreed purchase price of $120 per share, stated that it was necessary for Petro-Canada to increase the tax basis of the underlying assets of Petrofina for the acquisition to be economically feasible. They outlined in detail a method to effect an asset "bump-up", which required the formation of a partnership. The share-offer also suggested that, for taxation purposes, assets might be transferred to a partnership prior to the share purchase.
3.83 However, we reviewed the income tax legislation in effect in May 1981 when control of Petrofina Canada was acquired and determined that forming a partnership would not have enabled Petro-Canada to recognize for tax purposes the cost paid for the assets, which was approximately $1 billion more than their book value. For Petro-Canada to have established a cost for tax purposes equal to the price paid for the assets, it would have had to acquire the assets through a straightforward purchase. Had that been done, Petrofina would have become liable for Canadian income taxes, which we estimate would have been between $250 million and $500 million.
3.84 Income tax amendments proposed in April 1983 and enacted in January 1984 changed the situation. The use of tax-free rollover and the formation of a partnership in 1981, followed by corporate and partnership liquidations, would enable Petro-Canada to "bump-up" the tax basis of the assets by approximately $500 million. We asked Petro-Canada if this was done or may still be done. At 20 September 1985, we had not received a reply.
(Exhibit 3.3 not available)
3.85 In our opinion, Parliament should have been advised that the retroactive effect of certain amendments to the Income Tax Act may have enabled Petro-Canada to reap substantial tax benefits not available at the date Petrofina was acquired.
Share Purchase3.86 We were advised by the Department of Finance that the purchase of only 51 per cent of the shares in the initial transaction with the balance of the shares being purchased over a 25-month period, may have exempted Petrofina's parent from income taxes in Belgium. This arrangement also resulted in eliminating Canadian withholding tax on the imputed interest adjustment of subsequent share purchases.
3.87 Under Canadian tax laws, the sale of Petrofina shares by its Belgian parent is subject to tax in Canada. However, under the Canada-Belgium Income Tax Convention, gains are exempted from Canadian tax unless the property consists principally of immovable property as defined in the Convention.
3.88 Because there was no pre-acquisition asset valuation available to National Revenue-Taxation and the Department of Finance, it is not clear whether the property of Petrofina consisted principally of immovable property according to the Convention. Technically, however, Petrofina's transfer of its assets to Petro-Canada Petroleum in return for preferred shares eliminated this question because the shares were clearly movable property.
3.89 National Revenue-Taxation ruled that the gain realized by Petrofina's parent on the sale of its shares would be exempted from Canadian tax under the Convention. It also ruled that the purchase price adjustments for imputed interest that would accrue on the shares to be sold over the 25-month period would form part of the proceeds of disposition. In effect, the imputed interest was a capital receipt and therefore not subject to Canadian withholding tax.
3.90 We estimate that if the gain had been subject to tax in Canada, Petrofina's Belgian parent's tax liability would have been $200 million.
Advance Income Tax Ruling3.91 Advance income tax rulings are an administrative service that National Revenue-Taxation has no legal requirement to provide. Generally, the Department attempts to rule on a transaction that has a bone fide business purpose, which may include tax planning. The Department's guidelines state that requests for rulings may be refused where this is not the case or where transactions appear to be designed primarily for improper avoidance, reduction or deferral of tax. They may also be refused where there are reasonable grounds for believing that they will be followed by other transactions that would ultimately result in the improper avoidance, reduction or deferral of tax. An advance ruling is regarded as binding upon the Department.
3.92 From our review of the ruling exempting Petrofina's Belgian parent from Canadian tax on the sale of its shares, we made the observations that follow.
3.93 The Department of Finance believed that a favourable advance ruling could be granted on the basis that Petrofina's assets were such that they did not consist principally of immovable property as defined in the Convention, and that therefore the gain would have been exempted from Canadian tax. The asset transfer could therefore not be viewed as a transaction designed to gain Convention exemption, and was not entered into primarily for the avoidance of tax. A ruling on this basis would not compromise National Revenue-Taxation's ability to refuse to rule favourably in other situations.
3.94 To determine whether exemption from the Convention would have been available to Petrofina's parent without the asset transfer taking place, in our opinion, it would be necessary to know the purchase price allocated to the assets in a pre-acquisition asset valuation. The absence of a pre-acquisition asset valuation would therefore preclude a ruling on this basis.
3.95 National Revenue-Taxation's ruling was not, however, made on this basis. The Department concluded that the asset transfer was within the framework of the law and that it resulted in converting immovable property to movable property. Any gain realized on the subsequent share sale was exempted from Canadian tax under the Convention, because, at the time of sale, the assets of Petrofina did not consist principally of immovable property as defined in the Convention. The Department concluded that it was obliged to rule favourably, and that the question of whether the transactions were considered to be designed primarily for improper avoidance, reduction or deferral of tax, did not arise.
3.96 At the 1979 Canadian Tax Foundation Conference, National Revenue-Taxation stated its position on a series of transactions which in our opinion have similarities to those under discussion. Although the proposed transactions were legal, and in July 1979 a favourable ruling had been given, National Revenue-Taxation stated at the Conference that it viewed them as being structured to avoid tax, and would not rule in favour of them. The Department has advised us that the thrust of the statement was a message that, in future, such a ruling would not be given, and that the law would be changed. The law was subsequently changed.
3.97 Because the criteria for issuing a favourable ruling are not limited to whether a particular transaction is within the confines of the Income Tax Act and because National Revenue-Taxation files do not contain the principles that rulings are based on, we were unable to determine whether, in this case, the parties received preferential treatment.
3.98 The basis on which the ruling was issued has, in our opinion, implications beyond the particular transaction. It accepted the position that, by a very simple transaction, immovable property can be converted to movable property. As a result, under the Canada-Belgium Income Tax Convention and other similar conventions, National Revenue-Taxation may be unable to tax gains that Parliament intended to tax. Because of this, we would have expected the Department to have obtained a legal opinion from the Department of Justice confirming that the letter of the law was not contravened. The Department did not do so.
3.99 We would also expect the Department to have advised the Minister of National Revenue that a ruling was being issued on transactions that a Crown corporation was party to, and that its basis could have a significant impact on international conventions and the revenue of Canada. The Department did not advise the Minister.
Cost Implications3.100 We believe the Government had the responsibility to inform Parliament of the total cost implications of this acquisition, including the possibility that the tax system might have been used or may be used to provide funds for the purchase of Petrofina.
3.101 We also believe that the tax system contributed funds for the purchase of Petrofina. The estimated $200 million in Canadian taxes "foregone" on the share sale, and the estimated total of $250 million in tax reduction related to the "bump-up" to Petro-Canada indicate the magnitude of the tax system's contribution.
3.102 Department of Public Works - Indirect Subsidy for Grants in Lieu of Taxes
The payment of grants in lieu of taxes by the Department of Public Works for properties administered and controlled, or occupied by Canada Post Corporation without recovery or disclosure requires clarification.3.103 In October 1981 The Canada Post Corporation took over administration and control of certain government-owned properties from the Department of Public Works. In addition, Canada Post occupies space in properties administered by Public Works. These properties have been managed by Public Works under a property management agreement entered into in August 1982. Under the terms of this agreement, Public Works has recovered operating and maintenance expenses other than grants in lieu of taxes relating to these properties from Canada Post.
3.104 The Minister of Public Works is authorized to make payments of grants in lieu of taxes on behalf of all other government departments and agencies listed in Schedule A of the Financial Administration Act and for certain properties of Crown corporations specified in Schedule I of the Municipal Grants Act, 1980. Crown corporations listed in Schedules III and IV of that Act normally pay their grants in lieu of taxes.
3.105 Canada Post is listed in both Schedules I and III of the Municipal Grants Act. In accordance with the Act, grants in lieu of taxes for properties transferred to or occupied by Canada Post have been borne by Public Works. The Department advises us that Canada Post was added to Schedule I of that Act as an interim measure to allow Public Works to legalize grant payments on properties occupied by Canada Post while it was completing the identification of the properties occupied by Canada Post; this process has now been substantially completed.
3.106 In our opinion, grants in lieu of taxes are an integral part of the operating cost of the buildings transferred to or occupied by Canada Post. Based on Public Works records, we estimate that these grants amounted to approximately $72 million for the period from 16 October 1981 to 31 March 1985. In substance, the payment of these grants by Public Works under the Municipal Grants Act constitutes an indirect subsidy to the Corporation that is not currently disclosed to Parliament by Public Works.
3.107 Further, in our opinion, the conflict between the terms of the property management agreement that require the recovery of operating and maintenance costs and the listing of Canada Post Corporation in Schedule I of the Municipal Grants Act needs to be clarified and resolved so that the payments by Public Works can either be recovered or appropriately disclosed.
3.108 Treasury Board Secretariat - Government Programs Bear Share of Public Service Superannuation Costs of Crown Corporations and other Organizations
The Government of Canada charges departmental programs an estimated amount of $34 million which pertains to Schedule C Crown corporations and other organizations that participate in the Public Service Superannuation Plan. This amount, which is included in the cost of departmental programs, is not separately disclosed in the Public Accounts of Canada and not reflected in the cost of operating these organizations.3.109 The government provides pensions to former employees who have retired from departments, certain Crown corporations and other organizations that participate in the Public Service Superannuation Plan. Dependants are also included. The government's liability in respect of its employees and those of participating Crown corporations and other organizations is reflected in the Public Accounts of Canada.
3.110 Under the terms of the Supplementary Retirement Benefits Act, annuitants' basic pensions are indexed each year to reflect increases in the Consumer Price Index. The indexed portion of the pension benefits is charged to the Supplementary Retirement Benefit Account. However, the maximum charge to this account for any individual must not exceed the amount to the credit of that individual. When the indexed portion of the pension benefits exceeds the amount to the beneficiary's credit, the excess amount is treated as a budgetary expenditure of the Government of Canada and ultimately charged to departmental programs.
3.111 Since these Schedule C Crown corporations and other organizations are excluded from the Government as an accounting entity, according to the stated accounting policies of the Government of Canada, we recommend that the excess amount of $34 million currently charged to departmental programs be separately disclosed in the Public Accounts of Canada.
3.112 It is our understanding that the funding and financing issues of the Public Service Superannuation Plan are currently under review by the Government.
Report Under Section 11 of the Auditor General Act on our Continuing Review of the Oil Pricing and Compensation Programs3.113 As directed by the Governor in Council, the Auditor General has undertaken a continuing enquiry into the administration of expenditures of the Oil Import Compensation Program, beginning with the 1973-74 fiscal year. From 1978 to 1982, the enquiry also included an audit of the Petroleum Compensation Revolving Fund. Since 1982, it has covered the administration of the revenues and expenditures of the Petroleum Compensation Accounting process, of which the Oil Import Compensation Program is now an element.
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3.114 Sections 65.11 to 65.19 of the Energy Administration Act provide authority for imposing a Petroleum Compensation Charge on domestic and foreign petroleum, including foreign petroleum products for processing, consumption, sale or other use in Canada. Proceeds from the Petroleum Compensation Charge are credited to Petroleum Compensation Accounting. Effective 1 January 1984, a designated portion of the Oil Export Charge revenue, under section 77 of the Energy Administration Act, was also credited to Petroleum Compensation Accounting. Pursuant to regulations made under sections 72 and 75 of the Act, compensation or supplement is paid to importers of foreign crude oil; to producers of new conventional oil, special old oil and synthetic oil; to producers of oil-based petrochemical feed-stocks, farmers, fishermen, loggers and mine operators to offset the impact of Petroleum Compensation Charge increases; and to companies transferring crude oil from Montreal to eastern Canada or exchanging Canadian crude for foreign crude oil.
3.115 On 28 March 1985, the Minister of Energy, Mines and Resources announced that the Government of Canada and the major energy-producing provinces of Alberta, British Columbia and Saskatchewan had agreed to deregulate crude oil prices effective 1 June 1985. As part of this deregulation, the Petroleum Compensation Charge and Oil Export Charge will no longer be imposed. All compensation and supplements - New Oil Reference Price Supplements, Special Old Oil Price Supplements, Oil Import Compensation, Synthetic Crude oil Price Supplements, Domestic Transfers Compensation, the Petroleum Levy Offset, the Primary Industries Levy Offset, and the Crude Oil Exchange Compensation - have been eliminated as well, effective 1 June 1985.
Petroleum Compensation Accounting Transactions3.116 The following is a summary of Petroleum Compensation Accounting for 1984-85, with comparative figures for 1983-84:
|(millions of dollars)|
Petroleum Compensation Charge
Oil Export Charge
New Oil Reference Price Supplement
Oil Import Compensation
Synthetic Crude Oil Price Supplement
Special Old Oil Price Supplement
Domestic Transfers Compensation
Petroleum Levy Offset
Crude Oil Exchange Program
|Deficit||$ 1,247||$ 483|
|Provided for by:
|Less: Amount lapsed||94||17|
|$ 1,247||$ 483|
3.117 The cumulative deficit of Petroleum Compensation Accounting, from its inception on 1 January 1981 to 31 March 1985, is $1,634 million.
3.118 The increase in Petroleum Compensation Charge revenues from 1983-84 to 1984-85 was the result of an increased volume subject to the charge and an increase in the Petroleum Compensation Charge rate by $17.50/m3 on 10 November 1984. The substantial increase in the Oil Export Charge from 1983-84 to 1984-85 represented receipts of this charge for 12 months in 1984-85 as compared to 1 month in 1983-84.
3.119 The rate of compensation or supplement applicable to the four major expenditure categories increased from 1983-84 to 1984-85 as a result of the increasing spread between international and Canadian oil prices. Although international crude oil prices, specified in U.S. dollars, declined during the second part of the fiscal year, the decreasing value of the Canadian dollar against the U.S. dollar more than offset this decrease, resulting in overall higher prices for international crude oil in Canada. Under the Oil Import Compensation and Synthetic Crude Oil Price Supplement Programs, increasing rates resulted in increased expenditures, although the volumes of oil for both programs were fairly stable over the two years. The volumes of oil subject to the New Oil Reference Price Program, however, increased significantly. This increase in volume, combined with increasing rates, resulted in increased expenditures.
3.120 Because new oil and special old oil after 1 July 1983 received the same rate of supplement, Alberta did not differentiate these two oil categories in its applications; thus, the payments in respect of special old oil produced in Alberta are included under New Oil Reference Price Program Expenditures. The crude oil volume eligible for the Special Old Oil Price Supplement decreased, but the increased supplement rate more than offset the impact of this decrease in volume and resulted in an overall increase in expenditures.
3.121 Compensation paid to the producers of oil-based petrochemical feed-stock has been charged to Petroleum Compensation Accounting. Compensation to the primary industries (fishermen, farmers, loggers and mine operators) is administered by Revenue Canada Customs and Excise. No claims were submitted by Revenue Canada during the year.
3.122 The slight increase in the level of expenditures under the Domestic Transfers Compensation Program was the result of increased movement of crude oil. The substantial increase in expenditures for the Crude Oil Exchange Compensation Program, however, was the result of a significant increase in the crude volume exchanged, and some crude exchanges made in 1983-84 were settled in 1984-85.
Audit Scope and Conclusion3.123 We have examined the revenue and expenditure transactions of the Petroleum Compensation Accounting process, including compliance with Part III.1 and Part IV of the Energy Administration Act, and regulations made by the Governor in Council pursuant to the Act for the year ended 31 March 1985. Our examination was made in accordance with generally accepted auditing standards, and accordingly included such tests and other procedures as we considered necessary in the circumstances, except as explained in the following section on program administration audits.
3.124 In our opinion, except for any significant differences that may be identified as a result of subsequent program administration audits, revenue and expenditure transactions of the Petroleum Compensation Accounting process for the year ended 31 March 1985 have been properly processed within the accounts of Canada and these transactions have, in all significant respects, been in accordance with the authorities specified, applied on a basis consistent with that of the preceding year.
Audit Observations3.125 Program administration audits. Audits of revenue from the Petroleum Compensation Charge are performed by staff of the Department of National Revenue - Customs and Excise and those of the designated portion of the Oil Export Charge by the National Energy Board.
3.126 The New Oil Reference Price and Special Old Oil Price Supplement Programs are administered in co-operation with the governments of the producing provinces, in accordance with memoranda of agreement. The Department of Energy, Mines and Resources has access to provincial records for the purpose of audit, except in Alberta, where the Department does not audit directly, but relies on an audit by the Auditor General of Alberta. Staff from the Department of Energy, Mines and Resources have completed audits in respect of all producing provinces, except Alberta and Ontario, up to 30 November 1984. For Ontario, departmental staff have completed an audit up to 30 June 1983. The most recent audit report issued by the Auditor General of Alberta covers the year ended 31 December 1983.
3.127 That report cites two areas in which Alberta has not complied with the Memorandum of Agreement with Canada. Federal and provincial government officials are currently estimating the quantitative impact of this situation and will together agree on what action, if any, is required for its resolution. Initial federal government estimates indicate that the quantitative impact may not be significant in relation to the total expenditures under the New Oil Reference Price and Special Old Oil Price Supplement Programs.
3.128 Audits of companies that have received payments under the remaining compensation programs are performed either by independent auditors on behalf of the Department of Energy, Mines and Resources or by departmental staff. Audits relating to payments made in 1983-84 are partially complete; audits of payments made in 1984-85 have not yet begun. In view of the fact that the program would terminate on 1 June 1985, the Department of Energy, Mines and Resources elected to delay further audit activity until payments in respect of the period to 31 May 1985 could be completed. After that time, audits will be done for all payment periods to 31 May 1985 that have not been examined. It is expected that this approach will allow for all remaining audits to be performed in the most cost-effective manner.
3.129 At 30 June 1985, audits covering $310 million of the $3,455 million paid in 1984-85 (9 per cent) and $1,444 million of the $2,233 paid in 1983-84 (65 per cent) have been completed. In respect of particular programs, the proportion of payments audited ranges from 0 to 15 per cent for 1984-85 and 0 to 80 per cent for 1983-84, with more of the audit activity concentrated in programs having higher expenditures.
3.130 Unpaid levies. As of 31 March 1985, a total of $45.2 million in unpaid levies was owed to the Crown. As of 31 July 1985, this had increased to $76.9 million, and agreement had been reached with two levy payers to pay outstanding balances amounting to $23.2 million over the next seven years.
IMPAC Evaluation Study3.131 During the Public Accounts Committee hearings on our 1981 Report chapter on the government initiative for improved management practices and controls (IMPAC) program, the Comptroller General announced that his Office would conduct a formal evaluation of the program in 1984.
3.132 The evaluation process was begun in the spring of 1984, and the program evaluation report was submitted to the Comptroller General in August 1985. An evaluation Steering Committee, made up of senior government officials, including one from the Office of the Comptroller General, was appointed to manage the evaluation process. The evaluation was conducted by a consulting firm.
3.133 The evaluation consisted of an analysis of the Office of the Comptroller General's data base on IMPAC projects and interviews with a sample of departmental and central agency managers.
3.134 Because the report has only recently been made available, we have not had time to audit the study for this year's annual Report. However, the work will be completed in time for Public Accounts Committee hearings early in the new year.