2014-15 FEDERAL BUDGET RECOMMENDATIONS PRESENTED TO THE HOUSE OF COMMONS STANDING COMMITTEE ON FINANCE BY: JAYSON MYERS PRESIDENT & CEO CANADIAN MANUFACTURERS & EXPORTERS August 2014
Executive Summary Budget 2015 must set the framework for sustaining economic growth through innovation, productivity and attraction of international investments. To that end, it must adopt specific measures that will leverage private sector investments in productive assets and human resources, thereby creating more jobs, and increasing manufacturing outputs and exports. The Government is already committed to taking some very positive measures as part of Canada s Economic Action Plan. The forecast for 2015 is to have a small surplus, as a result of economic recovery and program spending review. In recent years, the federal government has also introduced a number of important fiscal measures that are already making a significant positive contribution to business investment, innovation, and job growth. Reductions in the business tax rate, the extension of the two-year write-off for investments in manufacturing and processing machinery and equipment, the elimination of import duties on materials and equipment used in manufacturing, and the signing of key international trade agreements will set the framework for growth in the future. However, further improvements in the tax system aimed at boosting productivity and innovation can still be made. Canada s innovation and productivity landscape has changed significantly in recent years, and now is the time to compare with other international jurisdictions and find ways to improve our capacity to attract major investments, especially in the manufacturing and other high-tech sectors. Canadian Manufacturers & Exporters 1
Canadian Manufacturers & Exporters (CME) Recommendations: 1. CME strongly recommends that the depreciation rate for manufacturing and processing machinery and equipment continue at a level that keeps investment in Canada at least as competitive as that in the United States. To that end, we encourage the Government to make the current 50 per cent straight-line depreciation rate permanent. The Capital Consumption Allowance should, in any case, not fall below an effective rate of 50 per cent on a declining balance basis. This will ensure that Canadian manufacturers are operating on a level playing field with their US counterparts. This will also assist in closing Canada s productivity gap with the US. 2. CME recommends the creation of a swap program to repurpose SR&ED tax credits for companies seeking to invest in their capital assets used for R&D purposes, thereby providing an alternative to the elimination of capital expenditures under the traditional SR&ED program. 3. CME recommends the adoption of the patent box model in order to increase the commercialization of innovation in Canada. 4. CME recommends the creation of a Capital Investment Fund (CIF), which will directly support the development, expanding, or upgrading of manufacturing facilities resulting in jobs, economic activity and/or improvements to manufacturing productivity. 5. CME supports elements of the existing Labour Market Development Agreement (LMDA) program, where investments are economically measurable and beneficial to the individuals and companies involved, however, we believe that significant improvements can and should be made to the existing LMDA program structure. We recommend the adoption of a program similar to the former On Site program, which could be combined with an incentive for Canadians to participate. This incentive could for example take the form of an extended EI benefits for program users. 6. CME urges the federal government to adopt a strategic procurement policy for all its infrastructure projects, which will emphasize the need to maximize domestic economic benefits, creating jobs and enabling economic growth, while respecting its current international trade obligations. 7. CME recommends the elimination of withholding requirements related to services performed and employment functions carried on in Canada where the non-resident certifies the income is exempt from Canadian tax because of a tax treaty. Canadian Manufacturers & Exporters 2
The Importance of Manufacturing and Exporting Manufacturing and exporting represent the two largest business sectors of the Canadian economy. Manufacturing alone accounts for 11 per cent of Canada s GDP and offers high-paying, stable employment to more than 1.7 million Canadians. The direct and indirect contributions that manufacturers and exporters make to the Canadian economy are critical to the country s economic well-being. Every dollar in value added output by manufacturers generates an estimated $3.05 in total economic activity the largest economic multiplier of any business sector. One in every three jobs in Canada depends on our export success. Manufacturing is the source of almost two-thirds of Canada s goods and services exports and more than half of all private sector research and development activity in the country. Manufacturers and exporters in Canada are currently facing a number of challenges that are fundamentally changing the nature of their business. It is imperative that the next federal budget consider and address these issues. Doing so will create ripple effects throughout the economy and could help usher in a new era of prosperity in Canada. Failure to do so could result in a lower standard of living for all Canadians. In 2013, investments in machinery and equipment surpassed pre-recession levels for the first time, reaching $14.3 billion. This is undoubtedly the area where the manufacturing sector has the best performance a result of smart tax policies such as the ACCA. Some Macro-economic Indicators for the Canadian Manufacturing Sector The Industrial Capacity Utilization Rate in the Canadian manufacturing sector has just passed 80 per cent last year, for the first time since 2011. This is a good indicator that capital investments are likely to grow in the short to mid-term, given that firms will need more capacity to meet growing sales. Employment in the manufacturing sector is currently at 1.73 million, while it was more than two million back in 2007. The economic downturn and more recent productivity gains have stabilized the employment rate in our sector in recent years. Canadian Manufacturers & Exporters 3
Manufacturing exports in 2013 have almost reached their pre-recession level. Canada s Tax Environment for Innovating Manufacturers While Canada has the lowest federal Corporate Income Tax (CIT) rate in the G8, and one of the lowest in the OECD, the combined federal provincial CIT rate is not very attractive for international business investment. The following table compared the OECD combined CIT rates. In 2014, Canada has the 20th most competitive combined CIT rate among the 34 countries. Finally, more worrying is the low level of corporate spending in research and development (R&D). While concerning, it is not entirely unexpected given the significant cuts to the Scientific Research and Experimental Development (SR&ED) program in recent years; corporate spending on R&D in 2013 was at its lowest level since 2010. Forecasts for next year are not positive, given that the elimination of capital expenditures and the reduction of the Investment Tax Credit from 20 per cent to 15 per cent are being implemented in 2014. Undoubtedly, these measures will have a negative effect on corporate R&D spending next year. Business (Intramural) Expenditures in R&D 2007 2013 Manufacturing ($ Billion) Total all Industries ($ Billion) 2007 8.43 16.75 2008 7.72 16.64 2009 7.76 16.04 2010 7.22 15.47 2011 7.37 15.96 2012 7.56 16.06 2013 7.35 15.62 Combined Corporate Income Tax (CIT) Rates (OECD) 2014 Country Combined CIT Rates Ireland 12.5 Slovenia 17 Czech Republic 19 Hungary 19 Poland 19 Chile 20 Finland 20 Iceland 20 Turkey 20 Estonia 21 United Kingdom 21 Switzerland 21.1 Slovak Republic 22 Sweden 22 Korea 24.2 Denmark 24.5 Austria 25 Netherlands 25 Greece 26 Canada 26.3 Israel 26.5 Norway 27 Italy 27.5 New Zealand 28 Luxembourg 29.2 Australia 30 Mexico 30 Spain 30 Germany 30.2 Portugal 31.5 Belgium 34 France 34.4 Japan 37 United States 39.1 Canadian Manufacturers & Exporters 4
International Attractiveness of the SR&ED Tax Credit In order to calculate the international attractiveness of R&D tax credits for large multinationals, it is important to take into account both the corporate income tax rate and the R&D investment tax credit (ITC). The OECD uses the B-Index to calculate the generosity of a R&D tax credit, based on these two criteria. The table below offers a comparison between OECD countries. Canada has one of the least attractive R&D tax credit for large corporations within the OECD. Generosity of R&D Tax Credits for Large Companies (Using OECD s B-Index) OECD 2013 USA 0.07 GBR 0.08 KOR 0.10 AUS 0.12 AUT 0.12 NLD 0.14 JPN 0.14 CHN 0.14 CAN* 0.14 BEL 0.15 SVN 0.18 CZE 0.20 NOR 0.22 ZAF 0.22 BRA 0.26 FRA 0.28 FIN 0.28 IRL 0.29 HUN 0.33 CHL 0.35 ESP 0.38 PRT 0.49 ITA 27.5 *For Canada, we have calculated the B-Index for 2014 to reflect the reduction of the ITC from 20 per cent to 14 per cent for large companies. When the federal government introduced its cuts to the SR&ED tax credit, it committed to offer more direct support to corporate R&D. A lot of work remains to be done however for Canada to become a competitive jurisdiction when it comes to direct support offered to large R&D performers. As shown in the table below, Canada is nowhere close to be a very attractive jurisdiction for direct Business Enterprise R&D (BERD) support, compared to other OECD countries. Direct Funding to R&D As a percentage of total expenditures of R&D (OECD comparison) 2013 Country Direct Government Funding of BERD Mexico 0.01 Chile 0.02 Austria 0.02 Poland 0.03 Slovakia 0.03 Turkey 0.03 Japan 0.03 Portugal 0.03 Luxembourg 0.04 Italy 0.04 South Africa 0.04 Netherlands 0.04 Canada 0.04 China 0.05 Denmark 0.05 Ireland 0.05 New Zealand 0.07 Finland 0.08 Norway 0.08 Germany 0.09 Great Britain 0.09 Belgium 0.09 Estonia 0.10 Brazil 0.10 Australia 0.10 Hungary 0.11 Sweden 0.12 Spain 0.12 France 0.12 Czech Republic 0.14 Israel 0.17 Korea 0.19 USA 0.26 Slovenia 0.28 Russia 0.39 Canadian Manufacturers & Exporters 5
Canadian Manufacturing is Driving Canada s Resurgence in Labour Productivity Labour productivity is an important indicator and driver of economic growth, and reflects the importance of business investment in productive assets such as machinery and equipment, as well as investment in human resources and labour training. Canada s labour productivity (all industries) is still lagging behind overall compared to the US and other countries of the OECD. Since 2010, however, Canada s average labour productivity growth has increased almost to the same level as the US, and more than the UK and Japan (see table below). Increased labour productivity in Canadian industry in recent years has been driven by the manufacturing sector. As shown in the table below, labour productivity growth in the Canadian manufacturing sector has outperformed the average growth in all Canadian industries (doubled between 2010 and 2013). Labour Productivity Growth in Canada (%) Manufacturing vs. Total Canadian Economy $2007 dollars/hour 2007 2008 2009 2010 2011 2012 2013 Average Annual % Growth Labour Productivity 2007-2010 2010-2013 Labour Productivity Growth (%) Canada vs. Other Countries (all industries) Total Economy Manufacturing 49.3 49.2 49.5 50.3 51 51 51.6 0.671612 0.854181 49.1 50.1 48.8 50.4 51.7 52.4 52.8 0.874876 1.562752 Country GDP Per Hour Worked $US constant prices, 2005 PPPs Average Annual % Growth 2010 2011 2012 2013 2010-2013 Labour productivity in Canadian manufacturing has also increased significantly since 2010 and has outperformed most major OECD countries (manufacturing only), including the US, the UK, France and Germany. Canada 41.857 42.276 42.276 42.588 0.578784404 UK 42.752 43.007 42.213 42.094-0.51569123 US 56.261 56.473 56.988 57.466 0.708897232 Germany 48.075 48.964 49.184 49.329 0.862022598 Japan 35.389 35.4 35.667 35.979 0.552668191 Korea 25.389 27.076 26.223 26.586 1.547476378 France 48.413 49.018 49.132 49.336 0.631507822 Mexico 14.681 15.119 15.218 15.102 0.946889722 Average Labour Productivity Growth (%) Manufacturing Only Country Average Annual % Growth 2007-2010 2010-2013 US 1.16-0.51 Netherlands -0.09 1.12 Germany -0.88 1.42 France 1.02 0.54 UK 1.16-0.51 Canada 0.87 1.56 Canada is emerging as a leader in productivity growth since the last economic downturn. This growth has been driven mostly by the Canadian manufacturing sector, which has invested billions of dollars in new machinery and equipment and in labour training. This resurgence in Canadian manufacturing productivity growth has in turn been boosted by tax measures such as ACCA. Canadian Manufacturers & Exporters 6
Proposed Measures to Increase Innovation, Productivity and Economic Growth Increasing the competitiveness of Canadian businesses through research, development, innovation and commercialization 1. Accelerated Capital Cost Allowance (ACCA) for the Acquisition of Machinery and Equipment The ACCA for machinery and equipment for manufacturing and processing has been in place since 2007 and is set to expire in 2015. In a recent study published by the Canadian Manufacturing Coalition, we compared the depreciation rules for certain types of assets in Canada versus the US (a copy of the report is attached to this submission). Our analysis shows that both the ACCA and the bonus depreciation in the US have had a strong effect on business investments in machinery and equipment. We also found, however, that the traditional model of depreciation in the US is much more advantageous for companies than Canada s traditional model of depreciation (30 per cent declining balance). As discussed in the previous section, the ACCA has been a huge driver of labour productivity in the Canadian manufacturing sector since its introduction in 2007, and particularly since the last recession. This provides evidence that targeted tax measures such as the ACCA can be a powerful tool to encourage Canadian manufacturers to invest in productive assets such as new machinery. Investments in machinery and equipment have a strong effect on labour productivity growth in the Canadian manufacturing sector: Year Manufacturing Capital Expenditure in Machinery and Equipment ($CAN) Annual Labour Productivity Dollars Per Hour Worked (2007 $) Canadian Manufacturing Sector 2010 $10,383,000,000 50.4 2011 $11,196,000,000 51.7 2012 $12,858,200,000 52.4 2013 $14,386,700,000 52.8 Recommendation No. 1: Recognizing the importance of capital expenditures for the future of our sector and for increased productivity in the Canadian economy, CME strongly recommends that the depreciation rate for manufacturing and processing machinery and equipment continue at a level that keeps investment in Canada at least as competitive as that in the United States. To that end, we encourage the Government to make the current 50% straight-line depreciation rate permanent. The Capital Consumption Allowance should, in any case, not fall below an effective rate of 50% on a declining balance basis. This will ensure that Canadian manufacturers are operating on a level playing field with their US counterparts. This will also assist in closing Canada s productivity gap with the US. Canadian Manufacturers & Exporters 7
2. Offset SR&ED Cuts by Easier Access to Unused SR&ED Credits While we understand that the Government has no intention of repealing the SR&ED cuts it introduced in past budgets, CME recommends that the Government investigate easier means for large companies to access their unused credits when required. The SR&ED program offers large manufacturing firms non-refundable tax credits that can be carried forward until profitable years when their use would reduce a company s overall tax burden. These provisions in the SR&ED program, in conjunction with the difficult economic period of the last decade, have culminated in larger firms carrying more than $10 billion in unused tax credits since 2001 (as of 2012), waiting for a profitable year to redeem them. CME recommends that SR&ED tax credits should be exchanged for direct funding at a percentage of their value, and then put to work on R&D projects. Estimated Pool of Unused SR&ED ITCs (2005-2012) Recommendation No. 2: CME recommends the creation of a swap program to repurpose tax credits for companies seeking to invest in their capital assets used for R&D purposes, therefore providing an alternative to the elimination of capital expenditures under the traditional SR&ED program. Included as a program requirement, any funds received through the swap of tax credits could then be used towards company R&D related projects, including capital assets, either through the upgrading of research and development facilities, the building of entirely new R&D facilities, or the acquisition of machinery and equipment used mostly for R&D purposes. Canadian Manufacturers & Exporters 8
3. Commercialization of Innovation: CME Recommends the Adoption of the Patent Box Model in Canada A patent box is a tax incentive that provides relief from corporate tax on income generated from certain types of qualifying intellectual property (IP), particularly patents. Patent boxes are distinct from other tax incentives such as R&D tax credits. R&D tax credits are provided at the front end of the innovation lifecycle, in the years when research and development expenditures are incurred. In contrast patent box regimes provide tax relief at a later stage of the innovation lifecycle, in the years when income is generated from exploiting IP. Relief can be given either as a reduced tax rate or a deduction for a portion of the patent box income. Patent boxes therefore generally target the commercial or manufacturing activities that follow development rather than R&D activities themselves. A patent box tax incentive would support companies at a critical point in their product development and financing cycle and encourage them to commercialize new products in Canada. Recommendation No 3: CME recommends the adoption of the Patent Box Model in order to increase the commercialization of innovation in Canada. We recommend to extend the application of the patent box to innovative products not patented, similar to the model used in the Netherlands the Innovation Box Model. Maximizing the Number and Types of Jobs for Canadians 4. Creating Jobs and Incentivizing Large- Scale Capital Investment Attraction Recommendation No. 4: CME is recommending the establishment of a Capital Investment Fund (CIF), which will directly support the development, expansion, or upgrading of manufacturing facilities that will result in jobs, economic activity and/or improvements to manufacturing productivity. This CIF would be a targeted investment fund, considering only those projects that would demonstrate an ability to increase manufacturing and processing output in Canada. The sorts of projects that could be eligible for such direct contributions would include the building of new production facilities, the expansion of current facilities, revamping existing operations, or the upgrading of machinery and equipment. In all of these preceding examples, the goal of increasing production in Canada would remain paramount, and would be a prerequisite to any direct funding. 5. Supporting Families and Helping Vulnerable Canadians by Focusing on Health, Education and Training Labour shortages cost billions of dollars in lost sales for manufacturers across Canada. CME and our member companies have been working closely with all levels of governments to strengthen the domestic labour pool and improve training programs, resulting in the creation of the Canada Jobs Canadian Manufacturers & Exporters 9
Grant, reforms to the EI system, and apprenticeship training programs. CME believes that Labour Market Development Agreements (LMDA) can be a far more important and effective tool than they are presently in addressing industry training needs and closing existing skills gaps. LMDA training funds should be leveraged and focused on the specific needs of industry and on closing the most pressing skills gaps to help businesses compete, grow, and employ Canadians. Specifically, LMDA funds should be invested into areas that are employerdriven and have specific economic outcomes similar to the way the Canada Job Grant is being established. Manufacturers and their employees pay roughly $2.1 billion in EI premiums annually with only $1.2 billion paid back in benefits, the majority of which are parental leave and other social supports. This leaves a gap of roughly $900 million in the manufacturing sector alone, which we believe should be available for training in the manufacturing sector through LMDAs or similar tools. As an example, a program that existed under the old system in the 1990s entitled On-Site placed EI recipients at manufacturing facilities for up to 26 weeks. The program focusing on training and particular skill sets, including occupational health and safety, production, or environmental management. While on placement, the recipients continued to receive their EI benefits, and also gained valuable work experience in the process. The program enabled companies to evaluate the workers, many of which were hired at the end of the project. Each participating employer paid $2,600 or $100 per week to cover administrative costs and about 80 per cent of the participants received full-time jobs at the end of 26 weeks. This program was cancelled in the early 2000s with the switch to the LMDA. To us, this is a great example of using the funds that are focused on employer needs, and producing real and demonstrable results for the economy. Recommendation No. 5: CME supports elements of the existing LMDA program, where investments are economically measurable and beneficial to the individuals and companies involved, however, we believe that significant improvements can and should be made to the existing LMDA program structure. We recommend the adoption of a program similar to On Site, which could be combined with an incentive for Canadians to participate in the program. This incentive could for example take the form of extended EI benefits for program users. 6. Ensuring Prosperous and Secure Communities, Including Through Support for Infrastructure The federal government has committed more than $50 billion for infrastructure projects over the next 10 years through the Building Canada Plan. CME urges the federal government to use this large investment in public infrastructure to leverage the capabilities of Canada s manufacturing sector and to ensure that Canadian companies can compete on a fair and reciprocal basis against international competitors when it comes to supplying goods, services, and new technologies to infrastructure projects in Canada and in export markets. CME is concerned that domestic economic benefits are not among the criteria used in the procurement process for federally-funded large-scale infrastructure projects. As an example, Canadian Manufacturers & Exporters 10
in addition to the Building Canada Plan, the government is currently undertaking a multi-billion project involving the replacement of the aging Champlain Bridge and several kilometres of urban highway infrastructure on either side. Despite calls to do so, domestic economic benefits are not included in the federal government s published call for proposals and evaluation grid. Recommendation No. 6: CME urges the federal government to adopt a strategic procurement policy for all its infrastructure projects, which will emphasize the need to maximize domestic economic benefits, creating jobs and enabling economic growth, while respecting its current international trade obligations. Evaluation Criteria Request for Qualifications for the Construction of the New Champlain Bridge (Montreal) Evaluation Area Applicable Weight Minimum Weighted Score Rated Evaluation Criteria Package 2 Team Partnering 5% Package 3 Financial Capability and Financial Abilities 30% 18/30 Package 4 Bridge Design Experience 15% 9/15 Package 4 Highway Design Experience 5% Package 5 Bridge Construction Experience 20% 12/20 Package 5 Highway Construction Experience 10% Package 6 Bridge & Highway Operations and Maintenance 10% Package 7 Tolling Operations and Maintenance 5% Source: https://buyandsell.gc.ca/procurement-data/tender-notice/pw-nb-001-64871 Canadian Manufacturers & Exporters 11
7. Improving Canada s Taxation and Regulatory Regimes Section 102 and 105 of the Income Tax Regulations impose withholding tax on payments on services rendered in Canada by non-residents. Reg. 105 covers situations where a fee is paid to a non-resident for services in Canada while 102 covers compensation paid to an employee who is working in Canada (even if the non-resident employee is a legal employee of the non-resident company and is not a resident of Canada). Under both sets of regulations: Legal obligations are imposed on the payer or employer to withhold, remit and report this means that foreign companies have to set up a payroll account, obtain a tax identification number and issue T4s (and possibly T4A-NRs) in Canada (even where no tax may be applicable due to treaty exemption). Companies and/or employees can apply for a waiver from withholding, and get the CRA to issue approval letters, before any payments are made or before any travel takes place this means that global multinationals have to set up a process to identify and track employees travelling into Canada and do all the paper work prior to travel this is not practical and is far too cumbersome. Employees are required to obtain Individual Tax Numbers in order for the CRA to either approve their waivers or to process refund requests that process is confusing, and has specific signature requirements that are antiquated in today s digital age. Tax returns must be filed by the non-resident company at the end of each tax year, as the case may be, to report any carrying on business in Canada activity and to recover a portion or all of the tax withheld. Employees must file a Canadian income tax return to obtain a refund of any withholding remitted for them by their employer. In a competitive global environment, Canadian companies are often required to strengthen the level of expertise on their Canadian project teams by accessing a global talent pool. Businesses can ill afford to look solely to resources and expertise available within their home country; thus, access to skilled foreign resources and know-how on a temporary or project basis is critical to Canada s competitiveness especially when those skills are unavailable in the domestic market. Administrative practices and costs that hamper the ability of Canadian companies in this regard should be eliminated. We would like to note that in many cases, these non-resident employees described above are ultimately not subject to tax in Canada (thus no revenue leakage to Canada) due to the availability of exemption provisions in Canada s many bilateral income tax treaties. These provisions exist to eliminate double-taxation. For example, under the Canada-US Tax Convention, unless the US resident employee was in Canada for more than 183 days, he or she is exempt from taxation in Canada. And yet, Regulation 102 would still require both the employer and the employee to deal with the cumbersome processes described above. Recommendation No. 7: CME recommends the elimination of withholding requirements related to services performed and employment functions carried on in Canada where the non-resident certifies the income is exempt from Canadian tax because of a tax treaty. Canadian Manufacturers & Exporters 12
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