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1997 December Report of the Auditor General of Canada

Main Points

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

36.2 The "Other Audit Observations" chapter fulfils a special role in the Reports. 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. This chapter reports on specific matters that have come to our attention during our financial and compliance audits of the Public Accounts of Canada, Crown corporations and other entities, or during our value-for-money audits.

36.3 The chapter normally contains observations concerning departmental expenditures and/or revenues. The issues addressed generally involve failure to comply with authorities, and the expenditure of money without due regard to economy.

36.4 Observations reported this year cover the following:

  • information to Parliament on the use of ``special measures" falls short of legislative requirements and Parliament's needs;
  • an initiative to provide spare parts failed to maximize its potential cost-saving benefits;
  • escalating costs of a water supply project were not adequately justified;
  • lack of compliance with a funding arrangement resulted in questionable costs;
  • an $801 million payment raises concerns over accountability requirements;
  • the design and construction of a facility illustrates a ``build [up] to budget" approach that does not encourage cost savings; and
  • departmental standards and practices were not followed in awarding a duty free shop licence.
36.5 Although the individual audit observations report matters of significance, they should not be used as a basis for drawing conclusions about matters we did not examine.

Introduction

36.6 This chapter contains matters of significance that are not included elsewhere in the Report and that we believe should be drawn to the attention of the House of Commons. The matters reported were noted during our financial and compliance audits of the Accounts of Canada, Crown corporations and other entities, or during our value-for-money audits.

36.7 Section 7(2) of the Auditor General Act requires the Auditor General to call to the attention of the House of Commons 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;
  • satisfactory procedures have not been established to measure and report the effectiveness of programs, where such procedures could appropriately and reasonably be implemented; or
  • money has been expended without due regard to the environmental effects of those expenditures in the context of sustainable development.
36.8 Each of the matters of significance reported in this chapter was examined in accordance with generally accepted auditing standards; accordingly, our examinations included such tests and other procedures as we considered necessary in the circumstances. The matters reported should not be used as a basis for drawing conclusions about matters not examined. The instances that we have observed are described in this chapter under the appropriate department headings.

36.9 Consistent with Office policy on the follow-up of matters in our Reports, other audit observations included in this chapter are normally followed up two years after initial reporting. Three observations were included in our 1995 Report. In our follow-up of these observations, we found that in one case corrective action had been taken to address the matter. In another case, follow-up was not required since we did not consider the matter to be an outstanding issue. One observation remains outstanding because it involves matters that we are continuing to monitor, and any lack of corrective action will be reported as deemed appropriate.

Agriculture and Agri-Food Canada

Information to Parliament on the use of ``special measures" falls short of legislative requirements and Parliament's needs
Assistant Auditor General: Don Young
Responsible Auditor: Neil Maxwell

Background

36.10 The Farm Income Protection Act (FIPA) was enacted in April 1991. The Act provides for the creation of ``safety net" programs by authorizing ``agreements between the Government of Canada and the provinces to provide for protection for the income of producers of agricultural products and to enable the Government of Canada to take additional measures for that purpose."

36.11 Section 12 of the Farm Income Protection Act is titled ``Special Measures", and subsection (1) provides:

Where the Minister is of the opinion that exceptional circumstances [emphasis added] exist that require that action be taken outside the scope of a program established under an agreement, the Minister may implement such procedures or other special measures as the Minister considers necessary to determine the appropriate action to be taken to remedy those circumstances ...
36.12 This section of the FIPA gives the Minister discretion to determine whether ``exceptional circumstances" exist and to identify the specific actions he or she considers necessary to deal with them. These actions are given legal authority through the issuance of orders by the Governor in Council under section 12(5) of the Act.

36.13 Because actions taken under section 12 are outside the scope of established safety net programs, Parliament included a requirement under section 12(7) to ensure that it would be kept informed of any use of these ``special measures". Subsection (7) states that every order taken under section 12(5) shall, "as soon as possible" [emphasis added] after it is authorized, "be laid before each House of Parliament."

Issues

36.14 At 1 October 1997, more than 30 provincial "companion programs" had been authorized by the Governor in Council pursuant to section 12(5) of the FIPA . Companion programs are province-specific agreements designed to enhance existing national safety net programs like the Net Income Stabilization Account and Crop Insurance. They are one element of the safety net framework negotiated with the provinces, and are intended to address region-specific needs. About $415 million has been committed to these programs to date.

36.15 However, at 1 October 1997, none of the orders-in-council issued under 12(5) to authorize these programs had been laid before either House of Parliament, as required by 12(7). This control, although ``after-the-fact", is an important tool for parliamentary oversight. In particular, it identifies for parliamentarians, in a timely fashion, any use of the ``special measures" provisions of the FIPA .

36.16 In its Estimates for both 1996-97 and 1997-98 and in its 1996 Performance Report, the Department has indicated that a new framework for safety net programming is now in place, and that companion programs are a major component of that framework. The 1996-97 Estimates included a description of broad categories of companion programs. However, Parliament has not received any detailed information about objectives, costs and results of the companion programs - information that is essential to any meaningful oversight role.

36.17 There are several factors associated with these companion programs that highlight the need for additional reporting to Parliament:

  • the existence of ``exceptional circumstances" and the extensive use of special measures under 12(5), which by themselves warrant being brought to Parliament's attention;
  • the significant financial commitment involved;
  • the ``pilot-like" nature of many of these companion programs, which address areas outside the scope of traditional safety net programs (e.g. adaptation, innovation, research and development); and
  • the impact these companion programs are expected to have on the design of the next generation of safety net programs coming on-stream in the 1999-2000 fiscal year, for which the consultation process is just beginning. Some form of reporting on the preliminary results achieved from the companion programs would obviously be pertinent to those consultations.
36.18 We think Parliament needs a concise, complete listing that provides summary information about program objectives, costs, expected results, how results will be measured and completion dates. The fact that, apart from 12(7), there are no specific legislative reporting requirements for the "special measures" gives the Department considerable flexibility to choose the vehicle or vehicles it feels are most appropriate for providing the necessary information. These could include the Department's Estimates Part III, its Performance Reports or presentations to the Standing Committee on Agriculture and Agri-Food, as well as providing this information in conjunction with the tabling of the orders-in-council under 12(7). The nature, extent and timing of the information to be provided are all important considerations in assisting Parliament in its oversight role.

Conclusion

36.19 To date, Parliament has not been provided with an adequate information base for oversight and control of the series of companion programs recently authorized under the ``special measures" provisions of the FIPA . To provide the necessary information, the Department should table before Parliament all orders-in-council issued under section 12(5) of the FIPA , as required by section 12(7). In addition, it should provide Parliament with timely and relevant information about the objectives, costs and expected results of the companion programs and, in due course, their actual results, in conjunction with the tabling of orders-in-council under 12(7) or by other means.

Department's response: Agriculture and Agri-Food Canada (AAFC) shares the Auditor General's commitment to improving the quality and timeliness of information provided to Parliament. That is why AAFC was among the 16 departments and agencies that volunteered to participate in the Improved Reporting to Parliament Project. This pilot project resulted in the recent tabling of fall Performance Reports.

AAFC acknowledges its obligation under section 12(7) of the Farm Income Protection Act (FIPA) to table all orders-in-council pursuant to section 12(5). The Department's preference would have been to lay before Parliament a complete package pertaining to all federal-provincial companion programs since these have been developed as a set. There are still some agreements under negotiation. Nonetheless, in light of the concerns of the Office of the Auditor General (OAG), the Department has initiated a process to table existing orders-in-council as soon as possible.

The Department looks forward to continuing to work co-operatively with the OAG and other stakeholders to improve parliamentary reporting practices.

Fisheries and Oceans / Coast Guard

Assistant Auditor General: Shahid Minto
Responsible Auditor: Reno Cyr

An initiative to provide spare parts for the Louis S. St. Laurent icebreaker has failed to maximize its potential cost-saving benefits
In 1996, we found significant deficiencies in the government's materiel management practices, including buying and stocking inventories of items that were readily available commercially. Our current audit illustrates the challenges posed when adopting new management practices. Since December 1994, the Coast Guard has taken a new approach to acquiring spare parts for the Louis S. St. Laurent icebreaker, and has now paid over $300,000 to a private sector supplier to stock an inventory of engine spare parts. The spirit and intent of this initiative are consistent with the objectives of better service at less cost; however, it appears that neither of these objectives is being maximized. In 1994, the contract was entered into without adequate analysis. In 1996, a new contract did not reflect changes in requirements. In our opinion, to obtain better value for money for the Crown, the Coast Guard needs to re-examine the provisions of this agreement in light of past performance and the current operational requirements of the vessel.

Background

36.20 The Fisheries and Oceans/Coast Guard Icebreaker Louis S. St. Laurent (the Louis), Canada's largest and most powerful icebreaker, was built in 1969. In 1988, the Canadian Coast Guard delivered the Louis to a shipyard for a midlife modernization project that included a 20-year life extension. In 1993, the ship re-entered service following the problematic modernization project, in which the total cost escalated from an effective project approval of $75.8 million in 1987 to about $159 million. We reported on the midlife modernization issues in 1990. (see photograph)

36.21 In our November 1996 Report chapter, Materiel Management in the Federal Government, we noted significant deficiencies in the government's materiel management practices. Departments were holding excessive quantities of items that had to be stocked, as well as items that were readily available commercially and did not have to be stocked. We became aware of this Coast Guard initiative during the 1996 audit.

36.22 The Coast Guard took a new approach to acquiring genuine replacement spare parts and technical support for the German-manufactured diesel engine propulsion units of the Louis. Rather than the traditional approach of purchasing a complete set of spare parts and incurring holding costs to store them itself, the Department entered into a life-cycle support agreement with the supplier of the engines to provide these services for a basic monthly holding fee plus the cost of any parts used. The intended benefits to the Coast Guard of this arrangement included no up-front capital investment in spare parts, no direct holding costs, no risk of obsolescence, and delivery within 24 to 48 hours of genuine replacement parts when needed, resulting in minimum downtime of the vessel on operational taskings.

36.23 In our opinion, before entering into such an agreement, the participants must have a good knowledge of the costs and clearly articulated performance expectations. Once a contract is signed, there needs to be ongoing monitoring of performance and refinement of requirements based on the experience gained. In the case of this initiative, we found neither.

Issues

36.24 Lack of adequate analysis prior to entering into a contract. The Louis was expected to be heavily tasked after completion of the costly modernization project; quick response times to mechanical breakdowns would be necessary to maintain a high level of operational readiness.

36.25 In December 1994, the Coast Guard entered into an agreement under which it would pay the supplier approximately $5,600 per month to hold specific items in storage at the company's Canadian warehouse, for the exclusive use of the Louis. Neither the Coast Guard nor Public Works and Government Services Canada, who negotiated the agreement, could clarify for us the basis and justification of the supplier's $5,600 monthly fee for its services. The supplier did provide a rationale for pricing based upon a percentage of the inventory held, but it was found to be weak and lacking in detail. We also noted the absence of any risk analysis by the Coast Guard to establish the need to hold various types of spare parts. In our opinion, those parts that could be purchased through the supplier's normal commercial channels would not need to be held and incur holding fees.

36.26 The supplier's literature advertises a worldwide sales and service organization that ensures around-the-clock customer satisfaction through well-equipped spares depots in the main markets. In addition, the supplier has a central spares depot in Germany with approximately 96 percent of all engine parts in stock, and claims that more than 80 percent of orders received in the morning are filled the same day. The scope of our audit did not include verifying these claims. We have been informed by the supplier that it does not maintain a dedicated stock, such as that for the Coast Guard, for its other commercial clients.

36.27 We support the Coast Guard's initiative in trying a new approach to providing spare parts. However, we would have expected that before entering into such a contractual arrangement, the Coast Guard, with the support of Public Works and Government Services Canada, would have conducted a thorough analysis to determine whether the arrangement would be beneficial to the Crown. This would include estimating the costs and benefits of all available options. We found no evidence of such an analysis.

36.28 New contract does not reflect changes in requirements. In January 1996, a new contract was signed that extended the agreement to 30 May 1999. The contract increased both the total value of the spare parts held by the supplier (from about $570,000 to about $920,000) and, commensurately, the monthly holding fee (from about $5,600 to about $10,300). We found inadequate information to support the increase in the monthly fee and no rationale for the increase in inventory. Prior to signing the new contract, an internal report by a Public Works and Government Services Canada cost analyst had raised similar concerns about the justification of the monthly fee.

36.29 The significant increase in the spare parts inventory came at a time when the Louis was being underutilized. Coast Guard records indicate that since its redeployment following the modernization project, the Louis has been tasked less than 50 percent of its available time. On occasion, there have been lengthy periods of time between taskings. Coast Guard officials have stated that the engines' performance has been better than specifications and that the contractor's service record has been excellent.

Conclusion

36.30 We found no program of monitoring the usage rates and operational taskings as a basis for refining the appropriate levels of inventory of spares held. In our opinion, since signing the contract in 1994, the Coast Guard has not performed sufficient monitoring and analysis to manage and refine the level of spare parts held in order to obtain best value for the Crown. We would expect to see an analysis identifying the minimum inventory of spare parts needed to be held for the Louis, taking into account the worldwide availability of parts from the supplier.

36.31 Subsequent events. In the spring of 1997, during the conduct of our audit fieldwork, we expressed our concerns to the Coast Guard about the size of the inventory and the monthly fees paid. The opportunity to revise the contract on its renewal date in June 1997 was missed. In September 1997, the Coast Guard informed us that the contractor's inventory had been reviewed and a reduction of $156,000 had been identified for the period June 1997 to May 1998. The Coast Guard acknowledges that this information was not forwarded to the contractor by the June renewal date, but it believes that an interim adjustment will be negotiated. We believe that this has resulted in additional needless expenditures and poor value for money for the Crown.

Department's response: As at 4 November 1997, inventory levels had been reduced by $156,000 as identified by the Auditor General. The Department will continue to reduce holdings, with the ultimate goal being "just-in-time" delivery of spare parts. These reductions will be based upon analysis of data from upgraded machinery and inventory monitoring programs now in place, in conjunction with the demonstrated delivery track record of the propulsion system contractor and the contract further adjusted accordingly.

Given the remote area of deployment, the Department followed a prudent course of action in treating the serviceability claims of the manufacturers with cautious optimism. The soundness of this approach has been confirmed by the stellar performance of the vessel to date, meeting every challenging demand and setting many new records in Arctic navigation.

This objective is an integral part of the maintenance management philosophy of the Department to maintain a high level of performance at minimum cost.

Indian and Northern Affairs Canada

Assistant Auditor General: Don Young
Responsible Auditor: Grant Wilson

Escalating costs of on-reserve water supply project not adequately justified
A water supply development project, funded by Indian and Northern Affairs Canada, was undertaken on a reserve because of contamination in a river used as a source of treated drinking water. Estimated costs of the project, currently in progress, increased significantly in less than two years. Preliminary project approval by Indian and Northern Affairs Canada in September 1995 was $1 million. By April 1997, the revised planned cost had climbed to $2.3 million, more than twice the original estimate. Furthermore, the Department was aware that according to an engineering consultant engaged by the First Nation, the contamination could have been treated by improving the existing water treatment plant at an estimated cost of $26,000.

Background

36.32 Adequate drinking water is an important priority for Indian reserves across Canada and for Indian and Northern Affairs Canada in its funding of on-reserve capital projects. It is especially important that adequate water be made available in a cost-effective way, because resources are limited and the needs are considerable.

36.33 During the follow-up of our November 1995 Chapter, Indian and Northern Affairs Canada: On-Reserve Capital Facilities and Maintenance (see Chapter 35 of this Report), we observed the following case.

36.34 In March 1993, a First Nation community of about 400 reported its concerns to the Department regarding contamination in the community's drinking water sourced from a river. In the same month, a study by an engineering consultant engaged by the First Nation identified deficiencies in the existing on-reserve water treatment plant and its operation. The estimated cost to improve the plant and the quality of water was $26,000 for an expected population of 700 by year 2000. Other considerations for longer-range needs and fire control were identified but not costed.

36.35 In May 1993, the Department noted that tests of treated water at the treatment plant showed a higher concentration of aluminum than that found in tests of river water. According to the Department's Technical Services, the problem appeared to stem from the water treatment plant. In September 1993, the Department recommended that the First Nation improve the treatment plant. In May 1994, the First Nation reported to the Department that the funds provided to it by the Department to repair the plant and to cover an interim supply of bottled water were inadequate.

36.36 According to the Department, the First Nation had lost confidence in the river as a source of potable water and insisted on establishing a new source of supply. In September 1995, the Department gave preliminary approval to the First Nation's proposal for a $1 million project to develop a new source of water on the reserve.

Issues

36.37 Our review of this project disclosed that the approach and scope of the work changed significantly over time. The approach recommended in the March 1993 study to improve the treatment plant and its operations at a cost of $26,000 would provide for continued use of the river as a source of drinking water. Although the Department indicated that it had provided $30,000 to the First Nation to implement the study's recommendations, no evidence was available in the Department to show what improvements had been made with these funds.

36.38 At various times, up to preliminary approval in September 1995 and subsequently, several technical issues and options were discussed for establishing an alternative supply of drinking water. For example, in May 1995 another engineering consultant engaged by the First Nation proposed four options for developing a new source of raw water. However, none of the options included a cost analysis of continuing to use the river as a source.

36.39 One of the options was selected at a proposed cost of $1 million. This involved constructing three wells as a new source of supply, which were intended to service a community of 800 expected by 2025. However, this approach was abandoned, and under a proposal in November 1996 by yet another engineering consultant engaged by the First Nation, approval was given to construct five new wells in another location. This included the necessary water mains and related facilities for $1.6 million. The estimated cost increased to $2.3 million by April 1997, including the cost of treating other identified contamination associated with the new location. By this time, over $1 million had been spent on or committed to this project.

36.40 We believe that significant issues were not adequately resolved before the decisions were made to proceed with and expand the project. These include the following:

  • The Department failed to ensure that identified problems in the existing treatment plant were remedied and that funds provided to the First Nation for this purpose were used appropriately.
  • The Department did not adequately take into account the contamination relating to the wells before committing to this approach.
  • The Department accepted analyses of four options submitted by the First Nation, which excluded the river as a water source option. This was despite the Department's knowledge before approving the project that the river could be a viable source of water, properly treated in the existing plant, and that plant improvements could be achieved for only nominal cost.
  • We could find no life-cycle cost analysis that compared the estimated $2.3 million cost of the selected project, to service the estimated needs of a projected population of 800 by 2025, with a $26,000 cost to improve the existing plant for a projected population of 700 by 2000. We would expect an analysis to have disclosed the assumed benefits and costs of the alternatives, including consideration of the river as a continued source of treatable water.

Conclusion

36.41 Accordingly, we concluded that there was inadequate justification for the cost escalation in this project. Given the considerable demand for improvements to on-reserve capital facilities, we believe that other worthy projects may have been adversely affected because of the cost escalation in this project.

Department's response: The First Nation had serious concerns regarding the contamination of their water supply. Those concerns were subsequently confirmed with Health Canada. The Department worked with the First Nation to ensure that the community had access to safe, reliable drinking water.

The Department carefully examined potential options to solve the water quality issue, including retrofitting the existing plant, but ultimately other alternative sources had to be examined. The options considered needed to address the concerns of the community carefully and provide them with an appropriate source of water.

Given the circumstances involved in this particular case, the Department feels that it took a reasonable approach in providing a safe, reliable source of drinking water in a cost-effective manner, taking into consideration the concerns of the community. The project is expected to be put into operation in November 1997.

Indian and Northern Affairs Canada

Assistant Auditor General: Don Young
Responsible Auditor: Grant Wilson

Lack of compliance with funding arrangement results in questionable costs and benefits
During the fiscal year 1996-97, Indian and Northern Affairs Canada approved an $8.9 million on-reserve infrastructure project to be constructed by a First Nation. As of March 1997, the Department had allocated $3.5 million toward the project. A condition in the project funding arrangement between the Department and the First Nation requires that the First Nation call for public tenders of all construction contracts.

Instead, according to the Department, the general contractor selected by the First Nation was awarded the contract on a negotiated fixed-price basis. Furthermore, a departmental project risk analysis determined that the lack of tendering and the selection of the chosen contractor resulted in estimated extra costs ranging from $700,000 to about $1 million. The analysis also estimated other risks at $594,000, although this amount might have been applicable to any contractor selected. The Department indicated that the extra costs and risks were offset by socio-economic spinoff benefits to the community. However, the Department could not adequately demonstrate the basis for the offset.

Background

36.42 During the follow-up of our audit reported in Chapter 23 of the November 1995 Report, Indian and Northern Affairs Canada: On-Reserve Capital Facilities and Maintenance, we noted unresolved issues regarding bid tendering (see Chapter 35 of this Report). The following case came to our attention.

36.43 A major capital construction project to provide water and sewer services on a reserve was approved by the Department for $8.9 million during the fiscal year 1996-97. As of March 1997, the Department had allocated $3.5 million to the First Nation for this project, which was still in progress at the time of our audit.

36.44 Under the funding arrangement between the Department and the First Nation, public tendering is required for all construction contracts to ensure prudence, probity, sound contract management, and best value, which may include consideration of opportunities to secure socio-economic benefits for the community. Instead, public tendering was not used to select the general contractor, which was awarded the project by the First Nation for a negotiated fixed price of $8.9 million.

Issues

36.45 According to the Department, the general contractor was an incorporated company formed just prior to the project and owned by the same First Nation that received approval and funding for the project. A departmental project risk analysis estimated that the extra cost to the project arising from the lack of tendering was about $700,000. Additional potential costs attributable to the inexperience of the selected contractor and to related matters were estimated at $358,000, bringing the estimated cost and risk premium to about $1 million. Other project risks were estimated at $594,000, which, according to the Department, might have been applicable to any selected contractor. The Department indicated that all of these costs were included in the approved amount of $8.9 million. The First Nation indicated that in its view, there were no extra costs and risks attributable to the selection of the contractor as described in the Department's analysis.

36.46 The Department stated that the extra costs and risks incurred in the fixed price award to the general contractor were offset by socio-economic spinoff benefits, deemed to be $2.4 million. We believe that project spinoff benefits and the premium paid to achieve them should be supported by an appropriate analysis that determines, among other things, the value of benefits by type and their expected duration. Assumptions used for each benefit also need to be clearly stated, consistent with supporting rationale. However, during our review, the Department could provide no analysis to support the deemed benefits. The First Nation reported that community spinoff benefits were achieved and, although it did not quantify them, did not agree with the deemed value of $2.4 million.

Conclusion

36.47 The Department failed to comply with the conditions of its funding arrangement. The tendering requirement was not enforced by the Department and tenders were not called for by the First Nation as required. In our opinion, non-compliance by the parties does not augur well for effective implementation of the arrangement. Furthermore, in the absence of a supporting analysis, the justification for accepting the cost and risk premium of up to $1 million by not tendering, and the deeming of benefits of $2.4 million, were questionable.

Department's response: In this particular case, a reasonable final price for the project was obtained. The Department ensured local benefits for the First Nation through a flexible approach to the tendering process. This approach enabled the First Nation to participate in a joint venture on components of the project, which, in turn, supported capacity development at the local level.

The Department ensured that value for money was obtained by negotiating with the First Nation an upper limit for the project costs and requiring that the subcontracts (approximately 70 percent of the total project cost) were publicly tendered. The remaining 30 percent of the work was negotiated as local set asides using standard industry rates in the area to ensure that a fair and reasonable price was obtained. The final costs for the project are comparable with the cost estimated for a public tendered contract including a local preference allowance.

The Department has established a requirement for First Nations to use a tendering process for capital projects over $500,000, excluding housing, and it recognizes the need to work with First Nations to implement this policy. As recognized by the Auditor General, the Department is faced with the challenge of achieving a balance between the concepts of achieving best value for federal funds and increased socio-economic benefits for First Nations. The Department is working on a paper to define general principles for guiding First Nations tendering policies.

Industry Canada

Assistant Auditor General: Richard Flageole
Responsible Auditor: Peter Simeoni

Concerns over accountability requirements for $801 million payment
The government made a payment of $801 million to the Canada Foundation for Innovation. The funding agreement does not obligate the Foundation to report on the results it achieves with this money. In our view, it is important that any future funding agreements with similar organizations provide for a full annual report on performance to Parliament.

Background

36.48 Parliament established the Canada Foundation for Innovation through the Budget Implementation Act, 1997 as an independent, not-for-profit corporation whose purpose is to make grants "to increase the capability of carrying on high-quality research in Canada." The Foundation is made up of 15 members, representing the research and business communities, and is managed by a separate board of directors. The Act authorized the Minister of Industry to pay up to $800 million plus interest to the Foundation.

36.49 The Minister and the Foundation reached a funding agreement in July 1997. Its purpose was to set out the terms and conditions under which the Foundation would administer and invest the payment from the government and would determine which projects to fund. The agreement requires the Foundation to endeavour to commit the $801 million and any investment proceeds (an estimated $100 million) to projects within five years. The Foundation will use the money to support the modernization, acquisition or development of research infrastructure such as equipment, software, buildings and other facilities by making grants of up to 50 percent of the total cost of eligible projects. The agreement also defines eligible recipients, projects and costs as well as setting out submission requirements and factors the Foundation must consider in reviewing applications. The provisions are intended to help ensure that the Foundation funds projects that meet the agreement's objectives.

36.50 In announcing the creation of the Foundation, the government stated:

The Foundation represents an entirely new approach by the government to supporting innovation and research. It will be an independent corporation, at arm's length from the government, and its members will be drawn from the research community and the private sector. They, not the government, will be responsible for spending decisions.
36.51 We examined the government's funding agreement with the Foundation to determine whether it provided for good accountability to Parliament for the $801 million payment. In our view, good accountability begins with the government clearly describing its goals and planned actions and ends with a full accounting to Parliament for the results achieved. Reporting obligations need to be clearly set out and cover both financial and operational results when the government enters into "arm's length" arrangements or into partnerships to achieve these goals.

Issues

No obligation to report on results achieved with $801 million
36.52 The Act requires the Foundation to prepare an annual report of its activities, including audited financial statements, which the Minister of Industry tables in Parliament. We expected that the funding agreement would elaborate on this general requirement to provide for good accountability to Parliament for the $801 million payment by obligating the Foundation to report not only on its activities but also on its performance more broadly - in other words, on the results it achieved with the grants it made. While we recognize that the Foundation is independent, the annual performance reports of the government's granting councils for science illustrate at least the kind of reporting that is possible. In particular, these annual reports are supposed to present results achieved by the councils through their granting activities. However, the funding agreement with the Foundation contains no such provision. While it appears that the Foundation will nonetheless make every effort to give a good annual account of its achievements toward its objectives, our concern is that the government did not obligate it to do so. In our view, any future funding agreements with similar organizations should unambiguously require that a full, annual accounting for performance be made to Parliament, and that this report be audited. This is particularly important as the government provides more goods and services through partnerships with organizations outside the traditional public service, and therefore outside established performance reporting systems.

36.53 Although the funding agreement does not provide for it, program evaluation is an important part of performance measurement and reporting. There is, of course, nothing preventing the Foundation from having an evaluation carried out and reporting the results to Parliament. In our view, future funding agreements such as this should have an evaluation requirement so that Parliament is informed of what was accomplished with the funding provided.

Conclusion

36.54 The government made a payment of $801 million to the Canada Foundation for Innovation. The funding agreement does not obligate the Foundation to report on the results it achieves with this money. In our view, it is important that any future funding agreements with similar organizations provide for a full annual report on performance to Parliament.

Department's response: The funding agreement addresses the accountability issue by setting out appropriate terms and conditions on the use of the $801 million by the Foundation. Specifically, the agreement sets out: four specific objectives that will guide the Foundation in all of its activities and decisions; extensive provisions with respect to the specific project costs that are eligible and excluded, for purposes of cost-sharing with the Foundation; a requirement that applicants must provide a research plan that contains specified information, as well as other information; mandatory criteria that all successful applicants must meet, as well as criteria to be used when assessing proposals; the requirement to establish a peer review system to assess research plans; and how in-kind contributions are to be treated. Taken together, these provisions will be critical in ensuring that those infrastructure projects funded by the Foundation will be of the highest quality, with the highest socio-economic potential.

The Foundation is working to develop a framework to evaluate the results of its grants for research infrastructure. Of course, one has to bear in mind that the research projects will take time to come to fruition and have an impact on the economy and society. The establishment of the Foundation as an arm's length organization represents an original and unique approach to supporting innovation in Canada. A highly qualified Board of Directors with diverse expertise, experience and perspective is being put in place that, we are confident, will meet the challenge of maximizing the benefits flowing from the Foundation and meet the innovation needs of Canada.

National Archives of Canada and Public Works and Government Services Canada

Assistant Auditor General: Shahid Minto
Responsible Auditor: Reno Cyr

The design and construction of the National Archives of Canada's Gatineau Preservation Centre could have been achieved in a less costly building. The facility illustrates a "build [up] to budget" approach that does not encourage cost savings
Design and construction of the Gatineau facility has been achieved at a higher unit cost than a similar-purpose U.S. facility. The design requirements imposed by the selected site, and the creation of this striking facility in response to the National Archives' objective to create a facility with the image of a leading archival centre having a national heritage and cultural element, have contributed to the higher cost.

During construction of the Gatineau Preservation Centre and subsequent to our 1994 audit, the elimination of $10 million in unnecessary extras in the design, finish and landscaping was required to meet budget targets. The reduction was achieved without unduly compromising program requirements.

In our opinion, the storage, preservation and active conservation functions, which exclude any significant access to the facility by the public, could have been accommodated in a less expensive building. The fact that significant cuts were achieved but that additional cost-saving opportunities were not exercised illustrates the lack of cost-saving incentives under the government's "build [up] to budget" approach.

Background

36.55 As part of a composite project to respond to the needs of the National Archives of Canada, including the need to arrest the deterioration of records in existing storage facilities, a new conservation and laboratory building was constructed in the city centre of Gatineau, Quebec, at a total project cost of $107 million. The second part of the composite project was to renovate the West Memorial Building to create public research facilities and replace those currently provided in the National Library building, and to refurbish the National Archives headquarters. The second project was approved in May 1996 and is expected to be completed by 2002.

36.56 The new Gatineau facility provides for the consolidation of storage and laboratories from several facilities and allows for further consolidation and future growth of the archival records. The facility has been designed to provide a safe environment for the long-term storage and active preservation of the country's valuable collections.

36.57 In 1994 we examined the preliminary stages of construction of the new Gatineau facility and concluded, in part, that there was a lack of due regard to economy in the site selection and related design, finish and landscaping considerations for the facility.

36.58 In 1995 we undertook a joint study with National Archives of Canada and Public Works and Government Services Canada to compare the cost of the new Gatineau facility with a similar-purpose U.S. facility.

36.59 In 1996 we reported on the government's "build [up] to budget" philosophy in our audit of a large government-owned special purpose facility. Under this approach, certain aesthetic enhancements to the facility were included on the basis that the budget would not be exceeded. In its published response, the Treasury Board Secretariat acknowledged the need to place greater emphasis on cost savings within the overall approved budget.

36.60 The new Gatineau facility, now referred to as the National Archives of Canada Gatineau Preservation Centre, was made available for occupancy in December 1996, and was officially opened on 4 June 1997. The relocation of records into the new vaults of Phase I of the Gatineau facility is ongoing and expected to be completed by March 1998. A Phase II project is planned in Gatineau for some time in the future to provide for further consolidation and growth of the collections.

Issues

36.61 Gatineau facility is more expensive than a similar-purpose U.S. facility. At the time of reporting our 1994 audit, agreement could not be reached with National Archives of Canada and Public Works and Government Services Canada on the appropriate costs to include in comparing the Gatineau facility with the recently completed United States National Archives and Records Administration (NARA) II facility in College Park, Maryland. It was agreed that a joint study would be undertaken to confirm and explain the cost differences. The study findings, agreed to by the joint participants and reported to the deputy heads in October 1995, are summarized in this section. (see photograph)

36.62 The three major cost elements of both projects, representing approximately 80 percent of the total project costs, include construction (contracts and material), architectural and engineering services (A & ES) management, and professional services. Architectural and engineering services management includes design reviews, preparation and review of documents, commissioning, administration and auditing. Professional services cover such things as architectural fees, special consultants and taxes.

36.63 The findings of the cost study, which support the preliminary conclusions of our 1994 audit, are summarized in Exhibit 36.1 . Comparison of the individual project cost elements for the two facilities, on a unit-cost basis, shows a cost difference of 29 to 66 percent. The construction management activity, represented by combining the individual elements of A & ES and professional services, account for a 58 percent difference. In all cases, the percentage differences reflect the lower cost of the U.S. facility.

36.64 Due to the differences in size of the facilities, the comparison uses the industry standard approach of comparing costs per square metre of building gross area in arriving at the percent differences. Construction unit costs, based on industry standards for measuring gross area, were calculated after deleting some components from the NARA II facility to achieve a more accurate comparison of constructed features.

36.65 It should be noted, however, that the study also indicated that comparisons between unique special purpose buildings are difficult and will not give a definitive answer. The factors that limited the opportunity for comparison of the projects included funding mechanisms, design life cycles, building area and location, user programs, and contracting and implementation policies. These limitations notwithstanding, the study identified several factors that contributed to the higher cost of the Gatineau facility, as follows:

  • The method of funding. Because the funding for the NARA II facility was received as a lump sum, the project benefited from the ability to tender contracts when the timing in the construction industry was opportune.
  • The management of tendering and contracting. NARA had final contracting authority and did not have to seek additional approvals for each contract. This authority shortened the tendering period and encouraged the use of more and smaller tender packages.
  • Site selection. The design of the Gatineau facility was significantly influenced by its urban and highly visible site. The design of the NARA II facility was not influenced to this extent by its siting.
  • Fees. Consultant fees and management and supervision fees were higher on the Gatineau project. There were extra layers of management, due in part to the number of parties involved and the division of their roles.
  • Incentives for cost savings. There were incentives for NARA to achieve cost savings on its construction project, but no such incentives for National Archives on its project. Since NARA had complete control of its construction budget and would have had to fund any shortfalls from its operating budget, there was pressure to control costs. As an added incentive, cost savings on construction could be and were used to purchase furniture and equipment and to upgrade some key systems. For the Gatineau facility, any cost savings from construction would not accrue to the client but rather to Public Works and Government Services Canada, the contracting agent.
36.66 "Build [up] to budget" approach does not encourage cost savings. In 1994 we noted that funds were being spent on site and design considerations that exceeded the functional needs of the building. In granting preliminary project approval, Treasury Board ministers expressed the view that design and consequent costs of the Gatineau facility should place emphasis on functional requirements. We concluded that the siting of the facility and concerns with public visibility resulted in a design that emphasized factors other than the functional requirements. For example, the intent of the client's general design, as conveyed to the architect, emphasized that "the Gatineau Building will present the image of a leading archival centre, a National heritage and cultural element", despite the absence of plans for any significant access to the facility by the public and a mandate to stress functionality.

36.67 Since 1994, a review of the project budget and contract requirements was necessitated when the low bid for the major construction contract came in approximately $10 million over budget. The review concluded that significant cost savings were possible without unduly compromising program requirements. Revisions were then made to the design and materials to meet the budget. We believe that this illustrates the need for a more rigorous and meaningful analysis of project requirements before a budget is approved.

36.68 The government's project approval and project management policies provide incentives not to exceed approved budgets, but there is little incentive to bring projects in under budget, even where significant excesses exist. In this project, the elimination of $10 million of unnecessary extras, of which a significant portion represents the cost of stainless steel, would not have occurred had the low bid not exceeded the contract budget. However, notwithstanding the cuts already made, the completed facility retains large quantities of costly stainless steel in the superstructure. These facts raise serious questions about whether further cost savings could have been achieved without compromising program requirements.

36.69 Commitment to emphasize functional requirements with simple and proven approaches not met. In 1994 we identified design features that were not consistent with the commitment made to the Treasury Board to emphasize functional requirements using simple and proven approaches. In its published response, Public Works and Government Services Canada noted that the design and construction were appropriate for a utilitarian building. In our opinion, however, the following examples illustrate that key elements of this project were neither utilitarian nor simple and proven.

36.70 The original stainless steel roof was subsequently redesigned using a less costly material as part of the cost-cutting measures. However, the composition and assembly of the new design were unproven and complex, because no company had ever constructed such a roof and because of its unique layered construction and assembly requirements.

36.71 The "building within a building" design of the Gatineau facility incorporates a concrete structure enclosed by an outer shell consisting of a hanging glass curtain wall and a stainless steel superstructure, as discussed earlier. The glass curtain wall comprises a size of glazing that restricted the number of potential suppliers and has resulted in problems with specifications, quality control in the manufacture and installation to meet industry standards, and the degradation of thermal properties of the curtain wall. (see photograph)

36.72 A simpler and less costly exterior finish such as brick, pre-cast concrete or porcelain enamel steel would have avoided these difficulties.

36.73 Extensive landscaping plans scaled back. In 1994 we noted that plans included extensive landscaping to create a park-like setting and to mitigate the imposing nature of the building. There was also a desire to ensure that the building did not look like a warehouse, given its siting within the Gatineau city centre and its proximity to a residential neighbourhood.

36.74 We are encouraged to report that, since 1994, changes have been made to the landscaping design that have considerably reduced the extent of work done while attempting to maintain the original landscaping objectives. The changes were partly in response to our concerns about the magnitude and functionality of this cost element and partly in response to the need to cut $10 million to meet the project budget.

36.75 In our opinion, however, the original landscaping plans, like the original stainless steel roof, were based on the availability of funding in the project budget, and reduction of the landscaping would not have occurred had there not existed budget or other external pressures to do so.

Conclusion

36.76 The National Archives' design objective for the new Gatineau facility has been achieved. The impressive facility makes a striking architectural statement and has received significant positive public attention. The stated objective of creating a facility that provides a safe and secure environment for the long-term storage and ongoing preservation of the country's historic treasures has also been achieved.

36.77 Although not all costs have been finalized, it now appears that the budget targets have been achieved and that National Archives of Canada is satisfied that its program requirements have not been significantly compromised as a result of the cost reductions. However, in our opinion, the storage, preservation and active conservation functions, which exclude any significant access to the facility by the public, could have been accommodated in a less expensive building.

36.78 The project approval and budgeting processes set out in the Treasury Board policies for managing capital projects of this magnitude require departments to examine their needs, analyze options available to meet those needs, prepare cost estimates and seek Treasury Board approvals and any adjustments to departmental reference levels to meet the capital or operating and maintenance costs of the new facility.

36.79 One key element of this process is that the project budget be subjected to a rigorous and meaningful analysis to ensure that it is sufficient but not excessive in supporting the project objectives. In the case of the new Gatineau facility, however, the approved budget exceeded that needed to address the functional requirements of this building, as outlined in the National Archives' project submission and the resulting Treasury Board approvals. The result was a "build [up] to budget" approach that included costly aesthetic elements in the design. It has been recognized that many such projects are built to budget, and that there is a need to change this culture. We would have expected a more rigorous challenge of the design and associated budget by the departments and by the Treasury Board Secretariat.

36.80 In its Eighteenth Report to Parliament in December 1995, the Public Accounts Committee noted that there is more to being a good officeholder than simply following the rules. It maintained that those who hold public office are also obliged to show regard for the interests of citizens and to protect those interests to the fullest possible extent. In our opinion, the interests of the taxpayer would have been better served by constructing a facility that responded more to the mandate to emphasize functional requirements related to safeguarding and preserving the historic records and less to creating an architectural statement of national significance.

Department's response: The National Archives of Canada - Gatineau Preservation Centre (GPC) project was delivered on time and on budget and fully meets the expectations of all affected parties including the National Archives of Canada, Heritage Canada, the National Capital Commission and the Municipality of Gatineau. Within the project investment and management context of the early 1990s, Public Works and Government Services Canada (PWGSC) delivered a project that met established standards for success (scope, functionality, time, budget) for a project that has been recognized as an "impressive facility" that has received "significant positive comment". However, PWGSC recognizes the concerns raised by the Office of the Auditor General regarding the "build to budget" approach, and is currently working to identify ways to introduce, into the overall contracting process, viable and meaningful incentives for reducing costs.

PWGSC also concurs with the observation that a definitive cost comparison between unique special purpose buildings such as the American NARA II facility and the GPC is difficult.

The location of the GPC is a major element of the cost differential. The criteria governing the site selection and development of the GPC warranted investments that contributed significantly to project costs. Unlike the facility in the United States, the GPC is a significant landmark in the town centre of a major Outouais community within the National Capital Region. PWGSC therefore concurs with the Office of the Auditor General that the facility has met its objective "to present an image of a leading archival centre, a national heritage and cultural element." PWGSC believes that the broader government objectives affecting the qualitative aspects of investment considerations must be incorporated into the assessment of the project. PWGSC recognizes that these value-for-money considerations as well as related constraints should be specifically articulated within project approval documentation. PWGSC will reaffirm internal policies accordingly and ensure that future projects explicitly reference such considerations where applicable.

Revenue Canada

Assistant Auditor General: Shahid Minto
Responsible Auditor: Alan Gilmore

Revenue Canada departed from departmental standards and practices in awarding a duty free shop licence
Since 1985 Revenue Canada has maintained rigorous standards and practices for the award of duty free shop licences at land border crossings to individuals or corporations. The standards and practices followed by Revenue Canada in the 1995 and 1997 award of a duty free shop licence at one land border crossing differed significantly from those normally used. The precedents set may undermine the transparency and credibility of the duty free shop licence award process. There are conflicting interpretations of a section of the Regulations relating to beneficial ownership. In our opinion, a reasonable case can be made that the awarding of the licences was not done in accordance with the intent of the law.

Background

36.81 Revenue Canada is responsible for issuing licences for the operation of duty free shops and for monitoring and controlling their ongoing operation. In 1995, Revenue Canada awarded a duty free shop licence in Ontario to an individual at a major land border crossing where there had been a demand for such a shop. Revenue Canada estimated that gross revenue to the duty free shop operator at the site would be approximately $13.5 million dollars annually. In September 1997, subsequent to the death of the licensee, a new duty free shop licence was awarded to a corporation.

36.82 Since 1985, Revenue Canada has maintained rigorous standards and practices that must be followed in the award of licences to individuals or corporations. These standards and practices are described in the following documents: Customs Act, Duty Free Shop - Regulations; Duty Free Shop - Licensing (Guidelines); the Applicant's Guide and Application; and, in Ontario, the Memorandum of Understanding between Revenue Canada and the Ontario Ministry of Consumer and Commercial Relations and the Liquor Control Board of Ontario.

36.83 The Regulations and Guidelines require that all applicants meet the following prerequisites before their application is considered. To be eligible, under the Regulations, to operate a licensed facility at a land border crossing, applicants must be Canadian citizens or permanent residents of Canada. A corporation can be considered for a licence at a border crossing if it is incorporated in Canada and all shares are beneficially owned by Canadian citizens or permanent residents of Canada. The Guidelines state that an applicant must qualify as a small-size business or, in exceptional circumstances, as a medium-size business in Canada to be considered to operate a land border crossing duty free shop.

36.84 Applicants who meet these qualifications may submit an application for a licence for the operation of a duty free shop. Revenue Canada selects the successful applicant on the basis of an evaluation and ranking of the individual proposals, which must provide detailed information in seven areas. These include the qualifications of the beneficial owners, the applicant's financial stability, financial statements presenting detailed three-year forecasts of operational performance, a description of the applicant's management capabilities and retail experience, site and building proposals, a comprehensive business plan, and employment policy.

36.85 No fee is paid to Revenue Canada for the issuance of a duty free shop licence; however, a shop pays Revenue Canada a licence fee based on
a percentage of its annual gross revenue. Once a duty free shop licence is awarded, the operator retains the rights to the licence indefinitely unless proven to be in breach of the Duty Free Shop Regulations.

Issues

36.86 In 1995 and 1997, Revenue Canada awarded a duty free shop licence at the same land border crossing in Ontario. We found that the standards and practices used in the award of these duty free shop licences in Ontario differed significantly from those used in other land border crossing licence awards.

36.87 In awarding the licences in 1995 and 1997, Revenue Canada departed from its standard duty free shop licence award practices at land border crossings. The information on which Revenue Canada made the award was incomplete and did not address key areas such as business competence and operating practices.

36.88 Furthermore, in our opinion, the awards were not consistent with the intent of the Duty Free Shop Regulations' requirement that the ultimate beneficial ownership of a shop rest with Canadian citizens or permanent residents. In both instances, Revenue Canada documentation indicates that the ultimate beneficial ownership rests with a third party that does not qualify to operate a duty free shop because it is a foreign entity.

36.89 Revenue Canada explained to us that the circumstances in these awards were unique because the owner of the land at this border crossing refused to lease property for a duty free shop to anyone other than the landowner's nominee for the shop. The owner of the land is a foreign-owned Canadian corporation.

36.90 Revenue Canada also stated that both licences were awarded in accordance with the law. In our opinion, an equally reasonable case could be made that the licences were not awarded in accordance with the law. This is a matter that only a court could decide conclusively.

36.91 Revenue Canada indicated to us that it was faced with a difficult situation. Officials were anxious to fulfil a public need while dealing with a landowner who insisted on his nominee and at the same time complying with Revenue Canada Regulations and Guidelines that provided the officials with limited options.

36.92 In contrast with standard practice, there was no national tender call in the award of these duty free shop licences. For all other licence awards since 1985, Revenue Canada has placed a national advertisement inviting applications for the establishment and operation of a land border crossing duty free shop. The applications are reviewed by Revenue Canada staff, a professional accounting firm, and a Selection Advisory Committee. In Ontario, this committee consists of representatives from Revenue Canada, Industry Canada and the Liquor Control Board of Ontario. The granting of a liquor Authorization by the Liquor Control Board is usually made concurrently with the duty free shop licence award.

36.93 The awarding of these two licences to operate the duty free shop was non-competitive. All licence awards at other land border crossings were competitively bid. The opportunity to secure a licence at this facility was not made known to the public, even though a number of individuals had expressed a strong interest to Revenue Canada in operating a facility at this site. Further, Revenue Canada did not provide complete and accurate information to some of these individuals on the availability of a licence at this site. In our opinion, these actions were inconsistent with historical practice, the standards defined in the Duty Free Shop - Licensing Guidelines, the Applicant's Guide and the Memorandum of Understanding.

36.94 Revenue Canada proceeded with the award of the licences without the agreement of the Province of Ontario as required by a June 1985 Memorandum of Understanding among Revenue Canada, the Ontario Ministry of Consumer and Commercial Relations, and the Liquor Control Board of Ontario. The Memorandum also requires Revenue Canada to "invite applications by national advertisement for the establishment and operation of duty free shops" and to consult and reach a consensus on the selected operator with the Province prior to the award of licences in Ontario.

36.95 The licence awards are not consistent with the intent of the Duty Free Shop Regulations and Guidelines that beneficial owners be Canadian citizens or permanent residents. In our opinion, the intent of the Duty Free Shop Regulations and Guidelines is to require that all direct or indirect beneficial ownership interest in a duty free shop at a land border crossing be held by individuals who are Canadian citizens or permanent residents. A Canadian corporation may also be awarded a licence if all its shares are beneficially owned by Canadian citizens or permanent residents. The Guidelines state that the "applicant must qualify as a small-size business" or, in exceptional circumstances, as a medium-size business.

36.96 Revenue Canada states that since only the holders of a licence for a land duty free shop need to be Canadian citizens, the issue of beneficial ownership is simply not in question. We disagree with this interpretation since this presents a very restricted view of the intent of the Regulations. The licence awards at this site are not consistent with the substance of the above-noted requirements. In 1995 the licence was awarded to a Canadian citizen. However, this individual was serving as a nominee for third parties who do not qualify to be awarded a duty free shop licence. Revenue Canada documentation indicates that the ultimate beneficial ownership of the licence appears to rest with a foreign entity. While a Canadian corporation is managing and operating the duty free shop on behalf of the nominee, the corporation does not qualify as a small or medium-size business and, further, it is foreign-owned.

36.97 In 1997, the licence was awarded to a Canadian corporation for the 34 months remaining in the 1995 licence. Revenue Canada documentation indicates that the award was made because "many of the circumstances will remain unchanged with respect to this duty free shop operation, the Department believes this would recognize commitments and interests that were made in good faith by the parties involved."

36.98 The corporation shareholders have indicated to Revenue Canada that they are the "true beneficial shareholders". However, in our opinion, Revenue Canada did not obtain sufficient documentation to determine and verify that the shareholders are the true beneficiaries of the licence - that is, whether they are the effective owners with all the benefits and responsibilities associated with ownership as opposed to a situation where the owners function merely as intermediaries. The 1997 licence award was made subsequent to our raising with Revenue Canada our concerns about the 1995 award.

36.99 Revenue Canada did not have sufficient information to ascertain whether the applicants met the qualifications to operate a duty free shop at a land border crossing. The normal practice in the process for awarding duty free shop licences at a land border crossing is for all agreements, including commercial agreements and information on duty free shop ownership and operation, to be examined by Revenue Canada. The object of the examination is to ascertain whether the applicant is in compliance with the Regulations and Guidelines, and particularly whether the applicant is qualified to operate a duty free shop.

36.100 For the 1995 and 1997 awards, the agreements between the Canadian nominee and the foreign-owned companies relating to ownership structure and the financial, retailing and operating plans for the duty free shop were not fully disclosed to Revenue Canada as required by the Duty Free Shop Licensing Guidelines. The Department states that since a tendering process was not deemed appropriate, information normally required as part of a competitive tendering process was not obtained.

36.101 Revenue Canada documentation for the 1995 licence indicates that the foreign-owned companies entered into a number of agreements. For instance, one established a Canadian-based representative (nominee) who, in return for certain benefits, would hold the licence on their behalf; another involved a contract between the nominee and one of these foreign-owned firms to manage and operate the duty free shop.

36.102 The foreign-owned Canadian company requested that it not be required to disclose its private commercial information, including its agreements. Revenue Canada agreed to this request and thus could not make a fully informed assessment of whether the applicant for the 1995 licence was qualified. For the 1997 licence, similar information was not disclosed to Revenue Canada.

36.103 The 1995 and the 1997 application also did not address whether the applicants met the key business competence requirements of the Duty Free Shop - Licensing Guidelines and Applicant's Guide. For example, for both the 1995 and 1997 award, the applicant's submissions did not contain a comprehensive business plan or information on the applicant's management capabilities and retail experience. This incomplete application information was accepted by Revenue Canada.

36.104 Revenue Canada informed us that it had deviated from normal licence award practices due to the unique circumstances at this site. Revenue Canada documentation indicates that the foreign-owned Canadian corporation, the owner of the land at the border crossing, refused to lease property for a duty free shop to anyone other than its nominee. This position was accepted by Revenue Canada officials who were anxious to fulfil a public need for a duty free shop at this crossing.

36.105 Conflicting interpretations of the Regulations raise concerns about the intent of the law. Revenue Canada informed us that the 1995 and 1997 licences were awarded in accordance with the Duty Free Shop Regulations. We examined this representation. The relevant sections of the Regulations state:

3.(3) A corporation is qualified to operate a duty free shop at a border crossing point if
(a) the corporation is incorporated in Canada; and
(b) all the shares of the corporation are beneficially owned by Canadian citizens or permanent residents...
3.(4) A person other than a corporation is qualified to operate a duty free shop at a border crossing point if the person
(a) is a Canadian citizen or permanent resident...
36.106 The 1995 licence was awarded to an individual. The position of Revenue Canada that the 1995 award was made in accordance with the law would be correct if the Duty Free Shop Regulations were read strictly and literally, in particular, sub-section 3(4), which does not expressly stipulate that a person who is licensed needs be the beneficial owner of the duty free shop. However, if one were to take the position that the Regulations must be given an interpretation that would best ensure the attainment of the objectives of the Regulations, then, in our opinion, an equally reasonable case could be made that the granting of the 1995 licence was not in accordance with the law. This interpretation would be supported by the interpretation given the Regulations in Revenue Canada's Guidelines for licensing duty free shops at land border crossings. However, only a court could resolve these legal issues conclusively.

36.107 As indicated, in September 1997, a new licence was awarded to a Canadian corporation. Paragraph 3.(3)(b) of the Regulations requires that the beneficial owners of the duty free shop be Canadian citizens or permanent residents. The Canadian shareholders of the corporation wrote to Revenue Canada stating that they are the "true beneficial owners". However, Revenue Canada did not verify this representation. If the beneficial ownership actually rests with a foreign entity, as we think may well be the case, then, in our opinion, the licence award was not made in accordance with the law.

Conclusion

36.108 The duty free shop program may have been adversely affected by the precedents set by these licence awards. In awarding the licences discussed above, Revenue Canada did not, for reasons explained earlier, follow certain of its standards and practices for awarding duty free shop licences.

36.109 We are concerned that other individuals, corporations or government agencies who have property ownership or jurisdictional control at land border crossings may now similarly demand that duty free shop licences be awarded to designated individuals of their choice without a competitive process and without disclosure of their ownership and operating agreements. More important, we are concerned that the manner in which these duty free shop licences were awarded may undermine the transparency and credibility of the duty free shop licence award process.

Department's response: It is the position of the Department that the applicants for the licences in question satisfied all of the requirements under the law and regulations as they pertain to the operation of duty free shops at land border crossings. Moreover, it is our position that the decision to award the licences without recourse to an open tendering process was in full conformity with the law, reflected appropriate judgment in light of the unique circumstances of this case, and in no manner compromised the integrity of the duty free shop program.

The applicants for the duty free shop licences submitted documentation demonstrating that they met all of the requirements set out in section 3.0 of the Duty Free Shop Regulations, including the principal requirement that beneficial ownership of the shares of any corporation applying for a duty free shop be held by individuals who are Canadian citizens or permanent residents. This documentation was reviewed thoroughly by departmental officials, in consultation with lawyers from the Department of Justice, and was found to satisfy all of the regulatory requirements. Information normally required as part of a competitive tendering process was neither requested nor required, as a tendering process was not undertaken in this case.

With regard to the Department's decision not to award the licences through a competitive process, it should be noted that there is no statutory or regulatory requirement that a licence for a duty free shop be awarded through a tendering process. Moreover, the case at hand is unique and without precedent. It is the first occasion that the Department has been formally approached by a private interest and asked to award a duty free shop licence to a specific, qualified applicant. Indeed, the owners of the land upon which the duty free shop was to be located stated categorically that they would only provide a lease to their nominee. This being the case, once the nominee was considered to be qualified according to the Regulations, a tendering process was not a viable option. It would not have been in the public's best interest as the outcome was a foregone conclusion.

However, the concerns raised by the Auditor General with respect to the transparency and credibility of the duty free shop licence award process have been duly noted. As a consequence, upon the expiration of the current licence, the Department intends to award any future duty free shop licence at that site through an open, competitive process, notwithstanding any position the owners of the land may take in advance.

It is the Department's position that the decisions and actions of its officials were entirely in accordance with the law and do not constitute a precedent that would adversely affect the administration of the duty free shop program. Departmental officials exercised prudent judgment in administering the law and regulations in a fair, equitable and impartial manner. There is no evidence to suggest that the actions of our officials jeopardized the integrity of the duty free shop program or were precedent-setting.

Finally, in light of the issues raised by the Auditor General with respect to conflicting interpretations of the regulations and the intent of the law, the Department has undertaken to pursue a full review of the Duty Free Shop Regulations, in concert with the Department of Finance, commencing in January 1998.