Canadian government backs down on controversial budget move

In late March I talked about the Canadian Federal budget, which had been recently released, and how it included a measure to prevent companies from deducting interest on debt incurred to fund foreign operations. I couldn’t understand the logic of the move.

It seemed strange for a conservative government normally known to be friendly to business. It also was inconsistent with how interest is generally treated for tax – that is, it is deductible if incurred to earn income both for businesses and individuals.

I wrote the blog post with more than a little trepidation, however, as I couldn’t shake the feeling that I might be missing something. The last thing I wanted was to appear the fool – perhaps the Finance Minister knew something I didn’t.

In the weeks that have passed since then, I have been joined by business leaders throughout the country decrying the move. It’s been sweet vindication reading every article featuring various business groups, executives and financial experts putting forward strong arguments against the now very controversial measure.

Now it appears the government is listening to us. They are “retreating” from the measure, and will continue to allow the deductibility of interest in these cases.

Companies will still be allowed to deduct the interest costs, but only once, Flaherty said Tuesday, claiming the measure was not aimed at eliminating the deduction but at corporations who were using offshore tax havens to claim the deduction twice — in Canada and in a foreign country.

The move was too much of a blunt instrument for the precise target Flaherty’s now claiming for the move.

On top of that, since when is it the Canadian government’s business what companies are deducting in other countries? Shouldn’t the government be focusing on establishing tax treaties with these countries, or at least working with other governments to put more pressure on countries with lax tax law?

Keep in mind I’m in way over my head here on this undoubtedly very complicated international tax issue. But it’s pretty nice finding out my initial thoughts about the move were spot on.

Terence Corcoran of the National Post has some smarter thoughts on the issue than I do:

Something is amiss in the ability of Canadian companies to deduct interest expense on their foreign investment. All serious reviews of the subject have concluded that the strange combination of Canada’s high corporate tax rates, interest-deductibility rules and the dense world of global tax law has produced a great distortionary mess that needs fixing. The question is how and when to fix it. Mr. Flaherty would be wise to announce that, in view of all the serious comment and inherent complexity surrounding deductibility, he will turn the subject over to a panel of experts to get to the bottom of the mess.

Something tells me I won’t be asked to be on the panel!