2.1 The Auditor General Act requires the Auditor General to include in his annual Report matters of significance that, in his opinion, should be brought to the attention of the House of Commons.

2.2 The Audit Notes chapter fulfils a special role in the annual report. Other chapters normally describe the findings of the comprehensive audits we perform in particular departments; or they report on audits and studies of issues that relate to operations of the government as a whole. The Audit Notes chapter is a compilation of individual matters that have come to our attention during our financial and compliance audits of the Public Accounts of Canada, Crown corporations and other entities. It is also used to report some specific matters that have come to our attention during our comprehensive audits.

2.3 The chapter contains a wide range of notes. One note concerns a reservation in the auditor's report on a Crown corporation's financial statements for the year ended 31 March 1991. The other 18 notes concern departmental operations. One note on departmental operations deals with Parliament's control over taxing, and another note concerns access to information on undertakings to recommend amendments to the Income Tax Act . The remaining notes on departmental operations generally concern compliance with authorities, cash management practices, controls over revenue or the expenditure of public money without due regard to economy.

2.4 Although the notes report matters of significance, they should not be used as a basis for drawing wider conclusions about matters we did not examine.

Introduction

2.5 This chapter contains matters of significance not included elsewhere in the Report that we believe should be drawn to the attention of the House of Commons. They have come to our notice during our financial and compliance audits of the Accounts of Canada, Crown corporations and other entities, or during our comprehensive, value-for-money audits.

2.6 Section 7(2) of the Auditor General Act requires the Auditor General to call to Parliament's attention any significant cases where he has observed that:

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;
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;
money has been expended other than for purposes for which it was appropriated by Parliament;
money has been expended without due regard to economy or efficiency; or
satisfactory procedures have not been established to measure and report the effectiveness of programs, where such procedures could appropriately and reasonably be implemented.

2.7 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 Crown corporation or department heading.

Observations on Crown Corporations

2.8 The Auditor General is appointed auditor of a number of Crown corporations and other entities, under the Financial Administration Act, individual Acts incorporating specific corporations, or by Orders-in-Council. Details of significant reservations and other matters contained in reports issued to these corporations and entities during the year are set out in this chapter. Although our observations on Crown corporations have already been raised in a public forum, they are reported in this chapter for emphasis and for consideration by Parliament.

Farm Credit Corporation

Limitation in the scope of the Auditor General's examination of Farm Credit Corporation's financial statements for the year ended 31 March 1991

The Auditor General has included a reservation in his report on the financial statements of the Farm Credit Corporation (FCC) for the year ended 31 March 1991. This is the second consecutive year that the Auditor General did not have sufficient evidence to conclude that the allowance for loan losses (and, consequentially, certain other items) in FCC's financial statements were fairly presented in accordance with generally accepted accounting principles.

2.9 Background. Management is responsible for preparing financial statements that fairly present the corporation's financial position and the results of its operations. In doing so, management uses supporting documentation, evidence and analyses for the assertions made in the financial statements. When, after reviewing the supporting documentation, evidence and analyses provided by management, and carrying out such other procedures as may be available to them, auditors conclude that they do not have sufficient and appropriate audit evidence to form an opinion on whether certain items in the financial statements are fairly presented, the standards of the profession require that they qualify their opinion in the form of a scope limitation in the Auditor's Report.

2.10 Farm Credit Corporation's financial statements for the year ended 31 March 1991 include loans receivable of $3,378.3 million (31 March 1990 - $3,573.4 million), which are stated net of a $232.7 million allowance for loan losses (31 March 1990 - $279.4 million). FCC's accounting policy for the allowance for loan losses requires that the allowance represent "...management's best estimate of probable losses on the loans outstanding at the end of the year."

2.11 Issue. The Corporation provided us with evidence and analysis supporting the inclusion of $136.1 million in the allowance for loan losses as at 31 March 1991 (31 March 1990 - $188.4 million). However, it was unable to provide adequate support, in our opinion, for the balance of the allowance of $96.6 million (31 March 1990 - $91.0 million). As a consequence, we were unable to satisfy ourselves as to the appropriateness of these additional amounts. Also as a consequence, we were unable to determine whether any adjustments might be necessary to FCC's allowance for loan losses and its deficit on its balance sheet, and to its provision for loan losses and its net income or loss on its statement of operations and deficit for each of the years ended 31 March 1991 and 31 March 1990. This was reported as a scope limitation in the Auditor's Report on FCC's financial statements for each of these years.

Observations on Departmental Operations

Atlantic Canada Opportunities Agency

Failure to adhere to the authorities governing the Action Program

During our examination of the Atlantic Canada Opportunities Agency's Action Program, as a part of the audit of the Public Accounts of Canada for the year ended 31 March 1991, we identified significant instances where officials of the Agency failed to adhere to the authorities governing the Action Program.

2.12 Background. The objective of the Atlantic Canada Opportunities Agency (ACOA) is "to support and promote opportunity for economic development of Atlantic Canada...".

2.13 The objectives of the Action Program, ACOA's most significant program, are to foster the development of entrepreneurship, to increase the rate of new business formation and to improve the competitiveness of small and medium-sized enterprises.

2.14 During the fiscal year ended 31 March 1991, ACOA paid out $179 million through the Action Program, representing 67 percent of its total expenditures. ACOA made payments on approximately 4,200 Action Plan contribution agreements during that same period.

2.15 The principal authorities governing the Action Program are the "Action Program terms and conditions", which have received Governor in Council and Treasury Board approval. The Action Program terms and conditions provide direction on such things as the criteria for determining eligibility for financial assistance; the various types of financial assistance that can be provided; the maximum individual levels of assistance; and the conditions under which assistance payments can be provided. Although some of the terms and conditions are clearly stated, others require interpretation by ACOA officials.

2.16 As part of our audit of the Public Accounts of Canada, we examined 30 Action Program contribution agreements for which payments were made during the year ended 31 March 1991. Our examination of the supporting files revealed the following four significant instances where, in our view, ACOA failed to adhere to the Action Program terms and conditions and to the interpretive policies. Other observations have been referred to ACOA officials for their attention.

Case 1 - Failure to adequately evaluate the net economic benefit of a project and to adhere to internal policies

Enterprise Cape Breton (ECB), a part of ACOA, did not adequately evaluate the net economic benefit of a project prior to its approval. ECB did not adhere to internal policies when it advanced a further $1,470,000 after the commencement of commercial production, despite knowing that the necessary environmental certificates for the production process had not been granted by the Province of Nova Scotia.

2.17 In July 1987, ECB received an application from a company for assistance to establish a facility in Cape Breton to manufacture vinyl wallcoverings.

2.18 In May 1987, the company had requested assistance from ECB under the Industrial and Regional Development Program but had withdrawn its application, primarily due to negative advice provided to ECB by the Department of Regional Industrial Expansion (DRIE). The Department expressed concerns about the project, citing existing industry overcapacity and the likely threat of countervail action if the level of assistance requested were provided.

2.19 In its application under the Atlantic Enterprise Program, now an element of the Action Program, the company proposed a two-phase approach, requesting assistance only for the first phase. Although this approach significantly reduced the assistance being requested from ECB, the total project cost did not change significantly. Information provided to the Minister for his approval of the project noted DRIE's lack of support for the first application for assistance, but did not indicate that DRIE's position on this second request was outstanding. In September 1987, one week after obtaining the Minister's approval but before the agreement was finalized with the company, DRIE provided Enterprise Cape Breton with its analysis of this request, and its conclusion that no new information had been supplied by ECB that would address its original concerns. This information was not subsequently provided to the Minister. The agreement was entered into on 17 September 1987.

2.20 In our view, DRIE's concerns had not been adequately addressed and the procedures used to evaluate the net economic benefit of the project, one of the eligibility criteria of the Action Program terms and conditions, were not adequate.

2.21 Subsequent requests for further economic assistance, which cited increased project costs, received ministerial and Treasury Board approval. Final ACOA assistance included an interest buy-down contribution (a form of interest rate subsidy) of $5,145,000, and loan insurance for loans valued up to $10,412,500. Final total eligible capital costs were estimated to be $15,450,000, with total federal assistance valued at $13,158,913.

2.22 In accordance with ECB policy, the interest buy-down contribution agreement contained a condition requiring the applicant, on or before the commencement of commercial production, to have incorporated and used environmental protection measures that satisfied the requirements of all regulatory bodies having jurisdiction. ECB determined that the company achieved commercial production as of 31 December 1988. Even though the facility was operating, it had not received environmental certification from the Province of Nova Scotia. The provincial Department of Environment had serious concerns about emissions of organic vapours from the manufacturing process.

2.23 Issue. Even though Enterprise Cape Breton was fully aware of the absence of the provincial certification for the production process, it continued to advance funds to the company. It advanced $1,793,260, of which $1,470,000 was advanced after the commencement of commercial production, contrary to ECB's policy and the conditions of the contribution agreement with the company.

2.24 The company went into receivership in March 1991 without ever receiving environmental certification from the provincial Department of Environment.

2.25 The federal government is further exposed financially, due to the following:

Since ECB provided loan insurance for loans from a commercial bank that were valued up to $10,412,500, it is conceivable that it will be required to honour any claim under this agreement.
An environmental assessment of the facility, completed for the receiver, indicated that, in addition to the emission of organic vapours from the manufacturing process, there are problems with the storage and disposal of hazardous materials and there is potential soil contamination. An estimate of $400,000 was provided as the cost to clean up the facility. It is not clear who will be held responsible for clean-up costs.

Case 2 - Failure to adequately evaluate, monitor and control an Action Program contribution agreement

ACOA did not adequately evaluate the commercial viability of a proposed project in Newfoundland. Furthermore, ACOA failed to have the Minister approve several significant changes to the project, which occurred after his initial approval but before a contribution agreement was finalized.

2.26 In July 1988, ACOA received an application from a company for assistance to establish a facility in Newfoundland to produce vinyl windows and patio doors.

2.27 In its evaluation of the project, ACOA requested technical advice from DRIE. The Department of Regional Industrial Expansion expressed several serious concerns about the commercial viability of the project, including the projected level of sales and the economic disadvantage the company faced due to its distance from its main market in Ontario. The Atlantic Canada Opportunities Agency did not obtain other independent advice to assist in its evaluation of the project, and it did not forward any responses obtained from the applicant to DRIE for subsequent evaluation. In our view, DRIE's concerns were not adequately addressed, and the procedures used to evaluate the project's commercial viability -- a significant Action Program eligibility criterion -- were not adequate.

2.28 In August 1988, ACOA approved a non-repayable contribution of $5,225,000 based on total estimated eligible capital costs of $10,450,000. The total of all federal government assistance was valued at $6,078,000.

2.29 Information given to the Minister with the request for approval of the project described the ownership structure and the levels of expertise brought to the project by the owners. The original ownership structure was to have included individuals who would provide technical expertise, including knowledge of the manufacture of vinyl windows and doors and of market conditions in the key Ontario marketplace.

2.30 In October 1988, one of the shareholders informed ACOA of a change in the ownership structure of the project. An international plastics company would now control 50 percent of the company and bring its own technology and equipment into the project. The cost and size of the project were to rise but it was not clear by how much. The Atlantic Canada Opportunities Agency was provided with a market study by the new owner but did not receive a new business plan.

2.31 Issue. In our view, the change in ownership was significant to the commercial viability of the project. The Atlantic Canada Opportunities Agency should have completed a full re-evaluation of all aspects of the project, including commercial viability and the level of assistance requested. In addition, the Minister should have been informed of this significant change before the contract was finalized. In January 1989, ACOA entered into the non-repayable contribution agreement with the company without informing the Minister of the change in ownership and the implications this could have on the success of the project.

2.32 Since January 1989, ACOA has made payments to the company totalling $5,878,125, including allowable cost overruns.

2.33 In addition, the federal government is potentially exposed financially as follows:

In the Atlantic Region there are several companies involved in the manufacture of vinyl window profiles. There was no indication in the ACOA files that an evaluation was done of the impact of the proposed facility on the operations of these manufacturers. The Atlantic Canada Opportunities Agency has informed us that a competitor of the company is taking legal action against ACOA, alleging that its support for the company played a significant part in the competitor's current financial difficulties.

Case 3 - Failure to adequately monitor and control an Action Program contribution agreement

Contrary to the Action Program terms and conditions, ACOA made second and third payments totalling $2,293,043 to a company in advance of its having achieved commercial production.

2.34 In November 1988, ACOA received an application from a company for assistance to establish a facility in Saint John, New Brunswick to manufacture lightweight steel pallets, using a patented Swedish design.

2.35 In January 1989, ACOA approved a non-repayable contribution of $5,782,616 and an interest buy-down contribution valued at $1,219,904, based on estimated eligible capital costs of $11,565,233. In August 1989, ACOA also approved loan insurance for this project.

2.36 The Atlantic Canada Opportunities Agency determined the date of commercial production to be 28 February 1990, despite available file documentation indicating that the company was still in the product development phase. Subsequently, the company informed ACOA that it would have to redesign the product in order to meet North American consumer demands. At the date of our review, there was no evidence of production in commercial volumes and, as noted, the company had stated its intention to redesign the product. The Atlantic Canada Opportunities Agency had made three payments to the applicant, totalling $3,622,900.

2.37 Under the Action Program terms and conditions, only one payment, representing no more than 50 percent of the contribution agreement amount, may be paid prior to commencement of commercial production. In accordance with the company's request, ACOA made one payment of $1,329,857 prior to 28 February 1990.

2.38 Issue. In our view, commercial production was not achieved by 28 February 1990 and, by means of the second and third payments (which totalled $2,293,043), ACOA paid the company more than was permitted by the Action Program terms and conditions.

Department's response to cases 1, 2 and 3: The Atlantic Canada Opportunities Agency considers that it has taken positive steps relating to those processes and procedures identified in cases 1, 2 and 3 above, as requiring improvement. More specifically, ACOA has either begun or intends to undertake a review of:

the standard procedures and criteria used for evaluating commercial viability to determine their adequacy and application on a consistent basis.
the criteria for the identification of what actions constitute a significant change in ownership for a client, and the conditions for notification to the Minister.
the criteria for the determination of commercial production and its relationship to the advance of funds.

Case 4 - Provision of an Action Program contribution for an ineligible project

In May 1990, ACOA approved the provision of an interest buy-down contribution toward the modernization and expansion of a fish-meal processing facility. The Action Program terms and conditions state that approval should not be given for projects that would proceed without funding. This project should not have been considered eligible for the interest buy-down contribution, as the construction of the facility was essentially complete at the time of approval.

2.39 In July 1988, ACOA received an application from a company to expand and modernize its fish-meal processing facility in Nova Scotia. In September 1988, ACOA approved a non-repayable contribution of $1,277,400 based on estimated eligible capital costs of $4,258,000.

2.40 In April 1989, the company submitted an amended application requesting additional assistance, as it had decided to use a new process for its fish-meal processing facility that would raise the estimated capital costs of the project to $7,282,000. In September 1989, the amended request was rejected by ACOA. One of the reasons cited was that the company was considered to have sufficient financial strength to proceed without the additional assistance.

2.41 In early 1990, due mainly to financial problems caused by a downturn in the fishing industry, the company made representations to ACOA for interest buy-down assistance for the project.

2.42 On 16 May 1990, ACOA approved a non-repayable interest buy-down contribution amounting to $697,192. The Atlantic Canada Opportunities Agency signed the contribution agreement on 12 June 1990, although the project had been essentially completed by 30 May 1990.

2.43 Issue. Although, at the date of our review, the company had yet to make a claim for reimbursement under this interest buy-down contribution agreement, the Action Program terms and conditions state that no assistance may be given if the project would otherwise proceed without the funding. As this project was essentially complete, the additional request for interest buy-down assistance should have been rejected as ineligible.

Department's response to case 4: The Atlantic Canada Opportunities Agency considers that non-continuance of the project may have been the outcome if the applicant had not received the additional interest buy-down assistance. The Atlantic Canada Opportunities Agency considers its actions with respect to approval of this additional assistance package to have been fully within the Action Program terms and conditions.

Atlantic Canada Opportunities Agency

Failure to adhere to a Treasury Board authority

In September 1988, the Treasury Board authorized the Atlantic Canada Opportunities Agency (ACOA) to enter into a $19.9 million non-repayable contribution agreement with a New Brunswick provincial Crown corporation. The corporation, however, was unable to provide all the documentation required for a contribution arrangement. The Atlantic Canada Opportunities Agency changed a portion of the contribution agreement to a grant, thereby eliminating the requirement for supporting documentation. The Atlantic Canada Opportunities Agency did not request Treasury Board approval for this change, as required. To date, ACOA has paid $1.925 million to the corporation in the form of grants and $7.6 million in contributions.

2.44 Background. In August 1988, ACOA received an application from a New Brunswick provincial Crown corporation, which provides technology and productivity improvement services to small and medium-sized business in New Brunswick. The request was for assistance in implementing a revitalization program over a five-year period.

2.45 In early September 1988, the ACOA Minister entered into a Memorandum of Understanding with the Province of New Brunswick to provide up to $20 million in assistance for the revitalization program. On 22 September 1988, Treasury Board approved the Minister's submission for a non-repayable contribution of $19.9 million to the corporation, under the Action Program.

2.46 Issue. Contribution agreements require the applicant to submit receipts or other supporting documentation to substantiate the expenditures claimed. The corporation, however, was unable to provide the necessary documentation to support the operating overhead portion of the claim. The Atlantic Canada Opportunities Agency changed a portion of the contribution agreement to a grant, thereby eliminating the requirement for supporting documentation.

2.47 The Atlantic Canada Opportunities Agency did not request Treasury Board approval before changing the nature of the payments. As a result, ACOA failed to adhere to the Treasury Board authority.

2.48 At the date of our review, ACOA has paid $1.925 million in grants and $7.6 million in contributions to the corporation.

Department's response: The Atlantic Canada Opportunities Agency will undertake a review of the future funding arrangements for the applicant and, if necessary, prepare a submission to Treasury Board to ensure the method of providing funds, whether by contribution or grant, is complied with.

Canada Employment and Immigration Commission

Payments to a province for institutional classroom training without obtaining certification of the cost and number of training days, as required by an agreement

The federal government purchases adult training courses every year through federal-provincial/territorial agreements on institutional classroom training. Over a five-year period, the Canada Employment and Immigration Commission (CEIC) spent close to $500 million for one province without obtaining any cost certification from that province to confirm the claimed expenses.

2.49 Background. The National Training Act allows Canada to conclude agreements with provinces and territories for the payment of training courses for adults and for apprentices at public learning institutions. The principles governing course planning, purchase and payment are outlined in the federal-provincial/territorial agreements on institutional classroom training.

2.50 Audit observations on training agreements have been the subject of past annual reports in 1978 and 1986. To follow up on these observations we examined agreements with three provinces, each of which had expired in 1990-91.

2.51 One of the conditions of the agreements requires certification by the province or territory for any expense related to the training it has provided. Such certification confirms the number of training days offered, as well as direct and administrative costs chargeable to the federal government for the year in question.

2.52 Issue. Our examination revealed that, over the past five years, the Commission paid almost $500 million to one of the three provinces even though it had not supplied the required cost certification for those years. In January 1991 the CEIC and the province, in an effort to solve the problem, signed a document of interpretation on matters of certification. At the time of our audit, the Commission was unable to obtain from the province the cost certifications provided for in the agreement.

2.53 In our opinion, the CEIC spent nearly $500 million over a five-year period without receiving certifications of the costs of institutional classroom training purchased under the terms of a federal-provincial agreement.

Department's response: Under the federal-provincial agreement on training, it is up to the province to provide course cost certifications to the CEIC. Even though a province has failed to provide these certifications, the CEIC is convinced, based on other available and verifiable sources of information, that the amounts of training expenditures are correct and allowable.

Department of External Affairs

After expenditures of $53 million, the future direction of the Canadian Online Secure Information and Communications System project is being reassessed

Since 1987, the Department of External Affairs has invested $53 million in Phase I of the Canadian Online Secure Information and Communications System (COSICS) project, which is two years behind schedule, not yet fully operational, and may not be used for classified purposes until final acceptance tests are completed and certification obtained, expected in the fall of 1991. Given advances in computer technology, some of this investment will not be applicable in any future development.

2.54 Background. The Department initiated the COSICS project to improve administrative efficiency and reduce person-years. Mission sites were to be provided with an integrated, secure and automated approach to telecommunications, word and data processing, and a centralized information management records facility. Plans for Phase I were to program additional security controls in an existing software package, acquire communications and terminal equipment, and install a secure network in North American sites. Phase II plans were to extend the project worldwide.

2.55 Our Office audited the COSICS project in 1987 during a review of departmental common administrative services. We reported that the Department risked exceeding cost estimates and that predicted savings would not be realized. In a follow-up audit in 1989 we found that, before the commencement of the project, approved cost estimates for Phase I had increased from $28.8 million to $50 million and total project estimates increased from $111 million to $208.6 million. We again reported that there was a risk of further cost increases, and again expressed concern that a portion of the expected savings in person-years would not be fully realized.

2.56 Issue. Having expended $53 million to date ($42 million for the main contractor and $11 million for the security upgrades at missions), the Department has delivered a North American communications network linking 1,100 terminals, with an electronic mail system, word processing and spreadsheet capability. The original estimated date of completion for Phase I was September 1989. The Department is still verifying the capability of the system to handle the full classified and unclassified operational traffic loads, and testing all the modifications to the security software. A working and stable system is a prerequisite for the departmental security authority to grant certification for classified communications. The Department now expects that the undelivered portion, as well as testing of the entire system, will be completed in the fall of 1991, with certification to follow soon after.

2.57 In February 1991 the Department completed an assessment of the COSICS project, and decided not to exercise its option to proceed with Phase II as planned. We support this decision. Since the project's conception in 1986, there have been advances in information technology that offer more cost-effective solutions. As a result, the Department investigated technology that would give a new direction to the project. It dissolved the project office and requested $1 million to pilot a revised system architecture based on local area networks for classified and unclassified communications in missions, and to undertake security threat and risk assessments. An Information Technology Strategic Plan for the next phase has also been prepared in consultation with Treasury Board Secretariat, and will be presented to Treasury Board Ministers for approval.

2.58 Some users, many of whom were already using other widely available personal computer packages, commented that the software package selected for COSICS was not up to their expectations. But electronic mail, which is central to the Department's operations, has been well received and constitutes the main use of the system. While the system was designed for classified communications, it has yet to be certified for such; however, we noted instances where it has been used for classified communications, in contravention of departmental security policy.

2.59 Anticipating a reduction of person-years as a result of COSICS, the Department reduced its budget by 114 person-years in return for project funds from the Treasury Board. The Department now believes that anticipated COSICS-related savings in personnel and operational costs will not be achieved. The Department obtained assistance from the Department of Supply and Services in managing the contract, but this still did not fully compensate for the lack of overall experience required to set up and manage a major Crown information systems project.

2.60 Conclusion. The Department shares our opinion that it underestimated the level of effort needed to develop and put into operation such a complex system and that it also overestimated the anticipated person-year savings. Moreover, security requirements continued to evolve over the life of the project, and there were significant difficulties in arriving at a consensus as to what constituted adequate systems security controls. As a result, the Department has developed a system for $53 million that will be used in Phase I sites but that will not be carried forward in the automation of other missions. The Department has suggested a review in 1993 to monitor the progress made, and we intend to do such a review.

Department of Finance

Delayed recovery from the Province of Quebec of the amount in lieu of the Youth Allowances income tax abatement provided to Quebec residents has increased interest costs to the federal government

Since 1974 the federal government has provided an income tax abatement of three percent (i.e. reduced the federal tax) to the residents of Quebec, which amount is recovered in full from the Province of Quebec. However, its recovery is delayed. As a result, there have been increased interest costs to the federal government -- an estimated $6 million for 1989 alone.

2.61 Background. Prior to 1964 the Family Allowances Program, a federal program applying to all provinces, provided benefits to children under the age of 16 years. In 1964, Parliament enacted the Youth Allowances Act to provide monthly allowances to parents supporting children who were of 16 and 17 years of age. The benefits under this Act were available to all provinces except Quebec, which already had its own program of benefits for that age group. To put Quebec residents on the same footing as those of other provinces, the federal government allowed them an individual income tax abatement of three percent in lieu of the youth allowances it would otherwise have paid them.

2.62 In 1974 the Family Allowances Program was expanded to include children of 16 and 17 years of age. As a result, both the Youth Allowances Program and the similar Quebec program were terminated. The federal and Quebec governments agreed that the three percent individual income tax abatement would continue, with the provision that the federal government would recover the abatement from the Province of Quebec. The schedule of payments has resulted in a delay in the recovery of the abatement for each year since 1974 (except 1988, for which there were special arrangements). The total amount recovered for 1989 -- the latest year for which final figures are available -- was $347 million.

2.63 Issue. The three percent abatement is built into the federal individual income tax withholding tables for the Province of Quebec. The benefit of this abatement, therefore, is being transferred to the residents of Quebec throughout the year. But for the taxation year 1989, for example, the payments by the Province of Quebec to the federal government were made about 50 percent (of the estimated amount) on 3 April 1989 and the balance on 30 March 1990. Taking the time value of money into account, the payment schedule should have been advanced by a few months. The delay in recovering the funds has resulted in additional interest cost to the federal government. We have estimated (using average 90-day Treasury Bill rates) that, for the 1989 taxation year alone, the interest costs amounted to approximately $6 million. For the entire period from 1974, the interest costs would be substantial, particularly when the compounding effect is taken into account. Earlier recovery of the abatement could eliminate these additional interest costs.

2.64 The Department is of the view that Youth Allowances Recovery is an integral part of the framework of federal-provincial fiscal arrangements, which is governed by rules quite different from those for commercial transactions. In particular, interest neutrality has never been a primary objective of these arrangements. Indeed, under the fiscal arrangements legislation, all provinces receive interest benefits from a federal policy that defers the recovery of overpayments to them.

2.65 However, we have noted that the regulations issued under the fiscal arrangements legislation, which permit the deferral of recovery of overpayments from the provinces, apply only to the fiscal transfer payments programs, namely fiscal equalization payments, fiscal stabilization payments, revenue guarantee payments and to the income tax payments under the tax collection agreements. Even in those cases, the time value of money is an important consideration in designing the time schedule for payments.

2.66 In our view, the Youth Allowances Recovery is a specially designed arrangement whereby Quebec has agreed to compensate the federal government fully for the three percent tax abatement. Therefore, the schedule of payments adopted should be improved to take better account of the time value of money. The Department of Finance has advised us that it will, as it has done in the past, include cash management considerations in its forthcoming discussions with provinces.

Department of Finance

Income tax comfort letters may provide some taxpayers with an advantage not available to others

A comfort letter provides a taxpayer with an undertaking that amendments to the Income Tax Act will be recommended. Because they are given without public announcement, they do not meet a commitment made in the Declaration of Taxpayer Rights, and they may provide some taxpayers with an advantage not available to others.

2.67 Background. If an amendment to the Income Tax Act is to be proposed as a result of a suggestion made by a taxpayer, the Department of Finance will, on request, issue the taxpayer a letter of comfort undertaking to recommend amendments to take effect on a specified date. The Department of Finance advised us that, during 1990, 20 letters of comfort were issued to taxpayers or their representatives.

2.68 Issue. It has not been the practice of the Department of Finance to make a public announcement at the time a letter of comfort is issued. We are concerned that this practice breaches a commitment made to taxpayers in the Department of National Revenue - Taxation's Declaration of Taxpayer Rights. Taxpayers are told they have the right to expect that the government will make every reasonable effort to provide them with access to full, accurate and timely information about the Income Tax Act, and their rights under it. We are also concerned that this practice may provide some taxpayers with an advantage not available to others.

Department's response: The Department of Finance considers the OAG's concerns with respect to income tax comfort letters to be overstated. These letters are provided in order that taxpayers may conduct their business affairs and other concerns with more certainty and invariably relate to relatively narrow technical, as opposed to policy, questions; a comfort letter never indicates a change in government policy but rather confirms that an amendment will be recommended to correct a technical deficiency to ensure that the legislation achieves its original intent. Since comfort letters deal with technical matters only and serve to reinforce already established policy they are of very narrow interest; nor is any information provided in a comfort letter which could give a particular taxpayer an advantage over others. Moreover, the government intends to release a package of income tax technical amendments on an annual basis, so that taxpayers will not be subject to more lengthy waiting periods as in the past before these amendments are released to the public.

Departments of Finance and National Revenue - Taxation

Administrative procedures diminish Parliament's control over taxing

Proposed changes to the Income Tax Act are often administered as though they were law. The departments of Finance and National Revenue - Taxation believe that this is not an infringement on Parliament's jurisdiction -- it enables Parliament to operate more responsively to the needs it seeks to address through the tax system. We believe that the practice of administering proposed tax changes in anticipation of their passage by Parliament, and other assessing practices not authorized by law, violate the basic principle that the right to tax rests with Parliament, through the legislative process.

2.69 Background. It is a long-standing practice to put certain proposed tax measures into effect before they are enacted in law. Until the enabling legislation is passed by Parliament, with a provision for retroactive application, the payment and collection of these taxes is voluntary, and legally cannot be enforced.

2.70 This practice is common in the commodity tax system. For example, tax increases on tobacco products announced in a budget usually take effect at midnight the same day. Tobacco product manufacturers begin collecting the tax increase from their customers as soon as it comes into effect. However, they are not obligated to remit to the government the increased taxes they collect, until the enabling legislation receives Royal Assent.

2.71 The provisional implementation of commodity tax changes poses problems because the tax is imposed on a transaction basis, and redress is not as simple as in the income tax system. In the unlikely event that a taxpayer voluntarily paid income tax increases that did not become law, on the subsequent filing of an income tax return a refund could probably be obtained. However, in the commodity tax system, if the collection agent (in this example the tobacco product manufacturer) does not collect the announced tax increase, it risks having to subsequently pay amounts not previously collected. If the tax increase is not enacted by Parliament, the risk is that the consumer will be out of pocket. As the GST matures and proposed changes to it are announced, millions of taxpayers could be exposed to these risks.

2.72 The provisional implementation of tax changes has not been as common in the income tax system. The Department of National Revenue - Taxation (NRT) in the past has declined to assess or to issue refunds where these were dependent on budget proposals that were not yet law.

2.73 We have observed a growing tendency by NRT to administer proposed changes to income tax laws as though they had been enacted.

2.74 The Department has advised us that it does this to avoid public confusion, improve administrative efficiency and reduce the need for later adjustments to returns. The Department of National Revenue - Taxation recognizes that, should Parliament change or not pass such proposed legislation, adjustments to some returns would be necessary. However, it is unlikely that it could identify all those returns; moreover, NRT could be barred by statute from adjusting returns. As a result, proposed legislation could effectively represent tax law, even though not enacted by Parliament.

2.75 In May 1985 the Minister of Finance provided Parliament with a paper entitled "The Canadian Budgetary Process: Proposals for Improvement". The paper dealt with the issue of putting proposed tax measures into effect before they are enacted in law. The paper contained a draft bill entitled the Provisional Implementation of Taxation Measures Act. The bill would have given statutory effect to proposed tax measures. Taxpayers would have had to pay and file and remit taxes on the basis of the proposed tax measures. The Department of National Revenue - Taxation would have had to assess, collect or refund taxes; third parties would have been required to deduct, withhold and remit taxes.

2.76 In its Report of 17 December 1985 considering the paper, the House of Commons Standing Committee on Procedures and Organization found the collection of taxes without the authority of Parliament to be offensive. On principle, the Committee recommended the rejection of the whole concept of a Provisional Implementation of Taxation Measures Act. However, if the government wished to proceed along this route, the Committee recommended a number of changes to the proposed bill. The bill was not enacted.

2.77 Issue. The practice of administering proposed tax changes in anticipation of their passage by Parliament, and other assessing practices not authorized by law, violate the basic principle that the right to tax rests with Parliament, through the legislative process. Some examples follow.

2.78 National Labour-Sponsored Venture Capital Corporation Tax Credit. Draft legislation released in January 1990 provided for a federal tax credit for taxation years after 1988 to individuals who invested in shares of a nationally registered, labour-sponsored venture capital corporation. The credit was 20 percent of the purchase price of the shares, to a maximum of $700 a year.

2.79 Although NRT did not have legislative authority, it advised us that it allowed about $600,000 in credits to taxpayers who claimed them on 1989 tax returns.

2.80 Interest deductibility. On 2 June 1987 the government tabled a notice of a Ways and Means motion indicating that it intended to amend the rules for deducting interest paid on money borrowed before 1989. The motion was extended to include money borrowed before 1990, and then 1991. The motion was used to continue administrative practices that had existed before a 1987 Supreme Court of Canada decision contradicted the principles upon which those practices were based.

2.81 Although NRT did not have legislative authority, it administered the motion as though it were law.

2.82 The Department of Finance has been reviewing the rules on the deductibility of interest and other financing costs since 1987.

2.83 Draft income tax legislation. In February 1991 the Department of Finance released revised draft technical amendments to legislation introduced the previous year. It also released new draft legislation to implement a new system of tax benefits for residents of Canada's northern and isolated regions. The proposed legislation, which contains retroactive and retrospective provisions, is intended to implement the income tax measures set out in the February 1990 budget and other proposals announced that spring. It also contains a significant number of technical amendments, which correct or clarify the application of existing income tax provisions.

2.84 The departments of Finance and National Revenue - Taxation had suggested that taxpayers complete their 1990 tax returns in accordance with the proposed tax measures. Where possible, 1990 public forms such as the 1990 T1 Guide informed taxpayers of the proposed changes. Most of the proposed changes were "favourable" to taxpayers; however, the bill provides for an increase in surtaxes in 1991, and current employee withholding taxes already reflect this.

2.85 Although NRT did not have Parliamentary authority, it administered the draft legislation as though it were law.

2.86 To examine a possible effect, we looked at the proposed changes to the child care expense deduction.

2.87 Child care expense deduction. By choosing to administer the proposed legislation, NRT gave taxpayers the option of using either the existing law or the proposed legislation.

2.88 The law allowed taxpayers to deduct child care expenses paid to relatives 21 years or older. The proposed legislation would allow the deduction of child care expenses paid to relatives 18 years of age or older. Returns of taxpayers using the more liberal proposed legislation would have to be adjusted if it were not enacted, but NRT did not have a mechanism in place to identify those returns. Without a manual review to identify affected claims, the proposed legislation would effectively represent tax law -- law established by NRT and the Department of Finance, not by Parliament.

2.89 Remission order. Prior to 1983, NRT had interpreted section 87(1) of the Indian Act as exempting Indians from taxation on employment income earned on reserves, notwithstanding where the employer was situated.

2.90 In 1983, the Supreme Court of Canada ruled that the criterion for exemption was the location of the employer rather than the place where the income was earned.

2.91 As a result of that decision, the government issued a remission order covering taxes, interest and penalties assessed for the years 1983 to 1985. The remission exempted employment income earned on reserves by Indians, even where the employer was off the reserve. This effectively continued the practice in existence before the Court's decision. The order was issued to provide a temporary solution while potential legislative solutions were studied. However, the order was subsequently extended to 1990 and now also exempts pension income derived from exempt income and certain training allowances.

2.92 It has been six years and a legislative solution still has not been presented to Parliament. Moreover, the remission order extends back to 1983, eight taxation years ago.

Departments' response: The practice of administering certain income tax measures proposed by the government before they have been enacted cannot be said to diminish Parliamentary control over the tax system. On the contrary, the operational necessity of the practice and its considerable benefits to both taxpayers and government mean that it facilitates the exercise by Parliament of its fiscal powers.

The basis for this practice is the release to the public of proposed legislation, or the presentation in Parliament of a Notice of Ways and Means Motion or a bill, setting forth proposed tax measures and specifying the date on which they will be effective. The administration of the measures as of the effective date proposed is neither a disregard of the law nor in disrespect of Parliament. Until a proposed tax measure is given Royal Assent there is neither any legal requirement for the taxpayer to pay a proposed tax, nor any legal authority for the government to enforce its collection. This is well established and well known.

The administration of proposed tax measures is thus in no sense a usurpation of Parliament's constitutional responsibility for legislation. It is, however, a practical necessity if many of Parliament's objectives for the tax system are to be realized. Fiscal, economic, anti-avoidance and relieving measures can all require an effective date prior to the date of Royal Assent. On the fiscal side, for example, the result of a measure designed to reduce or increase government revenue by changing the effective tax rate on a certain type of income will be impossible to predict if the measure takes effect only as of Royal Assent - a date which necessarily cannot be foreseen, given the fluidity of Parliamentary processes. For government to operate efficiently and responsibly, some certainty as to the fiscal impact of a given tax measure is a basic requirement.

Tax measures intended to implement economic or social policy, such as the example cited in the report, may also need to be effective before enactment. Where a tax credit or other benefit is targeted at a group or region determined to merit special attention, to delay its application until enactment would almost certainly reduce its effectiveness. Indeed, such a delay could give rise to a perverse impact if, for example, investment intended to be encouraged by the measure were delayed during the interim period.

Anti-avoidance measures - those which prevent the continued exploitation by certain taxpayers of unintended features of the tax system - must often be effective immediately upon announcement. Otherwise, the announcement would serve as nothing more than an advertisement of the avoidance opportunity.

Finally, a large proportion of the tax changes introduced in recent years have been designed to relieve taxpayers of the inappropriate effects of defects or inequities in the existing legislation. In such a case, an early or even retroactive coming-into-force will often be necessary in order to correct an unintended and unforeseen hardship. Many of the measures included in the package of draft income tax legislation referred to in the report fall into this category.

It does not follow that a measure which is appropriately brought into effect as of a date preceding enactment must necessarily be administered as though it had been in place from that date. It would be at least theoretically possible for taxpayers and the Department of National Revenue to operate on the basis of the existing legislation until the new measure is enacted, and then refile or reassess with respect to all events and transactions since that earlier date. The report states that the Department of National Revenue administers proposed tax amendments "to avoid public confusion, improve administrative efficiency and reduce the need for later adjustments to returns." This description is accurate, but two points should be emphasized. First, the Department of National Revenue cannot and does not compel taxpayer compliance with proposed measures. Second, the benefits of this practice are by no means restricted to National Revenue. There are a number of significant operational reasons why it is in the interests of both taxpayers and government to follow this practice. Taxpayers who choose to file on the basis of the new measure can avoid the difficulty of recalculating their taxes and refilling returns; employers and others responsible for withholding taxes can protect themselves from later additional liability; and non-deductible interest charges can be avoided. The Department of National Revenue, for its part, is spared the need either to reassess returns filed under the old law or to stockpile returns until enactment.

Should Parliament choose not to enact a proposed tax measure, a taxpayer who has been assessed on the basis of the measure may be reassessed. Two concerns in this regard are addressed in this report. The first is the unlikelihood that all affected returns could be identified by the Department of National Revenue. As an example, the report cites the Department's administration of proposed changes to the child care expense deduction - a relieving amendment. The report expresses concern that individuals filing under the proposed legislation will not be identifiable, and thus not subject to reassessment, if the amendment is not enacted. This, it should be noted, is a prudential question, relating more to the mechanics of administration of proposed tax changes rather than a question of its legality. At that pragmatic level, the possibility that some returns might escape detection must be weighed against the enormous costs to taxpayers and government alike of foregoing all anticipatory administration.

The second concern raised is the possibility that the adjustment of returns to reflect the non-enactment of a given measure might be statute-barred. For this to occur, the three-year reassessment period must have elapsed between the announcement of the measure and its ultimate failure to be enacted (presumably manifested by the withdrawal of the legislation in question or its enactment without the measure). While possible, this is an unlikely event.

The report identifies two other particular administrative policies: the administration of the Notice of Ways and Means Motion regarding the deductibility of interest expenses; and the continuation of the Indian taxation remission order. The focus of the report is the justifiability of the administration of proposed tax changes before their enactment in general. The continuation of the existing administration with respect to interest deductibility is an example of an appropriate and indeed, necessary application of this practice: incalculable commercial, administrative and legal difficulties would have arisen had the Department of National Revenue attempted to administer on the basis of the uncertain state of the law following the Bronfman Trust decision. The other objection, to the Indian taxation remission order, is not on its face an objection to the order's lawfulness, but rather to its continuation. The Departments of Finance and National Revenue acknowledge the desirability of replacing the remission order, and, in fact, the Department of Finance has launched a comprehensive review of Indian taxation issues. The review will seek to develop a federal policy for a new tax relationship with Indians, particularly in the context of Indian self-government, that defines the tax powers of Indian governments and, where applicable, provides clear rules for exemption from taxation.

In summary, the Department of National Revenue is aware that its mandate is to administer the income tax law once it is enacted. However, the tax cycle is an annual process, and guides and forms must be prepared and published in advance; also the system is highly modernized in its use of computer applications that require to be programmed for the annual cycle of return processing. Normally budget changes announced in the spring become law by December, in time for the annual processing in March to June. In recent years, however, the time involved in the legislative process has placed the Department in the position of having to suggest to taxpayers that they comply with proposed law. Most taxpayers have done so willingly to avoid the possibility of duplicate filing. While the Department would rather that the law was passed before it is administered, it generally has little choice but to suggest that taxpayers comply with proposed law to avoid public confusion, inconvenience and to deliver the tax process efficiently.

Thus it is the opinion of the Department of Finance and the Department of National Revenue that the practice of administering certain tax changes in anticipation of their passage by Parliament is defensible as a practical necessity for the efficient administration of the system and execution of the government's fiscal and tax policies. Far from being an infringement of Parliament's jurisdiction, the practice - which rests on the voluntary compliance of taxpayers - enables the legislature to operate more responsively to the needs it seeks to address through the tax system.

Department of Fisheries and Oceans

Project abandoned after expenditure of $2.5 million

The Department of Fisheries and Oceans spent $2.5 million in an attempt to replace an existing information system. The project has not been completed because of poor planning, implementation and control.

2.93 Background. In 1987 the Department of Fisheries and Oceans decided to replace an existing management information system (MIS). This system was supported by hardware that was approaching the end of its life expectancy and was no longer available from the supplier. The replacement was expected to increase the processing speed of the existing MIS by using more technically advanced hardware and software. The system was to consist of a data base, located at headquarters in Ottawa, that would be supplied with information from the regions by a communications link. The originally estimated cost of the conversion was $522,000, with an estimated time for completion of six months.

2.94 Issue. The Department did not conduct a user requirement study, which would have matched the information produced by the system to user needs. It also failed to develop specifications for hardware, software and communication links before beginning the replacement. After a series of attempts at developing the application software, it was established that the system could not perform as required without extensive modifications.

2.95 In 1990 the project management changed, and the new management decided to assess the project to date. By this time the Department had spent $2.5 million dollars including $330,000 for equipment over three years. The assessment revealed that the best alternative was to suspend the project.

Department's response: The Department has reoriented its approach to informatics project management to ensure proper involvement of specialist staff and improved project planning and control that conforms to Treasury Board policies.

Most of the equipment purchased during the replacement project is multi-purpose in nature and is currently being used in the Department.

Department of Industry, Science and Technology

Unnecessary payments made to avoid lapsing funds

To avoid lapsing funds, the Department of Industry, Science and Technology (ISTC) changed its normal cost-sharing practices in several contribution agreements with a number of companies under the Defence Industry Productivity Program. As a result, ISTC spent about $28 million more than it otherwise would have in 1990-91.

2.96 Background. To avoid lapsing funds under the Defence Industry Productivity Program (DIPP), ISTC amended several existing contribution agreements in March 1991 to retroactively increase the amounts it could pay to companies for projects in the fiscal year ending 31 March 1991. These additional payments came to $22.1 million. Roughly one third of these amounts were paid for project claims already fully settled in previous fiscal years.

2.97 The amendments took the form of an increase in the ISTC share of eligible costs, to as much as 90 percent of the claims under these agreements. The ISTC share had previously ranged from 35 to 50 percent.

2.98 In addition, the ISTC share for the 1990-91 portion of a contribution agreement signed on 29 March 1991 was set at 90 percent, rather than 50 percent as had been previous practice with that company. ISTC paid $13.2 million under this agreement in 1990-91. This was $5.9 million more than it would have paid under the normal 50/50 sharing ratio.

2.99 The overall result was that in 1990-91 ISTC spent $28 million more than it otherwise would have under DIPP.

2.100 Forecasting cash flows is difficult in the environment in which ISTC operates. The Department received Treasury Board approval to re-profile to future years $50 million of unspent contribution funds from 1990-91. It reprofiled this amount from programs other than DIPP, and changed the DIPP agreements so that the further $28 million would not lapse.

2.101 The amendments to the contribution agreements call for the companies to repay the increased ISTC share by submitting future claims in the normal way, but accepting an ISTC sharing ratio of zero as of 1 April 1991. This is to continue until the amount of additional funding received in 1990-91 is offset - that is, until the point when company claims and ISTC payments are restored to the sharing ratios in the original agreements. If this were to take between six months and a year, the additional interest cost to the Crown would be between $1 and $2 million.

2.102 As part of its approach, ISTC will ask companies who benefited from these early payments to favourably consider reverse agreements in future projects - that is, for the ISTC share to be lower initially and higher in later years. ISTC will also attempt to recover the interest cost of the early payments as part of this new approach to cost sharing in future agreements. However, ISTC has not obtained specific commitments from the companies who benefited from these arrangements to adjust future agreements in its favour.

2.103 Issue. In our view, retroactively increasing the amount to be paid under signed contribution agreements is not a sound business practice - particularly when the companies involved have not indicated that there was any need to do so. This practice also circumvents the fundamental requirement that unused appropriations should lapse at the end of the fiscal year.

2.104 Although ISTC is attempting to minimize the cost to the Crown of these arrangements, we disagree with this approach to cash management. In our view, it is based on a premise that all funds authorized for a program in a particular year should be spent in that year. This premise is contrary to government policy, which is that the authority to spend does not impose a requirement to spend all of the amount authorized.

Department's response: The Office of the Auditor General has acknowledged that it is questioning neither the legality of the payments nor the due process which was followed in their authorization. Rather, there is a genuine difference of opinion between the Department and the OAG as to whether these cash management arrangements should have been made in the way that they were.

Good business practice has been uppermost in our intentions; namely, to manage appropriated funds to create jobs and to advance the international competitiveness of our clients in a manner consistent with the approved purposes of the DIPP program. We are managing scarce resources in a multi-year time horizon. In our view, we should not be passive observers of events but instead must continuously anticipate and respond to the changing dynamics faced by our clients.

Our cash management initiatives are taken always with a view to incurring little or no additional cost to the Crown, including an appropriate recognition of the time value of money.

Department of National Defence

Need to review the cost-effectiveness of the VIP vehicle fleet at Canadian Forces Base Ottawa

Canadian Forces Base (CFB) Ottawa has a VIP fleet of 17 vehicles divided into a 6-vehicle "taxi" pool and an 11-vehicle VIP pool. The vehicles are available for use by the Department of National Defence (DND) generals and civilian executives and by non-DND VIPs. We found that the "taxi" pool was almost always used by DND personnel below these ranks, and that the VIP pool was used more than 80 percent of the time by generals and executives. Our findings indicate that 5 vehicles would suffice more than 90 percent of the time for transporting non-DND VIPs.

2.105 Background. In general, pay, benefits and other conditions of service in the military are to be comparable with those in the public service, while still recognizing unique military requirements.

2.106 Canadian Forces Base Ottawa has a fleet of 17 vehicles to provide transportation for Canadian and foreign "VIPs". These vehicles are not used by the Minister, the Chief of Staff, or other chiefs of staff who have dedicated vehicles. The Department of National Defence states that it is government policy that a fleet be maintained for non-DND VIPs, and it is DND policy that CFB Ottawa provide duty-related transportation support services for certain DND personnel considered by DND to also be VIPs. They include 55 generals and 69 civilian executives in Ottawa, and similar DND personnel outside Ottawa. These personnel are in the management category of the public service or at equivalent levels.

2.107 All 17 vehicles have drivers on call 24 hours a day, 365 days a year. The vehicles are full-size sedans and cost about $17,000 each. The number of persons assigned to operate the VIP vehicle fleet varies according to workload. On average, the equivalent of about 31 drivers and 2 dispatchers is required to operate the fleet. In 1990 the drivers logged about 6,230 overtime hours, or 19 hours per driver per month. We were told that, from time to time, staff of the VIP vehicle pool are assigned to other duties, such as honour guards, Base Defence Force, work parties, etc.

2.108 The 17 vehicles forming the VIP fleet have been divided into a "taxi" pool and a dedicated VIP pool. Vehicles are assigned to both pools each day.

2.109 The taxi pool has 6 vehicles and is supplemented by private taxis. We found that these vehicles were used only by DND personnel. About 94 percent of the time, the taxi pool is used by DND personnel below the rank of general, or by civilian executives. The Department of National Defence policy requires that a request for such use must be from a person on the authority list for official DND business. Use of the taxi pool is on a first come, first served basis.

2.110 Any request from generals or civilian executives, received 24 hours in advance, is met from the VIP pool. The 11 vehicles in the VIP pool are dedicated for use exclusively by non-DND VIPs or DND generals or executives. In peak periods they are supplemented by rentals, by vehicles from the VIP taxi pool and by other general-purpose vehicle pool resources.

2.111 We reviewed the use of these 11 vehicles and rentals for 1990-91. The 11 vehicles and supplementary rentals were used for about 18,000 hours. About 19 percent of these hours were used to transport non-DND VIPs, and the remaining time was used by DND generals and executives. Most of the non-DND VIP use was from April to July. Our analysis indicates that vehicles were used for non-DND VIPs on 149 days in 1990-91. We found that DND rented vehicles on 90 days (totalling 305 rental days), at a cost of about $8,000, to supplement VIP fleet vehicles.

2.112 During 1990-91 there were 3,519 trips, or about one trip a day per car. Trips ranged from one to 24 hours. Information on specific destinations was available for about 90 percent of the trips. The other 10 percent were logged in "as directed". More than half (54 percent) of the trips for which destination information was available were to residences or airports. A typical trip required the driver to be available one hour before the vehicle needed to leave the base. The vehicle was driven from the CFB Ottawa near the Ottawa airport to the location of the user, and then to the user's destination, waited at either or both locations, and was driven back to the base and usually washed.

2.113 Issue. The use of the VIP fleet by non-DND VIPs never exceeded the availability of the existing 17 VIP fleet vehicles during the fiscal year. We found that a fleet of 3 vehicles would be sufficient to provide transport for VIPs about 78 percent of the time. A fleet of 5 vehicles would suffice 91 percent of the time. These findings indicate that the number of vehicles in the total VIP fleet could be reduced from 17 to 5 or even 3, if the fleet provided service only to non-DND VIPs. These vehicles, with supplementary rentals, could provide transport to such VIPs. In view of these findings, we recommend that DND review the cost-effectiveness of the CFB Ottawa VIP fleet.

Department of National Health and Welfare

Demonstrated disregard for control framework

In an effort to obtain better value for money, the Department entered into an arrangement with a private sector firm to provide travel services to consultants and Department employees. In doing so, Department managers operated beyond their authority and breached numerous policies and directives in place to control the management of cash, contracting, travel and financial-reporting practices.

2.114 Background. This year the Income Security Programs (ISP) Branch of the Department of National Health and Welfare (NHW) completed the planning phase of the ISP redesign project. This is a multi-year project intended to upgrade the systems and delivery aspects of the Old Age Security and Canada Pension Plan programs.

2.115 The planning phase of the redesign project was to involve a significant amount of travel for both contractors and NHW employees. In an attempt to minimize costs, an early decision was taken to investigate the possibility of arranging cost-beneficial travel services by ensuring that lowest logical airfares were always obtained and by prepaying the travel costs.

2.116 In July 1990 arrangements were finalized with a firm that promised to turn a prepayment of $500,000 into $633,000 worth of travel. This would be accomplished by offering lowest logical airfares and by applying interest earned on the monthly balance of the account toward travel costs.

2.117 In February 1991 the assistant deputy minister of the ISP Branch requested that an internal audit be conducted, to determine the validity of charges to the travel account and the value for money obtained by the Crown as a result of the travel arrangements. That report, dated June 1991, was accepted by the ISP Branch management and contained management responses to the audit findings. Our observations are based on the results of that audit and, as required for purposes of reliance, we completed a review of the supporting audit files and satisfied ourselves that the work was carried out in accordance with appropriate professional standards.

2.118 Issue. The Treasury Board (TB) travel directive requires that all commercial air travel for public servants be reserved through the Government Travel Service unless otherwise authorized by the TB. Although the contract does not say that NHW employees would receive travel services, the audit report response by ISP Branch management acknowledges that they knew and intended all along that the contract was to pay for public servants' travel. Department management believed that the contract complied with the TB policy because it had been let by the Department of Supply and Services (DSS). The contract was not authorized by the Treasury Board, however, and therefore did not comply with the policy.

2.119 The internal auditors concluded that none of the conditions in the DSS contracting policy that would justify advance payments had been met, and that there had been no justification for an advance payment in the full amount of the contract. The required TB approval for such an advance payment was not obtained. The original agreement did not provide for an advance payment and the amendment to that effect was not signed until 23 May 1990.

2.120 Additionally, the Department does not have net-voting authority; thus, revenues earned must be credited to the Consolidated Revenue Fund (CRF) and are not available to the Department to increase program funding. Such authority must be specifically granted by Parliament. Over the 13-month course of the contract, the advance payment earned $59,000 interest, which was credited to the travel account and not the CRF. This interest was not reported in the Public Accounts as revenue.

2.121 The TB Guide on Financial Administration directs that cheques be mailed directly to the payee and never placed in the hands of persons who have been involved in the procurement or requisitioning process. In this case, the cheque was taken to Toronto by an employee who was very much involved in the process, and was deposited on 4 May 1990 at a local bank for later release to the firm providing the travel services. The auditors also concluded that the advance payment was not properly protected by a performance bond during that period, as was required.

2.122 Although the advance payment was requisitioned on 26 March 1990, the funds were not received by the firm until 18 July and NHW did not sign the final agreement until 23 July. The internal auditors concluded that the contract control processes of the Department had failed to ensure the financial prudence and probity of this transaction. Department management responded in the audit report that steps were taken in the fall of 1990 to strengthen the Branch's contract review process.

2.123 The Department reported the expenditure for the advance payment incorrectly in the 1989-90 Public Accounts. The $500,000 was recorded as a 1989-90 expense for professional services rather than for transportation costs. In addition, the travel charged against the account actually took place in 1990-91 and, at the end of that fiscal year, $350,000 of the advance still remained unspent. In June 1991 the Department recovered $348,026 representing the balance of the account, including all accrued interest, and deposited it to the CRF.

2.124 Did the Department, after all, obtain better value for money? The internal auditors reported that the travel services obtained under the arrangement cannot be shown conclusively to have realized actual savings. However, they did find that the travel transactions tested were all related to valid and legitimate ISP redesign business; the class of air travel used was consistent with TB policy; and charges to the account were accurate. There was no loss to the Crown.

2.125 Conclusion. Managers of the ISP redesign project did not fully investigate and comply with all requirements, in their efforts to obtain better value with the resources available to them. Although the internal audit found that there was no fraudulent intent, the nature and extent of the instances of non-compliance displayed a disregard for the control framework that was in place. Management's intent should be to encourage innovative and cost-effective program delivery within the bounds of existing control frameworks or to seek relief from those controls if they can be shown to be an unreasonable constraint.

Department of National Health and Welfare

Late payment of supplier invoices continues, and interest costs remain high

Interest costs incurred by the Department of National Health and Welfare (NHW) due to late payment of supplier invoices have escalated to $686,000 for the fiscal year 1990-91. Over the last five years, failure to pay supplier accounts on time resulted in payment by the Department of $2.5 million in interest charges, which could have been spent more productively for program purposes.

2.126 Background. In 1985 the Treasury Board introduced a new policy for the settlement of contractual commitments. The purpose was to promote good cash management by departments when paying for goods and services and to fairly compensate suppliers when payment was unavoidably delayed. Effective 1 April 1986, this became the payment-on-due-date (PODD) policy.

2.127 Under this policy, payments are to be scheduled as close as possible to, but no later than, a standard payment period of 30 days. Departments are to ensure that their systems and procedures are designed to meet this standard.

2.128 If payment is not made within 15 days after the 30-day payment period, interest is automatically calculated and paid on overdue supplier accounts, unless specifically exempted. Interest has been paid in accordance with the PODD policy for the past five years.

2.129 Ranked in terms of the amount of interest paid, NHW is the third-highest of all federal departments, accounting for approximately 10 percent of the total interest cost. The Department is also third-highest on the basis of the percentage of invoices paid after 45 days.

2.130 Issue. Under PODD some $500 million of NHW's expenditures for goods and services could attract interest charges if paid late. Of this amount, $300 million relates to non-insured health benefits (NIHB) - health-related goods and services provided by the Department to status Indians and to Inuit. The current level of interest paid indicates that roughly 20 percent of payments - $100 million - are made more than 45 days after the invoice is received.

2.131 We were able to identify the branches and locations where significant interest costs were incurred. We then tested a sample of transactions that had given rise to interest charges during 1990-91, in an effort to identify the underlying causes of late payments.

2.132 In some cases, procedures for the verification and payment of invoices led to delays; in other cases, staff was insufficient to process the volume of transactions. Late payments were most commonly related to drug invoices received from pharmacies, and to invoices associated with other high-volume, non-insured health benefits. Two thirds of the 1990-91 interest cost resulted from late payment of NIHB invoices by regional offices across the country. The proportion of late payments related to NIHB has increased over time.

2.133 For the last three years, we have monitored the Department's high interest costs and discussed our concerns with NHW officials. Each year, we have been told that procedural problems have been identified and corrective action taken. However, interest costs have still exceeded $650,000 for each of the last three years. Management attributes this to the increased volume of NIHB invoices and the impact of interest rate fluctuations.

2.134 The Department's response to the NIHB problem has been to contract out the verification and payment of these invoices to private sector firms. This was effected for dental services in 1987 and will be completed for pharmacy services in 1992. Under these arrangements, the Department is not liable for any interest costs incurred by the contractor.

2.135 Most of the remaining one third of interest costs can be traced to the processing of other commercial-supplier accounts by the Department's accounting unit in Ottawa. There was a marked improvement in performance during the past year, and a new invoice tracking and monitoring system is to be operational in October 1991. The Department believes that the reporting of late processing to the responsible parties, via the assistant deputy ministers, will reduce these interest costs to an acceptable level.

2.136 We were informed that, due to the initiatives noted above, a gradual decrease in interest costs can be expected to begin in 1991-92. Department managers emphasized, however, that this planned decrease will also be affected by interest rates in effect during the year, a variable that they cannot control.

2.137 Conclusion. Management at the Department of National Health and Welfare has so far been unsuccessful in reducing the amount of interest paid on overdue accounts to a reasonable level. Appropriate attention to this issue could enhance relations with the Department's suppliers, and should achieve a substantial - not gradual - reduction in its interest costs. Non-productive interest payments could instead be turned into money available for program purposes.

Department Of National Health And Welfare

There is significant overpayment and underpayment of benefits each year in the Department's Guaranteed Income Supplement program

An application process based on self-declaration of income, coupled with inadequate procedures for the assessment and verification of entitlement, results each year in significant overpayment and underpayment of Guaranteed Income Supplement benefits. The Department estimates that overpayments and underpayments were as high as $66 million and $22 million respectively in 1990-91. Many of these payments could be identified and corrected with the timely implementation of current initiatives.

2.138 Background. The Department of National Health and Welfare is responsible for matters related to promoting and preserving the health, social security and social welfare of all Canadians. The Income Security Programs Branch of the Department administers a number of programs designed to help Canadians maintain and improve their income security. One of these is the Guaranteed Income Supplement (GIS), which provides payments to Old Age Security recipients on the basis of their income. The Spouse's Allowance complements the GIS by extending the supplement to spouses of pensioners and to widows and widowers aged 60 to 64. The following references to GIS include Spouse's Allowance payments and recipients.

2.139 The GIS is a substantial pension expense. In 1990-91, some 1.5 million recipients received payments totalling $4.5 billion. The maximum annual benefit paid to a single pensioner in that year was $5,000. The supplement is reduced by one dollar for every two dollars of income; therefore, a pensioner with annual income in excess of $10,000 is not entitled to receive any supplement. The GIS entitlement is added to the Old Age Security pension amount and paid monthly.

2.140 Pensioners must apply for the supplement annually. An application stating the previously declared income, broken down into nine categories, is mailed to recipients in January, requesting the pensioner to update the income information. Most applications are returned by March. Generally the supplement entitlement is determined based on the previous year's income as declared by the applicant.

2.141 Issue. The Department can review the reasonableness of declared income at the time of application approval, but we found that the rigour of this review varied from region to region and even within regions. Different supervisors set varying levels and extents of income review. The result is that year-to-year income variances may be scrutinized quite closely, or not at all. A more uniform and rigourous review of declared income at the time of initial assessment could limit the size of overpayments and underpayments.

2.142 The Department is authorized by the Old Age Security Act to obtain income information for GIS recipients and their spouses from the Minister of National Revenue, and the annual application requires a signed acknowledgement to that effect. A GIS recipient's income, as declared on the application, is matched with the income assessed on the income tax return. The most commonly under-reported income relates to interest and dividends.

2.143 The coverage of this matching, however, is limited to only 750,000, or one half, of those receiving supplement payments. The other half are not matched because they do not have or provide a social insurance number, do not file an income tax return, or file late, after the matching has been done.

2.144 Of the 750,000 recipients whose income declaration is matched with the tax records, the Department investigates all income variances exceeding a predetermined amount. In 1990-91 more than 70,000 accounts were investigated; overpayments of $13.4 million and underpayments of $4.7 million were identified. Over the last five years, the Department has identified overpayments totalling $51 million and underpayments of $17 million. There has been a fairly consistent three-to-one ratio of overpayments to underpayments over this period.

2.145 In addition to the recipient accounts that have not been matched and those with no income variance, there is also no investigation of the roughly 500,000 accounts with variances smaller than the predetermined amount. Overall, only five percent of the total GIS accounts are subject to detailed income verification. We are of the view that a large number of overpayments and underpayments consequently remain undetected. The Department has referred to the current extent of verification as only the tip of the iceberg.

2.146 The Department estimates that the value of all overpayments in 1990-91 alone was in the range of $35 million to $66 million. Using the three-to-one ratio, underpayments in the same period would have been between $12 million and $22 million.

2.147 The Department recognizes the significant net cost of these overpayments and underpayments and is involved in two initiatives to improve the effectiveness of income verification. One is a cost-benefit review of the predetermined amount used to indicate when detailed investigation is warranted. The second is an effort to increase the number of recipient accounts subject to the match with income tax records.

2.148 The Department also recognizes the negative impact on client satisfaction that can result from the payment and subsequent adjustment of incorrect benefit amounts. The initiatives it is taking will aid in the detection of overpayments and underpayments, but will not prevent their occurring in the first place. Overpayments and underpayments will remain a problem so long as entitlement is based on self-declaration of income.

2.149 Conclusion. The Department does not have adequate procedures to minimize these incorrect payments at the time of application approval. As a result, some eligible Canadians are not receiving the pension supplement to which they are entitled under the legislation. With the timely implementation of its current initiatives, the Department could identify and investigate additional overpayments of up to $30 million and underpayments of up to $10 million annually.

Department of National Health and Welfare

$489 million overpayment to provinces resulted from failure to properly estimate advance contributions payable under the Canada Assistance Plan

The Department of National Health and Welfare did not take into account the limitation imposed by the Government Expenditures Restraint Act in estimating the advance payments due to certain provinces in respect of the Canada Assistance Plan. Contributions for fiscal year 1990-91 made under the Canada Assistance Plan to the three provinces affected by the Act exceeded the limit of five percent over 1989-90 expenditures imposed by Parliament; a $489 million overpayment resulted.

2.150 Background. The Canada Assistance Plan was enacted in 1966. It authorizes the Government of Canada to enter into agreements with provincial governments for the payment of contributions that match provincial expenditures on social assistance and welfare services, as defined in the Plan. Section 5 of the Plan authorizes payments to the provinces pursuant to such agreements. Regulations pursuant to the Plan provide for the timing and method of claiming contributions and paying advances on them. Provinces may continue to submit claims for a period of one year after the fiscal year to which they relate, or such longer period of time as the Minister may permit. The Department of National Health and Welfare is responsible for authorizing payment of these contributions, or advances, out of the Consolidated Revenue Fund. In 1990-91 payments to all provinces amounted to $5.9 billion.

2.151 In February 1990 the federal government announced expenditure measures intended to reduce the federal budget deficit. One feature of the government's expenditure control plan was a limitation on the growth of the payments made under Section 5 of the Canada Assistance Plan to financially stronger provinces. Such payments were to increase by no more than five percent per annum for fiscal years 1990-91 and 1991-92. The provinces affected are those that are not entitled to receive equalization payments from the government -- currently, British Columbia, Alberta, and Ontario. This change was embodied in Bill C-69, introduced in the House of Commons on 15 March 1990.

2.152 Shortly before Bill C-69 was introduced in Parliament, the Province of British Columbia asked the British Columbia Court of Appeal whether the Government of Canada had any authority to limit its obligations under the Canada Assistance Plan, and whether the terms of the Agreement pursuant to the Plan between the Governments of Canada and British Columbia gave rise to a legitimate expectation that the Government of Canada would not seek to limit its obligations under that Agreement without the consent of British Columbia. In June 1990 the Court, in answering these questions in favour of the Province, decided that the provinces had a right to expect that the federal government would not take unilateral action. The federal government appealed the findings of the British Columbia Court of Appeal to the Supreme Court of Canada. The federal Minister of Justice indicated publicly that Canada would abide by the spirit of the B.C. decision, pending the appeal to the Supreme Court.

2.153 The appeal was heard in December 1990. Department officials informed us that although Bill C-69 had proceeded through the legislative process in the House of Commons before the Supreme Court hearing, amendments had been prepared to be tabled when the Bill was considered in the Senate, which would have allowed for a separate coming-into-force provision for the amendments to the Canada Assistance Plan. However, Bill C-69 passed through the Senate without these amendments being included, and the legislation was given Royal Assent on 1 February 1991. Following Royal Assent, the Minister of Justice wrote to the Attorney General of British Columbia stating that, pending the Supreme Court of Canada ruling on the matter, payments would occur in the normal fashion subject to any adjustments that would be required as a result of that decision. In the Minister's view, there was no legal impediment to this arrangement.

2.154 The decision of the Supreme Court of Canada was rendered on 15 August 1991. It reversed the decision of the British Columbia Court of Appeal and found that Canada did have the right to limit, by legislative amendment, the amount of money payable under the Canada Assistance Plan.

2.155 Issue. The Government Expenditures Restraint Act obliged the federal government to ensure that the payments to the provinces affected did not exceed the limit of five percent over 1989-90 contributions. After receiving advice from the Department of Justice, the Department of National Health and Welfare continued to make payments after Bill C-69 received Royal Assent, exceeding the limit imposed in the Bill through the amendments to the Plan.

2.156 Department officials advised us that, in addition to the issue of the legality of the restrictions imposed by Bill C-69 being before the Supreme Court of Canada, that at that time (February 1991), the figures for 1989-90 had not yet been finalized. It was therefore not possible to say with certainty what the ceiling on 1990-91 contributions would be. As well, they pointed to the Regulations, which allow the adjustment of accounts for a period of time after the end of the fiscal year and provide for recovery of any overpayments against future payments. Department officials further advised us that it was their intention, and remains their intention, to recover any overpayments through this process.

2.157 Although the 1989-90 base year amounts may not yet be finalized, the Regulations pursuant to the Canada Assistance Plan require that, with respect to the payment of monthly advances under the Plan, the Minister may pay each month only one twelfth of the most recent estimate of the contribution to which a province is entitled for that year. In February 1991 following the enactment of Bill C-69, the Department prepared an analysis based on its current estimate of 1989-90 contributions. It indicated that 1990-91 contributions had already exceeded the five percent limit by $173 million. Nevertheless, the Department continued to make payments and the excess contribution for that fiscal year to 15 August 1991 amounted, in total, to an estimated $489 million. In our view, the February 1991 analysis constituted a sufficiently reasonable estimate to enable the Department to adjust monthly payments to certain provinces, in accordance with the Government Expenditures Restraint Act.

2.158 Conclusion. With the passage of the Government Expenditures Restraint Act, there was a requirement for the Department to ensure that contributions did not exceed the legislated limit. However, the Department's interpretation of the legislation was that, until 1989-90 expenditures were finalized and pending the decision of the Supreme Court of Canada, no limitation on contributions payable should be imposed. Consequently, the Department made payments of $489 million that were in contravention of the Canada Assistance Plan. This overpayment resulted in an interest-free advance to the provinces concerned, and the government's 1990-91 expenditures were not reduced as intended.

Department of National Revenue - Taxation

Concerns about specific matters related to the administration of the Income Tax Act

2.159 Reported below are a number of specific matters related to the Department of National Revenue - Taxation's administration of the Income Tax Act . They should not be used as a basis for drawing wider conclusions about matters we did not examine.

Certain issues have not been resolved in a timely manner. Two significant issues involving the insurance industry were under review for a long period of time.

2.160 Background - Disposition of investments in the insurance industry. For the past twenty years, insurance companies have generally enjoyed capital gains treatment on the gains and losses from the disposition of their investments. In the insurance business the amount of risk assumed always exceeds premium income and usually exceeds the total assets of the company. It is argued that investments support underwriting and therefore form part of an insurer's ordinary business. For other taxpayers, gains or losses on investments that are part of ordinary business activities do not, as a general rule, enjoy capital gains treatment.

2.161 In 1983, as a result of a Federal Court (Trial Division) decision, the Department of National Revenue - Taxation (NRT) decided that it should review whether it could treat such gains by insurance companies as income instead of capital gains.

2.162 Issue. It took until December 1990 for NRT to conclude that an insurance company's gains or losses on investments that are part of ordinary business activities should not, as a general rule, enjoy capital gains treatment.

2.163 Background - Insurance funds. To gain a tax advantage, a few corporations have set up employee insurance plans having higher policy premiums than are required. The excess premiums not needed to pay claims and the interest thereon accumulate tax-free. This arrangement enables the corporation to deduct the excess premiums and the insurer to deduct the interest paid on them.

2.164 One fund we looked at had assets valued at over $125 million. Using a federal and provincial income tax rate of 50 percent, the corporation's reduction in taxes otherwise payable would be about $63 million. The Department of National Revenue - Taxation has protected its ability to reassess for certain of the taxation years involved.

2.165 Legislative amendments were made in 1987 to stop this type of abuse.

2.166 Issue. The Department of National Revenue - Taxation has been reviewing this issue since 1984.

Department's response - Disposition of investments in the insurance industry. A review of the taxability of the proceeds on disposition of investments by the insurance industry commenced in July 1987 and ultimately recommended that in some cases the gains (or losses) should be considered on account of income, rather than capital, and be included in income. Note this relates to investments other than Canada Securities which are dealt with specifically in the Income Tax Act and are required to be included in income on disposition.

The scheme of the Income Tax Act for life insurance companies provided for the inclusion in income of gains or losses on the disposition of Canada Securities. Also, "gross investment revenue" of an insurer is defined and does not include gains on disposition of investments. The industry self assessed on the basis that proceeds of investment, other than Canada Securities, were on account of capital. It was assumed that investments are generally held for lengthy periods of time and that the insurer does not deal in the investments in the ordinary course of business. Also, Parliament appeared to be specific as to which investments, Canada Securities, were to be taxed on income account.

With respect to the issue of the character of proceeds of investments, income or capital, the review conducted by the Department involved consultations with the insurance industry who made extensive representations on the issue. In December 1990 the insurance industry was advised that generally gains or losses arising on the disposition of property would be considered on account of income. However, depending upon the facts, a company can take the position that it is on account of capital and these cases will be examined.

Whether proceeds on disposition of investments are on account of capital or income is a question of fact and law in each particular case. Although the Department has advised it is of the view that in most cases they are on account of income, ultimately the Courts may decide in particular cases.

This review was conducted at the same time as tax reform, which pointed out that deficiencies in the rules pertaining to major life insurance companies permitted the major companies to avoid taxation in Canada which was corrected by changes in legislation.

Given the income tax structure prior to tax reform any inclusion of gains or losses would have been nullified by the rules in force at the time.

Department's response - Insurance funds. This is a most complex matter which has been the subject of extensive review, legal analysis, and representations have been made that are ongoing. The parties, the contributor and the insurer, dispute that they have access to the employee benefit funds and are therefore not taxable. With respect to years prior to 1987 the Department has protected its position and may issue assessments. It is expected this matter will be brought to an early conclusion and it may have to be resolved by the Courts. In the meantime a legislative amendment in 1987 has prevented recurrences.

Certain assessing procedures need improvement. Assessing procedures have not been sufficient to secure an effective check on the right of taxpayers to claim Northern Tax Benefits and Political Contributions Tax Credits.

2.167 Background - Northern Tax Benefits. The Income Tax Act provides for a special deduction for employee travel benefits and living costs of individuals residing in certain northern or isolated regions.

2.168 When the measure was introduced in February 1986, the Department of Finance estimated that the annual cost in foregone federal income tax revenue would be about $130 million for the 1989 taxation year. We were advised that the costs for the 1989 taxation year were double the original estimate or approximately $260 million (about $1 billion in deductions at an estimated federal tax rate of 26 percent).

2.169 2.169 The Department of National Revenue - Taxation operates a compliance program of post assessing. Certain initially accepted claims for deductions, exemptions or credits are selected for a secondary review - comparing prior year returns or seeking additional information from taxpayers.

2.170 Claims for Northern Tax Benefits for the 1987 and 1988 taxation years were subjected to a limited review during the initial assessment process; a limited number of claims were later subjected to post assessing activities, using about 11,000 direct person-hours annually and producing additional federal and provincial income taxes of about $5.4 million for 1987 and $5.1 million for 1988. This represented a recovery of taxes of about $500 per direct person-hour of post assessing.

2.171 Issue. The Department of National Revenue - Taxation advised us that resource constraints had precluded post assessing of 1989 taxation year claims. In light of this, we find that NRT was unable to apply sufficient procedures for the 1989 taxation year to secure an effective check on the right of taxpayers to claim Northern Tax Benefits.

2.172 Background - Political contributions tax credit. Contributions to federally registered political parties and to officially nominated candidates for election to the House of Commons can yield a maximum federal tax credit of $500. In 1988 the program's estimated cost was $18.6 million in federal tax credits.

2.173 Issue. A key legislative control is the requirement that a taxpayer file a receipt with an income tax return to claim the federal tax credit. Although NRT does examine receipts filed with income tax returns, it does not have an appropriate audit program to verify their validity. As a result, in our view procedures have not been sufficient to secure an effective check on the right of taxpayers to claim federal tax credits for political contributions.

2.174 The legislation limits tax support to federally registered political parties and officially nominated candidates in federal elections. However, the law permits money to be channelled through registered parties to candidates in provincial or municipal elections or to others.

2.175 In addition, reporting to the Chief Electoral Officer has not been done in accordance with the law. The Income Tax Act requires NRT to periodically forward a report to the Chief Electoral Officer setting out the aggregate of amounts contributed to each registered party and to each candidate in a federal election. Instead, NRT has been reporting the aggregate of amounts contributed to all candidates belonging to each of the various parties.

Department's response - Northern Tax Benefits. The Department has to balance its activities in compliance verification taking into account the risk of non-compliance and the resources available. Initial and post assessing verification checks were carried out in 1987 and 1988 with respect to Northern Tax Benefits claimed. In 1989 initial assessing verifications checks were performed as well as a review program based on computer selection. The computer-generated selection, which is based on a number of comparisons, indicated a reduced risk of non-compliance in this area in 1989. As a result, enforcement resources were deployed to other activities.

Department's response - Political contributions tax credit. The Department ensures that the political contributions tax credit is properly supported by a tax receipt filed with the income tax return and is satisfied that this is a sufficient check on the appropriateness of the claim. Any indication that the receipts are improper or invalid will be followed up vigorously. The Income Tax Act provides for this tax credit based on a contribution to federally registered political parties and officially nominated candidates in federal elections. The intention is that funds contributed to federally registered parties or to officially nominated candidates are for federal elections; however, there are no specific restrictions in the Income Tax Act on the disbursement of these moneys. The Department has brought this to the attention of the Chief Electoral Officer and the Royal Commission on Electoral Reform.

The information that political parties must provide to both Revenue Canada, Taxation and the Chief Electoral Officer is identical in many respects. As a result, this Department has had ongoing discussions with Elections Canada officials concerning the reporting and filing requirements for political parties and candidates for election. These matters are still under active consideration by this Department. In the meantime, the Department will continue to submit reports to the Chief Electoral Officer as described and required under subsection 230.1(4) of the Income Tax Act.

Department of the Secretary of State

Excess Canada student loan amounts awarded in 1989-90 could cost taxpayers an estimated $39 million

The results of our statistical sample, covering five provinces for the loan year 1989-90, indicate that as many as 47,000 full-time students received Canada student loans that exceeded, by $72 million, the amounts to which they were entitled. The lack of legislative and administrative provisions to identify and recover those excess amounts could result in a cost to the taxpayers that we estimate could be approximately $39 million.

2.176 Background. Under the Canada Student Loans Act , the federal government guarantees loans made by lending institutions to students who have been issued a Certificate of Eligibility by a participating province or territory. The provinces combine the Canada Student Loans Program with their own programs of loans, grants and scholarships. They assess student applications and approve federal loans according to an official administrative agreement with the Department of the Secretary of State.

2.177 The amount of a loan, grant and/or scholarship depends on a student's educational fees, living expenses, and financial resources, including support from a spouse or parents where applicable. The student, spouse, and parents are required to sign an approval form for release of tax information, thereby allowing the province to verify all income data relating to the loan application.

2.178 Canada student loans are given to approximately one third of full-time students registered in universities and community colleges throughout Canada except in Quebec and the Northwest Territories, which have opted for alternative payments and manage their own programs. In 1989-90, for the five provinces selected, 173,000 full-time students received guaranteed loans totalling $466 million.

2.179 The interest on a Canada student loan is paid by the Department of the Secretary of State so long as the student continues to attend school, and for six months after the completion of studies. The Canada Student Loans Program also provides for an additional 18-month interest-free period, should the borrower be unemployed or unable to work because of illness or incapacity.

2.180 We conducted a value-for-money audit of the Canada Student Loans Program in fiscal year 1989-90. Part of our audit focussed on compliance with the legislative and administrative requirements dealing with criteria used to assess the financial needs of full-time students. We reported in 1990 (paragraph 29.76) that neither the Canada Student Loans Act nor the federal-provincial agreement requires provinces to identify and recover excess amounts in Canada student loans. Provinces do, however, recover excess provincial grants and loans.

2.181 Our audit objective this year was to determine, for loan year 1989-90 in the five provinces selected, the extent of excess loan amounts resulting from understatement or misrepresentation of financial resources by students at the time of their loan applications, and the consequent costs to taxpayers.

2.182 From a statistical sample of 408 students in the five provinces, our audit disclosed that 111 students (27 percent of our sample) understated or misrepresented their financial situation or did not, as per the terms and conditions on the loan application, advise the province of any increase in their resources.

2.183 Issue. Applying the results of our statistical sample to the total population of 173,000 for the five provinces indicates that, in 1989-90, as many as 47,000 full-time students received Canada student loans of approximately $72 million in excess of the amounts to which they were entitled. Although we believe that similar results existed in previous years, our audit was limited to 1989-90 due to the cost and difficulty of obtaining the necessary information.

2.184 The cost to taxpayers for each dollar of loan guaranteed by the Department in that year is estimated at 54 cents. This unit cost includes payments to lenders for interest and claims for default, alternative payments to Quebec and the Northwest Territories, collection costs, and other program costs. On this basis we estimate that awarding the excess Canada student loan amounts in 1989-90 could cost approximately $39 million.

2.185 In our opinion, there is an urgent need, without infringing on the rights of individuals who are entitled to loans, to:

seek revision of the Canada Student Loans Act and provide regulations with respect to the recovery of loans in excess of need;
review the administrative agreement with the provinces to clarify provincial responsibility for identifying and recovering excess amounts related to Canada student loans; and
implement proper mechanisms to monitor compliance with these revisions.

Department's response: We agree. The Department is working with its legal advisors and the provinces to implement the necessary legal and administrative changes, and consequently, will improve internal control mechanisms.

Department of Transport

Limited consideration of risk in entering into a land-lease agreement

The Department of Transport entered into a land-lease agreement in 1988 without adequately considering the risks related to the feasibility and financial viability of the proposed use of the land. As a result, expected revenues may not be realized and/or additional costs may be incurred.

2.186 Background. In 1987, as part of its ongoing efforts to commercialize operations at airports, the Department of Transport called for tenders to lease land for the construction and operation of major hotels at five airports across Canada (Vancouver, Regina, Ottawa, Dorval and Halifax). Pursuant to the call for tenders, the only valid bid received was for developing a hotel at Halifax International Airport.

2.187 In October 1988 the Department entered into a 41-year land lease agreement with the developer for the construction, maintenance and operation of a $20 million hotel at the airport. The agreement specified that, for the first year, the Department would receive only land rental and an airport maintenance charge; for the remainder of the lease, it would receive five percent of the annual gross revenue or an annual minimum guarantee, whichever were greater. The minimum guarantee for the second to the sixth year would total $750,000 for the five-year period.

2.188 Construction by a general contractor was to begin in May 1989; it eventually started in May 1990. In December 1990 the general contractor stopped construction and filed a lawsuit against the developer for non-payment of $3.5 million of the $4.5 million expended to that date. Construction has not resumed. As of 31 August 1991, the developer was up-to-date in payments to the Department for the land rental and airport maintenance charge.

2.189 Issues. Prior to entering into the lease agreement in October 1988, the Department:

did not ensure that the developer had done a study to determine the feasibility of having a hotel at Halifax International Airport and did not update one done 12 years earlier by a firm of consultants at the request of the Department. To not undertake a feasibility study was contrary to its own standards. In 1989, the Department re-emphasized the need for feasibility studies.
did not ensure that its concerns at the time of an earlier bid, in 1984, were no longer valid. Some of those concerns related to the financial viability of the project and its possible impact on off-airport competitors, including a hotel situated adjacent to the airport that had previously received federal financing for its development.
did not assess the financial viability of the project or adequately challenge the assumptions and information supplied by the developer in his forecast statement of operations. For example, the developer stated that he was using below-market rates for the first three years of operations, i.e. three percent mortgage financing. In addition, the Department did not obtain a forecast statement of operations that was based on payment terms specified in the lease agreement.
did not obtain a letter from a surety or guarantee company indicating that a surety bond for 50 percent or more of the total contract price, as required under the terms and conditions of the draft lease, would be provided on notice of award of the lease.
did not obtain adequate assurances that financing had been or would be arranged.

2.190 The lease agreement was amended in May 1990 due to construction delays. Before amending the lease and allowing construction to start, the Department again did not ensure that the developer had secured financing for the project.

2.191 The lease agreement and the amendment received ministerial, Treasury Board and Governor in Council approval. The information submitted by departmental officials for the approval of the amendment indicated that the Atlantic Canada Opportunities Agency would not grant financing to the developer because of changes in the Agency's funding criteria. However, the reason the Agency had given the Department was that an increase in the supply of accommodation units was not warranted and that, in its opinion, the proposed hotel would have a significant adverse impact on the existing hotel market. The Agency's reason for rejecting the developer's application was the same as one of the reasons the Department gave in 1984 when it rejected the developer's earlier proposal to build the hotel.

2.192 Additional concerns are that the Department:

obtained surety bonds from the general contractor but failed to obtain them from the developer, leaving only a $100,000 security deposit from the developer as protection in the event of non-performance.
did not include in the lease agreement a penalty clause in relation to any unreasonable delay in completing the construction of the hotel.

2.193 We were advised by the developer on 2 October 1991 that he had a feasibility study carried out, which was completed on 3 October 1988.

2.194 Conclusion. The Department did not adequately consider the risks related to the feasibility and financial viability of a project involving the construction of a major structure. As a result, expected revenues may not be realized due to delays in the start of hotel operations, and/or additional costs may be incurred to deal with the partially completed structure, if the lease is terminated.

Department's response : The OAG report suggests that actions of the Department have placed the Crown at risk. The major portion of risk, in this situation, has been borne by the Lessee. The Department chose to rely on the assessment of risk by the industry, as the Lessee, not the Department, was investing the risk capital in the development. By pursuing this project in the manner that it did, the Department has received rent for over a year, and it continues to collect monthly payments on the current annual $100,000 minimum guarantee. The Department also holds $100,000 in cash as security.

While the Department did not obtain a letter from a surety or guarantee company on notice of award of lease, the Department did obtain the required surety bonds prior to any construction on the leased land. In addition, the bonds taken out were for more than 50 percent of the total contract price.

The Department acknowledges that a Lessee's bond or similar guarantee would lessen the Crown's risk and is presently studying this option. However, the Department is concerned that attempts to further reduce the risk associated with commercial ventures may result in no new commercial development at almost all Transport Canada Airports. Had the Department insisted on a guarantee inconsistent with industry practices it is unlikely that the Hotel Project would ever have proceeded. It is difficult to understand how the Crown or local industry would benefit from such a situation.

It was interesting to note that the 1990 OAG Annual Report recognized the "fast-paced, highly commercial" environment of airports, the need for "flexible decision making" and a commercial-oriented management approach. Progress, in the commercial world, implies some degree of risk taking. This OAG audit note, in Transport Canada's view, implies an excessive elimination of risk taking.

Office of the Superintendent of Financial Institutions

Earlier billing of financial institutions for the cost of supervision and regulation could save the federal government at least $1 million annually

The Office of the Superintendent of Financial Institutions (OSFI) recovered $36 million, or 92 percent of its total expenses, from the financial institutions it supervised in 1989-90. However, the interim and final billings for its expenses are not sent until after the end of the fiscal year, even though the Office of the Superintendent of Financial Institutions Act allows OSFI to prepare an interim assessment during the fiscal year. As a result of OSFI's not preparing the interim assessment during the fiscal year, based on estimates of expenses, and not billing the financial institutions, the federal government's interest costs are increased by at least $1 million per year. If OSFI sent interim billings on a quarterly basis during the fiscal year, interest savings could be doubled. Further savings could be achieved if interim billings were sent more frequently.

2.195 Background. Under its Act, OSFI is required to determine by 31 December of each year the total expenses it incurred during the fiscal year immediately preceding, in connection with administering the various Acts for which it is responsible. The expenses are then allocated among financial institutions and recovered from them, based on formulas specified in the legislation and regulations. The total expenses incurred by OSFI for 1989-90 were $39 million, of which $36 million, or 92 percent, was recovered from the financial institutions. The balance of its expenses, for providing actuarial services and administering certain government pension plans, was not recoverable.

2.196 In our 1986 Report, we recommended that the Department of Insurance adopt the practice of billing all recoverable costs as they are incurred. In 1987 OSFI was created as an amalgamation of the Department of Insurance and the Office of the Inspector General of Banks. The enabling legislation allows OSFI to prepare an interim assessment for each institution. In our 1988 follow-up we noted that OSFI had commenced sending interim billings. At present, it sends the interim billings -75 percent of the estimated final expenses - to the institutions in May of the year immediately following the related fiscal year. The final billings are sent in September of that year.

2.197 The Office of the Superintendent of Financial Institutions receives interest-free advances from the Consolidated Revenue Fund to defray its operating expenses. If it were to send interim billings to financial institutions early in the related fiscal year, the need for advances from the Consolidated Revenue Fund would be substantially reduced, thereby resulting in interest savings to the federal government.

2.198 Issue. The present practice of sending the interim billings after the end of the related fiscal year results in interest costs to the federal government. We estimate that by not sending interim billings in September of the fiscal year - say, 50 percent of the estimated final expenses - and the final billings in September of the next year, the interest costs to the federal government were increased by approximately $1 million in fiscal year 1989-90 (using average 90-day Treasury Bill rates). Furthermore, if OSFI sent interim billings on a quarterly basis during the fiscal year to which the expenses related, the savings in interest costs could be doubled without any substantial increase in administration costs. The Office of the Superintendent of Financial Institutions has advised us that it is now considering a system of monthly interim billings to financial institutions, starting in fiscal year 1992-93.

Office of the Auditor General of Canada

www.oag-bvg.gc.ca

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1991 Report of the Auditor General of Canada

Chapter 2—Audit Notes

Main Points

Observations on Crown Corporations

Farm Credit Corporation

Limitation in the scope of the Auditor General's examination of Farm Credit Corporation's financial statements for the year ended 31 March 1991

Observations on Departmental Operations

Atlantic Canada Opportunities Agency

Failure to adhere to the authorities governing the Action Program

Case 1 - Failure to adequately evaluate the net economic benefit of a project and to adhere to internal policies

Case 2 - Failure to adequately evaluate, monitor and control an Action Program contribution agreement

Case 3 - Failure to adequately monitor and control an Action Program contribution agreement

Case 4 - Provision of an Action Program contribution for an ineligible project

Atlantic Canada Opportunities Agency

Failure to adhere to a Treasury Board authority

Canada Employment and Immigration Commission

Payments to a province for institutional classroom training without obtaining certification of the cost and number of training days, as required by an agreement

Department of External Affairs

After expenditures of $53 million, the future direction of the Canadian Online Secure Information and Communications System project is being reassessed

Department of Finance

Delayed recovery from the Province of Quebec of the amount in lieu of the Youth Allowances income tax abatement provided to Quebec residents has increased interest costs to the federal government

Department of Finance

Income tax comfort letters may provide some taxpayers with an advantage not available to others

Departments of Finance and National Revenue - Taxation

Administrative procedures diminish Parliament's control over taxing

Department of Fisheries and Oceans

Project abandoned after expenditure of $2.5 million

Department of Industry, Science and Technology

Unnecessary payments made to avoid lapsing funds

Department of National Defence

Need to review the cost-effectiveness of the VIP vehicle fleet at Canadian Forces Base Ottawa

Department of National Health and Welfare

Demonstrated disregard for control framework

Department of National Health and Welfare

Late payment of supplier invoices continues, and interest costs remain high

Department Of National Health And Welfare

There is significant overpayment and underpayment of benefits each year in the Department's Guaranteed Income Supplement program

Department of National Health and Welfare

$489 million overpayment to provinces resulted from failure to properly estimate advance contributions payable under the Canada Assistance Plan

Department of National Revenue - Taxation

Concerns about specific matters related to the administration of the Income Tax Act

Department of the Secretary of State

Excess Canada student loan amounts awarded in 1989-90 could cost taxpayers an estimated $39 million

Department of Transport

Limited consideration of risk in entering into a land-lease agreement

Office of the Superintendent of Financial Institutions

Earlier billing of financial institutions for the cost of supervision and regulation could save the federal government at least $1 million annually