1987 Report of the Auditor General of Canada
Chapter 3—Audit Notes
3.1 This chapter contains matters of significance that we believe should be drawn to the attention of the House of Commons. They 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.
3.2 Section 7(2) of the Auditor General Act requires the Auditor General to call Parliament's attention to any significant cases where he has observed that:
(a) accounts have not been faithfully and properly maintained or public money has not been fully accounted for or paid, where so required by law, into the Consolidated Revenue Fund;
(b) essential records have not been maintained or the rules and procedures applied have been insufficient to safeguard and control public property, to secure an effective check on the assessment, collection and proper allocation of the revenue and to ensure that expenditures have been made only as authorized;
(c) money has been expended other than for purposes for which it was appropriated by Parliament;
(d) money has been expended without due regard to economy or efficiency; or
(e) satisfactory procedures have not been established to measure and report the effectiveness of programs, where such procedures could appropriately and reasonably be implemented.
3.3 Each of the matters of significance reported in this chapter was examined in accordance with generally accepted auditing standards, and accordingly our examinations included such tests and other procedures as we considered necessary in the circumstances. The matters reported should not be used as a basis for drawing conclusions about matters not examined. The instances that we have observed are described in this chapter under the appropriate department, Crown corporation or other entity heading.
3.4 This year our report under section 11 of the Auditor General Act on the Oil Pricing Compensation Programs is not included in the annual Report. The programs were eliminated effective 1 June 1985 and during the fiscal year 1986-87 transactions totalled less than $10 million in revenue and $7 million in expenditures. As usual our audit report will be transmitted under separate cover to the Governor in Council.
Observations on Crown Corporations3.5 The Auditor General is appointed auditor of 44 Crown corporations, under the Financial Administration Act or individual Acts incorporating specific corporations. Details of significant reservations and other matters contained in reports issued to these corporations during the year are set out below. Most of these matters have already been raised in a public forum, but they are reported here for emphasis and for consideration by Parliament.
3.6 Canadian Broadcasting Corporation - Successful recovery program led to revision to the 31 March 1986 auditor's report
During 1985-86, a number of serious difficulties were experienced in implementing phase one of the National Finance System (NFS) and in maintaining proper books of account during the transition period. In our 1986 annual Report, we commented on these problems and recommended to the Corporation that, because public funds were at risk and several months had elapsed into the current fiscal year, these problems should be corrected immediately.3.7 In August 1986, the Corporation announced the establishment of a senior level Task Force to develop an action plan to examine and address these critical matters. In November 1986, the Task Force recommended an action plan which was adopted by the Corporation. During the year ended 31 March 1987, the Corporation took steps to overcome the effects of the implementation and design problems of the initial phase of the NFS. As a result, the Corporation succeeded in stabilizing the existing components of the NFS, in restating its financial statements for the year ended 31 March 1986, and in re-establishing proper books of account by 31 March 1987.
3.8 In our 1987 report to the Canadian Broadcasting Corporation and the Minister of Communications, we revised the auditor's report for the year ended 31 March 1986 to state that except for the effect of adjustments, if any, regarding the classification of expense amounts on the restated Statement of Income and Expense and Reconciliation to Government Funding Basis, the restated financial statements present fairly the financial position of the Corporation as at 31 March 1986. And we rendered an unqualified audit opinion on the 1987 financial statements.
3.9 National Museums of Canada - Overexpended appropriation, Department of Communications - Vote 70
For the fiscal year ended 31 March 1987, the Corporation's operating expenditures exceeded the parliamentary appropriation by $1,373,000. This situation is mainly attributable to the acquisition of all the assets from the Canada Pavilion at Expo 86 for use in the fit-up of its new museums facilities. These items, which, according to management, have an estimated market value of $4 million, were purchased at a cost of $2 million under a contractual agreement signed in August 1986.3.10 In August 1986, the National Museums of Canada entered into an agreement with another Crown corporation, to purchase the assets of the Canada Pavilion at Expo 86 for an all-inclusive price of $2 million. These assets, valued at $4 million by management, consisted mainly of audio-visual equipment, display materials and office furniture and equipment for use in fitting up its new museum facilities. This transaction was the main reason why the Corporation's operating expenditures exceeded its parliamentary appropriation by $1,373,000.
3.11 Our audit report on the financial statements of the National Museums of Canada for the year ended 31 March 1987 disclosed that the Corporation exceeded its parliamentary appropriation for operations. This is contrary to the provisions of the Financial Administration Act.
Observations on Departmental Operations3.12 Department of Agriculture - Lack of compliance with authorities by the Agricultural Products Board
The Agricultural Products Board is delivering a program through administrative arrangements that do not comply with the Financial Administration Act and the Agricultural Products Board Act. For this reason, we expressed an adverse opinion on the Board's compliance with authorities in connection with our examination of the Board's financial statements for the year ended 31 March 1987.3.13 The Board purchases and sells various agriculture commodities in order to stabilize their prices. In doing so, the Board may incur losses that are financed by moneys appropriated by Parliament. For the past three years, approximately 77 per cent of the Board's losses have resulted from the purchase and resale of Ontario grapes and grape products. Losses on these products have amounted to $11.2 million over three years, after $5.5 million contributed by the Province of Ontario.
3.14 As part of the Surplus 1986 Ontario Grapes Program, the Board entered into administrative arrangements that, in our opinion, were not in accordance with section 5 of the Agricultural Products Board Act. A bank account was established outside the Consolidated Revenue Fund. This account has been administered in trust by an agent and all public moneys associated with the Board's Surplus 1986 Grape Program have been deposited and disbursed through this account. The Board is not authorized to operate a program in this manner. As a result, $1 million of public moneys from the sale of grape products was not deposited to the Consolidated Revenue Fund, and program expenditures were not all paid from moneys appropriated by Parliament as required by the Board's Act. The use of these revenues to pay Board expenditures is not within the Board's authority. This was undertaken because of a budget shortfall originally estimated at $1.1 million.
3.15 In addition, the Board has incurred losses to 31 March 1987 of $2.8 million in excess of the maximum amount authorized by Governor in Council in respect of the Surplus 1984 Ontario Grapes Program. At the time of our audit, the Board had yet to obtain approval for this additional loss. Subsequently, authority was received for additional losses, bringing the total authorized loss to $5.85 million.
3.16 Department of Agriculture - Appropriation exceeded
Parliamentary appropriation to Agriculture Canada in respect of the Canadian Forestry Service Program for the fiscal year ended 31 March 1987 was, in substance, exceeded by $2.9 million. This resulted from a lack of financial control over certain contribution expenditures of the Canadian Forestry Service.3.17 As of 30 November 1986, expenditures of up to $17.6 million had been committed by the Forestry Service for payments under the Canada Ontario Forest Resource Development Agreement. Although this exceeded the authorized budget for 1986-87 by $6.1 million, management anticipated that all of the $17.6 million would likely not be spent by March 1987. Therefore, no forecast was prepared to determine whether funds would be available within Vote 30. Section 25(1) of the Financial Administration Act requires the Department to ensure that unencumbered funds are available for all expenditures.
3.18 Vote 30 has been reported to Parliament as having been exceeded by $1.3 million. However, this amount does not include unrecorded claims of $1.6 million applicable to the 1986-87 fiscal year, but which were received after the processing date. In our view, the parliamentary appropriation has, in substance, been exceeded by a total of $2.9 million.
3.19 Department of Agriculture - Failure to deposit public moneys in the Consolidated Revenue Fund and unauthorized use of public moneys
The Forest Pest Management Institute of the Canadian Forestry Service has conducted research with the financial support of private sector chemical companies. The Institute arranged to have funds sent from these chemical companies to personnel service agencies, which administered the funds as directed by the Institute. This bypassed normal financial controls and the authority of Parliament, since what should have been public moneys were not deposited to the Consolidated Revenue Fund as required by the Financial Administration Act. Additional amounts were properly deposited but were used for purposes not specifically authorized.3.20 Since 1981, chemical companies have paid a total of $738,198 for the cost of the Institute's testing of forest pest control products that were being developed by the chemical companies. The Institute arranged for the payment in two ways: a total of $437,765 was paid to personnel service agencies, and $300,433 was deposited direct to the Consolidated Revenue Fund.
3.21 Amounts sent by the chemical companies direct to personnel service agencies were subsequently spent by the agencies as directed by the Institute. In our view, these were public moneys which should have been deposited in the Consolidated Revenue Fund in accordance with the requirements of the Financial Administration Act. The money received by the personnel service agencies from the chemical companies was used to pay for staff salaries and other research costs incurred by the Institute. In normal circumstances, such costs would be charged to the Institute's budget. The agencies were compensated for their administrative services from the funds held by them.
3.22 Amounts received by the Institute were deposited in the Consolidated Revenue Fund to the credit of a specified purpose account. This provided additional funds to pay for Forestry Service operating costs, thus supplementing the operating budgets.
3.23 The Internal Audit Division of the Department of Agriculture reported that no authority or policy could be found for the use of external funding of research conducted by the Institute. Management responded by terminating the use of personnel service agencies. All moneys provided by chemical companies are now deposited in the Consolidated Revenue Fund. The Department is now taking steps to obtain the appropriate authorities.
3.24 Department of Communications - Inadequate control over contribution payment
On 23 February 1987, the Department of Communications approved a payment of $250,500 as part of a renovation and expansion project for a cultural centre. At the time the payment was approved, the Department was aware that the project differed substantially from what had been approved.3.25 In March 1985, the Department of Communications obtained Treasury Board approval under the Special Program of Cultural Initiatives to make a contribution of $870,000 to pay 50 per cent of the cost of a $1,740,000 project to renovate and expand the centre's facilities. The largest single component of the project was the construction of a fine arts school which was to comprise 40 per cent or $704,000 of the total estimated project costs. On 3 February 1987, as the result of a site visit, the Department became aware that the expenditures on the project were estimated to reach the full amount, without construction of the school.
3.26 All the funds had been spent on items such as theatre equipment, offices and general building renovations. Although it was aware that the expenditures by the centre on the project differed substantially from what had been approved, the Department paid the full amount of the contribution less the standard 10 per cent holdback. In our view, when it became aware that there had not been any expenditures for construction of the school, the Department should have reduced its assistance by $352,000 or 50 per cent of the estimated costs of the school, or else sought specific approval to proceed with a substantially different project, prior to making the payment of $250,500.
3.27 Canada Employment and Immigration Commission - Overcharge in the government's share of the cost of paying benefits - Unemployment Insurance Account
The methods used to administer claimants' records of employment by Employment and Immigration Canada resulted, for a number of years, in an overcharge to the government for its share of the cost of paying benefits and in a corresponding understatement of the share funded by employer and employee premiums. As a result, the cumulative deficit in the Unemployment Insurance Account was understated for those years.3.28 Our opinion on the financial statements of the Unemployment Insurance Account for the year ended 31 December 1985 was qualified because we were unable to satisfy ourselves as to the validity of the amount of overcharge in the government's share of the cost of paying benefits. It should be noted that the total benefits paid to claimants are not affected.
3.29 This situation has arisen because the methods used to determine benefits entitlement did not include a procedure to verify all records of employment for the qualifying period. This resulted in benefits being paid from the Regionally Extended Benefits Phase of the Unemployment Insurance program that is fully funded by the federal government, rather than from the other two phases that are funded by the employers and the employees.
3.30 In 1987, the Commission estimated the amount overcharged to the Crown at $73 million for 1985 and $70 million for 1986. The estimate for prior years is unavailable because of the cost and difficulty of obtaining the necessary information. The Crown has been reimbursed from the Unemployment Insurance Account for the 1985 and 1986 overcharges, and the financial statements of the Unemployment Insurance Account have been restated accordingly.
3.31 Subsequent to our audit the Commission took steps to correct this situation in 1987. It has issued a revised application form for Unemployment Insurance benefits requesting applicants to submit all records of employment dealing with their qualifying period. In addition, the Commission is taking measures to ensure that the records of employment filed with it are easily accessible so that it can ensure that a claim has been properly and accurately established. This should enable the Commission to determine accurately the cost of benefits to be charged to the Crown. However, close monitoring will be required to ensure that no overcharge to the government's cost of paying benefits exists for 1987 and future years.
3.32 Department of the Environment - Failure to provide Treasury Board with complete and accurate information
In 1983 Parks Canada requested Treasury Board to approve certain lease amendments in two national parks. This, the Department stated, would result in foregone revenue in excess of $2 million over the remainder of the decade. However, the Department had determined that a low estimate of the foregone revenue would be approximately $11 million and an estimate capable of withstanding scrutiny would be approximately $17 million. Furthermore, when Treasury Board questioned the $2 million, Parks Canada provided the Board with an estimate of $4.3 million. The decision to amend the leases was therefore made without complete and accurate information.3.33 The Crown owns substantially all the land within the boundaries of the national parks. Within the parks, there are seven townsites; the two largest are Banff and Jasper. Land in these townsites is leased primarily to two groups of users - residential and commercial.
3.34 For the commercial users, the National Parks Lease and License of Occupation Regulations contain various methods of determining lease payments. In 1982, two methods predominated - one based on gross revenues and the other based on appraised land values. From the early 1970s to 1982, all new leases had their rents set using the percentage of gross revenues, which Parks Canada believed to be more consistent with practices followed in the private sector outside national parks.
3.35 In 1982, many hotels with lease payments based on gross revenues were making substantially higher lease payments than similar hotels with lease payments based on appraised land values. The owners of one particular hotel believed that they were being treated unfairly and requested that the government allow them to change the basis of payment.
3.36 In 1983, Parks Canada undertook a study to determine whether or not inequities existed and to initiate appropriate corrective action. The study identified significant inequities and, in July 1983, Treasury Board was asked to approve amendments to the leases to change the basis of the lease payments to the appraised land value method. Parks Canada advised Treasury Board that the downward adjustment of rents caused by this change would mean that the Crown would forgo in excess of $2 million of anticipated revenue over the remainder of the decade. In October 1983, Treasury Board approved the request and the amending regulations were approved shortly thereafter.
3.37 For a number of reasons, the $2 million figure was much lower than the amount identified by Parks Canada. For example, it had been based on 1981 revenues from room rentals alone (that is, excluding revenues from food, beverages, etc.) and provided no allowance for increases due to inflation or real economic growth. In addition, the list of hotels used in the analysis excluded three properties, all of which are now paying a significantly lower rent. In one case, the rent was reduced from a guaranteed minimum of $90,000 per year (as established by tender in 1980) to an average of approximately $17,000 per year. An internal departmental memorandum indicates that Parks Canada had determined that, when some of those factors were taken into account, a low estimate would be $11 million, and an estimate capable of withstanding scrutiny would be in the neighborhood of $17 million.
3.38 Treasury Board questioned the $2 million figure and, in response, Parks Canada prepared an analysis showing the foregone revenue to be approximately $4.3 million. Although higher, this figure contained many of the same deficiencies as the $2 million figure.
3.39 The working papers supporting the $11 million and the $17 million have been misplaced by the Department. We have been informed, though, that they were detailed and that certain key inflation and economic growth parameters incorporated in them had been derived from discussions with Treasury Board personnel. Our own calculations indicate that an amount of $11 million can be supported using the conservative estimates of inflation and real economic growth contained in other departmental working papers.
3.40 Department of the Environment - Failure to comply with Cabinet directions, and poor control over expenditure
In April 1986 Cabinet approved the Department's proposal for increased funding for Environment Week 1986. We found that the Department did not implement the advertising campaign that had been approved and did not seek Treasury Board approval until after the expenditure had been incurred. In addition, the Department did not have sufficient information to ensure that the advertising firm complied with the terms of its contract, resulting in a potential overpayment by the Department.3.41 In 1985-86, the Department of the Environment proposed to Cabinet that funds for Environment Week 1986, an annual event sponsored by the Department to highlight environmental concerns, be increased from a budgeted $35,000 to $1 million in order that it could become a major public event.
3.42 In reviewing the Environment Week expenditures we noted the following:
3.43 Project authorization and implementation. On 16 April 1986, just six weeks prior to Environment Week, Cabinet approved the Department's proposal. Cabinet authorized $650,000 for advertising - $550,000 for media placements and $100,000 for fees to the Department of Supply and Services and/or an advertising agency. A further $350,000 was budgeted for administering, producing and evaluating the event.
3.44 Rather than implement the advertising campaign that had been approved, the Department implemented a campaign submitted by an advertising firm on 28 April 1986. This campaign included a new promotion strategy that involved a musical video, a record, and hot air balloons. On 29 April 1986 a contract for $650,000 - the entire advertising budget - was signed with the advertising firm.
3.45 In early July 1986, the Department requested Treasury Board to include funding for this program in Supplementary Estimates. Approval was granted on 23 July 1986, approximately one and one-half months after Environment Week. Treasury Board noted that approval had been sought after the expenditure had been incurred, and expressed reservations about the value of the program. Treasury Board made it clear that its retroactive approval of the $1 million should not be viewed as an endorsement of the program or the actual activities carried out in support of it.
3.46 Contract compliance. We have serious concerns regarding the $650,000 contract with the advertising firm. The contract contained the following components:
|Video and record||$370,000|
|Hot air balloons||80,000|
|Commissions on the above||73,000|
3.47 The contract allowed the advertising firm to be reimbursed for actual expenditures reasonably and properly made to acquire goods and services from outside suppliers at the suppliers' price, plus 17.65 per cent commission on some expenditures to cover overhead and profit. Copies of the suppliers' invoices and other supporting documentation were to be submitted to the Department.
3.48 The advertising firm subcontracted the entire project to two corporations, with both receiving fixed-price contracts for the full $577,000. This negated the "cost plus" nature of the main contract, and ensured that the Department would be billed the full $650,000. There was nothing in the main contract that prevented this from occurring.
3.49 For example, $80,000 plus commissions of $14,120 were budgeted for hot air balloon events. Because of safety concerns, five of the six events were cancelled. The subcontract, though, permitted the subcontractor to bill the entire $80,000 even in circumstances such as these. Accordingly, the subcontractor billed the advertising firm $80,000, and the advertising firm in turn billed the Department $80,000 plus $14,120 in commissions.
3.50 We also found that the Department did not have sufficient information to ensure that the advertising firm complied with the terms of the contract. For example, the Department paid $370,000 to the advertising firm for the video and record without ensuring that the full amount had been paid to the subcontractor. Our audit evidence indicates that approximately $70,000 of the $370,000 was never paid to the subcontractor. Of the $70,000, approximately $40,000 related to the production of 50,000 records, and the Department had not ensured that all 50,000 records had, in fact, been produced. Also, it did not question whether it should have made any payments at all with respect to the records, even if they had been produced.
3.51 Distribution of profits. All profits arising from the sales of the record and video were to go to a non-profit corporation, the Canadian Artist Foundation for the Environment Ltd. (CAFFE). This corporation, directly under the control of the performing artists themselves, was to distribute funds to various deserving national Canadian environmental groups and agencies.
3.52 In July 1986, the letters patent of the Corporation were amended to allow the Minister to appoint a member to CAFFE's Board of Directors. Discussions with the member indicated that he was not aware if any Board meetings had taken place, and was not aware of the financial position of CAFFE or the source and disposition of its funds. At the time of our audit, the Department did not have any pertinent financial information on CAFFE. The disposition of the sales proceeds in excess of manufacturing costs, if any, and the disposition of related royalties, has yet to be determined.
3.53 Department of External Affairs - Premature delivery of a computer system, to avoid lapsing funds at year end, and delays in renovations by Public Works Canada
In January 1986 the Department of External Affairs contracted for the purchase of a computer at a cost of $1.3 million for processing import permits. However, because the site could not be ready until August, the delivery at year end was made in advance of need, in order to avoid lapsing funds. This resulted in an opportunity cost of $50,000. Further delays occurred in preparing the site, delaying implementation an additional six months and resulting in foregone savings of $725,000.3.54 In October 1985, External Affairs obtained Treasury Board approval to spend $1.3 million to implement a computer system to issue import permits. The Department originally estimated savings of $80,000 per month from this acquisition; the monthly saving realized once the computer was operational was $145,000.
3.55 Public Works Canada was contacted on 25 February 1986 to make architectural, mechanical and electrical renovations to a building to accommodate the new computer. External Affairs assumed that this construction work would be finished by 1 August 1986 and that the system would be operational by 1 October 1986. This would allow termination of a service bureau contract by 30 October 1986. Public Works Canada determined that these targets could not be met and, in consultation with External Affairs, produced a revised target occupancy date of 27 August 1986.
3.56 These targets were not met. The computer room construction was not finalized until 24 September 1986, the system was not operational until 27 January 1987 and service bureau processing was not ended until 20 March 1987 -almost five months behind schedule. This delay increased operating costs by $725,000 over budgetary projections.
3.57 The Department was concerned that if the purchase was not completed before the end of the fiscal year 1985-86, the project might be indefinitely postponed. Funds were available in 1985-86 but future year funding was planned for other projects. Thus payment by year end became a prime consideration because otherwise funds would lapse.
3.58 Planning for the computer acquisition did not follow appropriate procedures to ensure due regard to economy. A clause was put into the contract requiring the supplier to have the system available for shipment by 31 March 1986. The supplier met this commitment. However, because the computer room was not ready, a departmental representative acknowledged acceptance on March 31st at the supplier's premises and left the computer stored there until mid-September when space was finally available. Also, the supplier's bill was paid in 12 days rather than the 30 days called for in the contract. The full amount was remitted even though installation and testing had not been completed.
3.59 The impact of these decisions was that an asset costing $996,000 sat idle and provided no benefit whatever for almost six months. Assuming 10 per cent financing, this cost the Government of Canada almost $50,000 in imputed borrowing costs.
3.60 One reason for not realizing the Department's expectations and for incurring the extra expense was that the Department did not involve Public Works Canada at a sufficiently early stage to set a realistic delivery date. External Affairs initially contacted Public Works Canada on 25 February 1986 - a month after the Letter of Intent was sent to the supplier and two days before the contract was signed. Public Works Canada claims that its late involvement made it impossible to attain the August 1st scheduled completion set by External Affairs.
3.61 Contracted work was not performed by DPW to External Affairs' satisfaction. Time commitments were not met, and a relatively small project costing less than $125,000 took seven months to complete. Serious air conditioning problems arose that delayed the system's start-up and interfered with processing. Public Works Canada assisted in resolving difficulties but only after numerous petitions from External Affairs and after considerable time was lost.
3.62 Department of Finance and Canada Deposit Insurance Corporation - Possible tax avoidance
The transaction that resulted in the Canada Deposit Insurance Corporation paying $200 million to facilitate the sale of the Bank of British Columbia was structured in way that could be regarded as an attempt to avoid income taxes.3.63 During our audit of the 31 December 1986 financial statements of the Canada Deposit Insurance Corporation, we examined the $200 million payment made by the Corporation to facilitate the sale of the Bank of British Columbia to the Hongkong Bank of Canada.
3.64 The House of Commons was informed that there would be no impact on the Government deficit arising out of the $200 million payment, and that the money was to provide a capital provision of $200 million for the Hongkong Bank of Canada to use as a source of capital, as a provision against future loan losses and as a capital base. Under the Income Tax Act, assistance provided by the Canada Deposit Insurance Corporation to the Hongkong Bank of Canada would be subject to Canadian income taxes.
3.65 For the transaction to take place without any impact on the deficit, the receipt of the $200 million by the Hongkong Bank of Canada would have to be subject to Canadian income taxes, and the Canada Deposit Insurance Corporation's $200 million cost would have to ultimately be borne by its member institutions through tax deductible premium payments.
3.66 The agreements, however, were structured so that the $200 million was paid by the Canada Deposit Insurance Corporation to the Hongkong Bank of Canada's parent in Nassau. The agreements also required the Hongkong Bank of Canada's parent to provide it with a capital reserve of $200 million. The $200 million made a circle - it went from the Canada Deposit Insurance Corporation in Canada to an account of the Hongkong Bank of Canada's parent in Nassau and found its way back to the Hongkong Bank of Canada in Canada.
3.67 We asked officials of the Department of Finance if the $200 million would now be subject to Canadian income taxes. Although officials of the Department of Finance were involved in negotiating the transaction, they advised us that the $200 million may or may not be taxable and that was a matter for Revenue Canada, Taxation to determine (see Exhibits 3.1 and 3.2).
Exhibits not available
3.68 If the transaction was not taxable, using a 50 per cent rate for federal and provincial income taxes, the $200 million cost would ultimately be shared equally by federal and provincial governments and the Canada Deposit Insurance Corporation's member institutions and it would have an impact on the deficit. We therefore undertook a detailed analysis of the income tax implications of the transaction.
3.69 We concluded that one of the main reasons for having the $200 million payment made off-shore was to attempt to avoid subjecting it to Canadian income taxes. In our opinion, and in the opinion of legal counsel, the structuring should prove to be unsuccessful in avoiding taxes.
3.70 We recognize that all corporations and individuals are entitled to minimize their taxes within the limits of Canadian tax law. We are concerned, however, that officials of federal government departments and a Crown corporation were involved in a transaction that could be regarded as an attempt to avoid income taxes. This could seriously undermine the integrity of the income tax system.
3.71 Department of Public Works - Amounts not recovered from Canada Post Corporation
Department of Public Works records indicate that a substantial receivable is outstanding from Canada Post for costs and fees relating to the operating costs of buildings and to tenant services with respect to properties under the administration and control of, or occupied by, Canada Post. At 30 June 1987, over $30 million recorded as receivables from the Corporation were in dispute and had been outstanding for over a year.3.72 Since 1982, Canada Post has engaged Public Works Canada as real property manager and service agent under an agreement.
3.73 Despite lengthy negotiations, Public Works and Canada Post have not been able to agree on the application of certain clauses described in general terms in the agreement. These clauses relate to the establishment of a weighted occupancy factor in allocating operating costs of buildings, the cost of employer's share of contribution to employee benefit plan for departmental employees working in the Canada Post facilities, and fees and costs charged for tenant services.
3.74 The agreement states that the Corporation will remit to Public Works a monthly payment for operating costs of buildings based on an annual cash budget, with adjustments to actual figures every six months. However, recently the two parties have not been able to agree on an annual work plan that would be the basis for developing the budget referred to in the agreement.
3.75 In May 1986, the two parties agreed to settle the 1985-86 operating costs of buildings at $125 million. This agreement was reached due to the lateness of the Public Works billing information. However, there is now a disagreement over what costs were included in this settlement since Public Works, because of problems with its billing system, manually billed Canada Post an additional $13 million that was not included in the normal billing process.
3.76 At 30 June 1987, $30 million recorded as receivables from the Corporation were in dispute and had been outstanding for over a year.
3.77 In addition, according to the agreement, rental revenue collected by Public Works on behalf of Canada Post will be passed to the Corporation. To date, approximately $1 million of this revenue has been held back by Public Works.
3.78 In April 1987 Canada Post drafted a proposed settlement, and negotiations between the two parties to resolve these outstanding amounts are continuing. However, if the amounts in dispute cannot be resolved in a mutually acceptable manner, the matter should be referred to the appropriate policy committee of Cabinet for a decision as provided for in the agreement.
3.79 Department of Regional Industrial Expansion - Overexpended Appropriation
In 1986-87, DRIE's authorized expenditures for grants and contributions under Vote 10 were set at $789,009,000 in the Main Estimates. This was increased by $10,000,001 through Supplementary Estimates to $799,009,001. At the end of the fiscal year, DRIE reported a total appropriation utilization of $878,782,237. This was $79,773,236 more than the amount authorized.3.80 The funds used by DRIE in 1986-87 were made up of cash outlays and amounts charged to 1986-87 under the Payable at Year End (PAYE) policy. In 1986-87, DRIE's actual cash expenditures were $777.6 million, and PAYE items were recorded as $101.2 million, for a use of appropriation totalling $878.8 million.
3.81 Under the PAYE policy, unpaid debts owing in respect of obligations incurred prior to the end of a fiscal year are recorded as expenditures against the appropriation for that fiscal year. This permits Parliament to get a picture of the total use of an appropriation that is more accurate than if only actual cash outlays were recorded. If a department does not have enough funds left in its appropriation to pay amounts owed as a result of PAYE items, the actual payment of the debt must be made from the next fiscal year's appropriation. This means that a department's available budget in the second year is reduced by the amount of the first year's over-utilization.
3.82 Forecasting the amount of likely expenditures in a particular fiscal year is difficult for large grants and contribution programs. Many projects involve multi-year commitments, and the timing of the flow of funds can depend on the actions of others that must incur costs and then seek reimbursement from DRIE according to whatever cost-sharing arrangement is in effect.
3.83 By late May 1986, DRIE was aware that the proposed regional and headquarters budgets for grants and contributions were more than the funds available. One of the reasons that DRIE did not react to the early indication of over-expenditure was that over the past few years, DRIE had lapsed funds. In 1985-86, DRIE's lapse was $219.4 million. As a result, DRIE's internal practice was to discount staff expenditure forecasts and assume that funds would turn out to be available at year end.
3.84 The environment changed in 1986-87. As part of general fiscal restraint, DRIE's authorized budget was lower than the previous year, and DRIE had agreed to a further reduction of $45 million as part of the special $500 million reduction in spending for 1986-87. Yet DRIE continued to approve new projects without adequate recognition of its existing commitments and the impact of its lower budget. Our analysis indicates that $121.8 million of DRIE's expenditures related to projects that were approved in 1986-87.
3.85 Department of Transport - Failure to establish the financial controls necessary to protect a $16.7 million financial interest of the Crown
The Department of Transport surrendered options with the two national railways to purchase, for $1.00, equipment valued at $37 million, without ensuring that the financial interests of the Crown were protected. The Department did not determine the market value of the equipment or perform an appropriate analysis of its options. In the case of Canadian Pacific Railway, it did not obtain a commitment covering the work to be done in exchange for the surrender of its option, valued at $16.7 million. In addition, the Department did not include an audit clause in the agreements or make progress reports to Treasury Board as required.3.86 The Prairie Branch Line Rehabilitation Program is a $1,072 million 12-year project that began in 1977. From 1977 to 1983, four agreements were entered into by the Department of Transport with both of Canada's national railways under which the Crown financed the acquisition of equipment costing approximately $60 million that was to remain in the name of the railways. The agreements included an option for the Crown to acquire this equipment from each railway for $1.00 at the end of these agreements.
3.87 In subsequent agreements the Department agreed to value the equipment at $37.3 million but also agreed not to exercise the options to acquire the equipment for $1.00 in return for work to be performed by the railways. These fixed price agreements were signed in 1984 after obtaining Treasury Board approval. We have several concerns with the new arrangements arising from the revised agreements.
3.88 Valuation of equipment. In determining the proper consideration for the equipment, the Department did not conduct an appraisal to obtain fair market values, but agreed to value the equipment at the net book value of $37.3 million. An appraisal would have provided a better picture of the full consideration the railways were to receive under the agreements.
3.89 Agreements. The annual work schedules prepared under the agreement with Canadian National Railways disclose the cash cost to the Crown of each project and the value of work to be performed in lieu of the equipment surrendered. However, as Exhibit 3.3 indicates, the annual work schedules and the agreement with Canadian Pacific Railway include no provision for any work to be done in exchange for the equipment surrendered. The Department has not provided us with a valid explanation for this significant omission in the Canadian Pacific agreement.
Exhibit not available
3.90 Financial controls. We noted that, contrary to the Treasury Board requirements for contribution agreements, no audit clause was included in the new agreements. We also noted that adjustments made as a result of audits under the previous four agreements resulted in recoveries of $14 million from both railways. In our opinion, such audit provisions would have provided useful compensating controls to assist the Department to monitor the railways' compliance with the agreements and to ensure the Department will receive full value from the railways. In addition, contrary to Treasury Board requirements, to date the Department has not submitted progress reports on this major Crown project to Treasury Board. Also, because of the non-cash nature of the $37.3 million consideration provided to the railways when the Department surrendered its $1.00 equipment purchase options, the real cost of the program from 1984 onwards has not been disclosed to Parliament in the Estimates.
3.91 These financial controls and reports are particularly important because subsequent to the signing of the agreements in 1984, many changes have been made to the annual work schedules in the agreements as a result of delays, postponements, changes and cancellations of projects, approval of new projects, and reprofiling as a result of budgetary constraints.
3.92 Overall, we concluded that in the absence of these financial controls, there is no assurance that the Crown has received full value for surrendering its $1.00 option to acquire equipment from CP Rail that has an agreed value of $16.7 million.
3.93 The Department states that it has attempted to ensure that fair and reasonable value is obtained from the railways and that it will pursue the issue of monitoring the equipment credit over the balance of the contract. All future contribution agreements will contain an appropriate audit clause in accordance with Treasury Board requirements, and from now on progress reports on this major Crown project will be submitted.