1989 Report of the Auditor General of Canada
Chapter 14—Department of Finance—Tax Collection Agreements
The tax collection agreements are not up to date, and some tax measures are being administered without proper authority
Reporting to the provinces is in accordance with the agreements and payments are made on a timely basis
14.1 Under the tax collection agreements, the federal government collects individual income taxes on behalf of all provinces and territories except Quebec and corporate income taxes for all provinces and territories except Quebec, Ontario and Alberta. Taxes collected on behalf of the provinces and territories for 1987-88 were about $20 billion (paragraphs 14.7, 14.10, 14.25).
14.2 The government's accountability to Parliament for the policy framework for, and administration of, the tax collection agreements should be improved; little useful information is currently provided to Parliament. Reporting to the provinces is generally in accordance with the agreements (14.24 to 14.32, 14.40).
14.3 The agreements have not been kept up to date. Also, the flat rate taxes administered by the federal government on behalf of three provinces contravene a specific provision of the agreements (14.33 to 14.39).
14.4 The methodology used by the Department of Finance in estimating provincial income taxes could be strengthened to reduce the possibility of significant underestimation or overestimation of interim payments to the provinces (14.41 to 14.47).
14.5 There are weaknesses in the existing accounting practices and procedures for estimating the tax collections attributable to the provinces, as reflected in the Provincial Tax Collection Agreements Account. This Account forms part of the financial statements of Canada. No one group within the federal government takes full responsibility for the Account as a whole (14.48 to 14.55).
14.6 Tax collection agreements between the Government of Canada and the provinces are an integral part of the general framework of federal-provincial fiscal relations. This framework includes Equalization Payments, Established Programs Financing, and other intergovernmental transfers.
14.7 Under the agreements, most of which were implemented in 1962, the federal government collects individual and corporate income taxes on behalf of the participating provinces and territories and remits to them taxes assessed under their respective income tax acts.
14.8 The remittances do not equal collections because they are based on taxes assessed under the provincial tax legislation and some of the taxes assessed are not recovered from taxpayers. The federal government assumes the cost of bad debts as well as the cost of administering the tax collection agreements. On the other hand, it retains interest and most penalties levied on taxpayers.
14.9 The federal government collects provincial income taxes subject to two main conditions. First, the provinces must use, as a basis for calculating their taxes, the basic federal tax for individuals and taxable income for corporations, as defined in the federal Income Tax Act. Second, the provinces must apply their tax as a constant percentage of basic federal tax or corporate taxable income.
14.10 Authority for the tax collection agreements is in Part III of the Federal-Provincial Fiscal Arrangements and Federal Post-Secondary Education and Health Contributions Act. Participation by the provinces and the federal government is entirely voluntary. At present, all provinces and territories except Quebec have agreements with the federal government for collection of individual income tax. Quebec, Ontario and Alberta collect their own corporate tax, and the federal government collects for the rest of the provinces and territories. The agreements vary only slightly from province to province.
14.11 According to the data obtained from the Departments of Finance and National Revenue - Taxation, the provinces participating in the tax collection agreements for corporate tax, which exclude Alberta, Ontario and Quebec, account for less than 20 percent of the corporate taxable income in Canada. On the other hand, with only Quebec administering its individual income tax, over 75 percent of individual taxable income is earned by residents in provinces that are participants.
Evolution of Tax Collection Agreements14.12 Since 1962, the provinces' share of total income tax revenue has increased substantially due largely to the federal government giving additional "tax room" to the provinces. Exhibit 14.1 shows that their share rose from 18 percent in 1962 to 38.6 percent in 1987. The provinces' increasing reliance on income tax revenue has resulted in pressure for greater flexibility in the system of tax collection agreements.
(Exhibit not available)
14.13 In response to the provinces' desire for greater flexibility to pursue provincial policy objectives and to generate increased tax revenue, the federal government has accepted modifications to the original framework of the agreements. There are now a large number of provincial tax measures administered by the federal government, including tax credits, rebates, surcharges and -- more recently -- flat rate taxes.
14.14 The flat rate taxes, which are applied on the net income of individuals for Saskatchewan and Manitoba and on taxable income for Alberta, represent a major move away from a basic principle of the tax collection agreements, namely determining provincial income tax as a percentage of the basic federal tax. The federal government regards the flat rate taxes as temporary experimental measures.
14.15 The objectives of the tax collection agreements, which have been formally agreed to by the federal government and individual provinces, are contained in the agreements. These are stated in terms of economical and expeditious administration of the provincial income tax acts and facilitation of the payment of taxes imposed under them.
14.16 Other objectives have, however, been mentioned elsewhere by the federal government. Federal-Provincial Programs and Activities -- A Descriptive Inventory 1987-88, a publication of the Federal-Provincial Relations Office of the Government of Canada, describes the federal objectives as:
to prevent unnecessary duplication in the application of income tax systems by the federal and provincial orders of government, to reduce taxpayer confusion and to contribute to the maintenance of a relatively uniform income taxation system across Canada.14.17 The Minister of Finance in his submission to the 1981 Parliamentary Task Force on the Federal-Provincial Fiscal Arrangements in the Eighties, outlined three guidelines for the admissibility of provincial tax measures, in order to preserve the objectives of the agreements. These guidelines deal with the impact of tax measures on effective administration, harmony and uniformity of the income tax systems, and avoidance of barriers to normal interprovincial investment flows.
14.19 In the Department of Finance, two divisions are involved. The Federal-Provincial Relations Division provides advice to the Minister of Finance on federal policy concerning the tax collection agreements, negotiates and renegotiates agreements with individual provinces, and administers payments of income tax revenue to the provinces. The Fiscal Policy Division produces forecasts of basic federal tax for the individual income tax, and taxable income for the corporation income tax, which provide the basis for calculating payments to the provinces by the Federal-Provincial Relations Division.
14.20 National Revenue - Taxation administers the provincial income tax legislation on behalf of participating provinces, including collecting and assessing provincial taxes. This process is closely integrated with the administration of the federal Income Tax Act, which enables taxpayers to file one tax return covering both federal and provincial income taxes.
14.21 The Department of Supply and Services does a part of the accounting for the Provincial Tax Collection Agreements Account. It credits the account with the provincial portion of estimated income taxes collected.
Audit Scope14.22 Our audit focussed principally on the Department of Finance's administration of the tax collection agreements. Our review of National Revenue-Taxation at this time was limited to interviews with officials.
14.23 We reviewed briefly the activities of the Department of Supply and Services in accounting for the estimated collections owing to the provinces. We also interviewed officials of four provinces for a provincial perspective on the administration of the agreements.
Accountability to Parliament is weak14.24 The Federal-Provincial Fiscal Arrangements and Federal Post-Secondary Education and Health Contributions Act contains no specific provision for the accountability of the federal government to Parliament in respect of the tax collection agreements. The government itself has done little to advise Parliament about how well the agreements are working.
14.25 The tax collection agreements program is a significant undertaking of the Government of Canada. The government collected about $89 billion in income taxes for 1987-88, of which about $20 billion pertained to the provincial taxes. This undertaking involves a considerable federal effort, entailing costs and generating benefits for which the federal government should be accountable to Parliament.
14.26 Accountability to Parliament requires a reporting of the objectives of the federal government in respect of the tax collection agreements, the resources required to administer them and the results achieved.
14.27 The only regular reporting to Parliament on tax collections, however, is in Sections 2 and 8 of Volume 1 of the Public Accounts 1987-88. In the Statement of Assets and Liabilities of Canada in Section 2, the current and previous years' balances in the Provincial Tax Collection Agreements Account are given. Section 8 contains a brief summary of the nature of the agreements. It also contains a table, shown in Exhibit 14.2, providing data that are difficult to understand without explanation.
(Exhibit not available)
14.28 Furthermore, there is no reporting to Parliament giving the basis on which payments to the provinces were calculated, the magnitude of any revisions in payments with respect to prior years, or the reasons for any revisions to payments.
14.29 There is no mechanism for reporting to Parliament on all provincial tax measures administered by the federal government from time to time. No information on the tax collection agreements is included in Part III of the Department of Finance's Main Estimates. The only information provided in National Revenue - Taxation's Part III is a list of provincial tax incentives administered by that department. There is no information on such measures as surtaxes, flat rate taxes and tax reductions administered on behalf of the provinces.
14.30 Neither the Department of Finance nor National Revenue-Taxation could provide us with the estimated cost of administering the tax collection agreements. The Department of Finance advises that in furtherance of the economy objective of the agreements, the administration of the federal and provincial income tax acts is integrated. Because of this integration, the Department stated that it is difficult to determine separately actual costs of administration of the tax collection agreements. We believe, however, that certain costs, such as bad debts, could be estimated. In 1988-89, the federal government wrote off $211 million as income tax bad debts and there was an allowance for accounts of doubtful collectibility at the end of that year of over $1.6 billion. (These figures exclude amounts relating to Scientific Research Tax Credits.) A portion of the write-off and the allowance would pertain to the provincial income taxes. However, no information on these elements is provided to Parliament.
14.31 While there has been no evaluation of the tax collection agreements system since its inception in 1962, the Department of Finance has occasionally carried out reviews of specific elements of the agreements.
14.32 In view of the importance of the tax collection agreements to the Canadian federal system, accountability and reporting to Parliament should be improved. Such reporting should include information on the nature of the agreements, the federal government objectives in respect of the agreements and the results achieved.
Management's Response: As noted in the Auditor General's remarks preceding the recommendation, the Federal-Provincial Fiscal Arrangements and Federal Post-Secondary Education and Health Contributions Act does not require or provide for any ongoing reporting to Parliament. This Act is frequently amended, as recently as 1987, at which time Parliamentarians have an opportunity to review it, including the part authorizing the Minister to enter into Tax Collection Agreements with the provinces. Nonetheless, the Department of Finance will take steps to improve the information available to Parliament on the Tax Collection Agreements. One appropriate mechanism might be through the Main Estimates, in particular Part III of these estimates, as they relate to the Department of Finance.
The tax collection agreements are not up to date, and some tax measures are being administered without proper authority14.33 A number of tax collection agreements are, in some respects, out of date. For example, the federal government administers eight tax credits for one province -- for which it charges an administrative fee -- but these are not part of the tax collection agreement with that province. Some of these credits were initiated as long ago as 1984.
14.34 It may be argued that, although the agreements have not been amended to include provincial tax credits, correspondence between the federal government and the provinces concerned has the same effect. However, the Federal-Provincial Fiscal Arrangements and Federal Post-Secondary Education and Health Contributions Act requires that amendments to the agreements can be made only with the approval of the Governor in Council.
14.35 The federal government charges an administrative fee for all provincial tax credits administered by it in accordance with a specified formula. When a credit is not included in the agreement, there is no authority for levying the fee.
14.36 The Department of Finance should, in co-operation with the provinces, ensure that the tax collection agreements are updated on a regular and timely basis and that activities under the agreements are supported by proper authority. The Department and the provinces are in the process of updating the agreements.
Management's response: These are agreements between two parties, the federal government and a province or territory, and as such are the joint responsibility of these parties. All of the provincial income tax measures administered by the federal government, and the manner of their administration, including the levying of any administration fee, have been agreed to with the provinces, at least by exchange of letters. As has been noted by the Auditor General, the federal government and the provinces are in the process of formally amending the agreements themselves so as to make them as up-to-date as possible. This will continue to be done expeditiously as future changes occur.
14.37 The flat rate taxes levied by Saskatchewan, Manitoba and Alberta contravene the provisions of their respective tax collection agreements. The agreements require that "... individual income tax shall be expressed as a constant percentage (in one or more half percentage points) of the federal tax payable...." (emphasis added). The flat rate taxes, on the other hand, are calculated by applying a fixed tax rate to net income or taxable income.
14.38 The Minister of Finance has categorized flat taxes as temporary experimental measures for the purposes of the tax collection agreements. However, in the case of one province, the flat tax has been in place since 1985 and constituted in 1987 about 25 percent of the Province's total individual tax revenue. If the Province were to eliminate the flat tax but raise the same tax revenue, it would need to adjust its provincial tax percentage applicable to the federal tax payable from the present 50 percent to 62.5 percent.
14.39 The Department of Finance should take steps to rectify the existing contravention of the tax collection agreements with Manitoba, Saskatchewan and Alberta, resulting from the imposition of the flat rate taxes.
Management's response: The Minister of Finance is discussing the future of flat taxes with provinces.
Reporting to the provinces is in accordance with the agreements and payments are made on a timely basis14.40 We found that the reporting to the provinces was generally in accordance with the tax collection agreements. There are regular consultations between federal and provincial officials about the administration of the agreements. The Department of Finance provides the provinces with information on such matters as estimates of payments and fiscal and economic forecasts. The Department also issues the Statement of Income Taxes Payable to the Provinces and Territories at the end of the year, which is accompanied by the opinion of the Auditor General of Canada. We found that the Department is making payments to the provinces on a timely basis as called for in the agreements.
Procedures for estimating payments to the provinces could be strengthened14.41 For a taxation year, the federal government makes regular payments to the provinces based on its estimate of the taxes to be assessed under the provincial income tax legislation. After the actual assessment data become available 15 months subsequent to the end of the taxation year, final settlement is made to clear any differences between the actual assessment data and the estimated data on the basis of which interim payments were made. In other words, the provinces are paid the correct amount in accordance with the actual assessment data upon final settlement. However, if the interim payments are low because of the underestimation of taxes to be assessed under the provincial income tax legislation, there is a cost to the provinces in terms of lost interest. Conversely, overestimation of payments has a cost to the federal government.
14.42 Except for one year in the period from 1980 to 1987, there has been net underestimation of interim payments to the provinces, in some years in significant amounts (see Exhibit 14.3).
(Exhibit not available)
14.43 The underestimation of interim payments has, in large part, resulted from deficiencies in the methodology used. Two of these deficiencies related to the valuation of allowances for the provincial share of estimated income tax deductions made at source for which no personal tax returns will be filed, and of provincial income taxes to be assessed in the current year but pertaining to earlier taxation years. The underestimation of basic federal tax has also sometimes contributed to interim underpayments. The Department of Finance has recently taken steps to deal with the first two deficiencies. The effectiveness of these steps in resolving the problem will need to be monitored.
14.44 The underestimation or overestimation of interim payments can have a disproportionately high impact on individual provinces. Their significance relative to the total provincial income tax revenue is demonstrated in Exhibit 14.3. For example, in 1987 the highest underestimation of payments to a province as a percentage of income taxes remitted by the federal government was 9.1 percent to Ontario, amounting to $893 million, while the highest overestimation in that year was 7.3 percent to Alberta, amounting to $153 million.
(Exhibit not available)
14.45 The Department of Finance allocates the estimated taxes payable to individual provinces on the basis of historical data. The data pertain to the proportionate shares of individual provinces of basic federal tax and corporate taxable income for the most recent taxation year for which assessment has been completed. This is normally one year before the current taxation year for individual income tax and two years before for corporation income tax.
14.46 The use of historical data results in low interim payments to the provinces experiencing proportionately higher economic growth than in previous years, as was the case with Ontario recently and Alberta in the 1970s. Some provinces have informed us that, in addition to interest loss, less accurate allocations can adversely affect their fiscal planning process. The Department of Finance prepares regular forecasts of provincial economies which could possibly be taken into account to provide a better basis for allocating taxes payable to the provinces.
14.47 The Department of Finance should review its methodology for the estimation and allocation of income taxes payable to the provinces.
Management's response: The Department of Finance continually reviews the methodology for the estimation and allocation of provincial income tax payable to the provinces. On an aggregate basis the annual forecast error since 1981 has been less than 5 percent. As noted by the Auditor General, the Department has taken steps recently to further improve the forecasts of provincial tax payable and the results will be monitored. Work is also under way on improving the forecast of the allocation across provinces of provincial tax payable.
There are weaknesses in the existing accounting practices and procedures related to the Provincial Tax Collection Agreements Account. This Account forms part of the financial statements of Canada14.48 The Provincial Tax Collection Agreements Account, which is maintained strictly for Public Accounts purposes, shows the liability of the federal government at any particular time, arising from the administration of the agreements. An entry is made in the Account every month making a provision for the liability to the provinces based on an estimated portion of the collections attributable to them. The liability is reduced as actual payments are made to the provinces by the federal government.
14.49 In recent years there has been underestimation or overestimation of the provincial share of tax collections in the Provincial Tax Collection Agreements Account (See Exhibit 14.4). Such underestimation or overestimation has a corresponding impact on the measurement of the budgetary deficit of Canada.
(Exhibit not available)
14.50 The underestimation or overestimation of the provincial share of tax collections has not been large in recent years relative to total provincial taxes assessed. However, the underestimation or overestimation can be significant relative to the budgetary deficit of Canada, particularly when one considers the changes in deficit from one year to another.
14.51 Several factors contribute to the underestimation or overestimation of the provincial share of tax collections in the Account. Some of these factors are within the control of the federal government.
14.52 In estimating the provincial share of tax collections, adjustments are made to the collections data for such elements as tax refunds and federal and provincial tax credits. The refunds and credits for the current year are estimated to equal the amounts for the previous year. This may not be an appropriate assumption, particularly when the tax structure is undergoing significant changes. Further, the timing of tax refunds for the previous year can be influenced by such factors as the timing of the assessment cycle by National Revenue - Taxation.
14.53 The estimating of the provincial share of tax collections could be improved, at least in part, by using available forecasts. The Department of Finance prepares forecasts of the current year's refunds and federal tax credits, and it receives forecasts of the provincial credits from the provinces. These forecasts, which take into account the current situation, particularly with respect to the tax base and rates, could provide a better basis for adjustment to the collections. We understand from the Department of Finance that it will examine the possibility of using forecasts of current year's refunds.
14.54 No one group within the government takes full responsibility for the Account as a whole. The Department of Finance only accepts responsibility for making debit entries to the Account for payments made to the provinces. The Department of Supply and Services makes credit entries to the Account for the estimated taxes collected on behalf of the provinces. Neither department takes responsibility for determining that the balance in the Account represents the best estimate of the liability to the provinces.
14.55 The Department of Finance should improve its methodology and procedures for estimating the provincial share of tax collections in the Provincial Tax Collection Agreements Account.
Management's response: The report recognizes that the underestimation or overestimation of the provincial share of tax collections has not been large in recent years when compared to total provincial taxes assessed.
The Auditor General feels that the estimation methodology could be improved by using current-year forecasts of refunds and tax credits. We feel that this suggestion is reasonable and, as noted in the report, will examine the possibility of changing the estimation methodology in this manner.