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By GUNDI JEFFREY

Describing it as “a phenom-enal opportunity,” Elio Luongo has agreed to

become the next CEO of KPMG Canada. As of Oct. 1, he replaces Bill Thomas, who will move on to focus on his role in the global firm as chair of the Americas region.

Thomas feels he is leaving the Canadian firm in capable hands. “Elio is a strong and accomplished leader, and I’ve had the great for-tune of witnessing his passion, dedication and drive over the many

y e a r s w e ’ v e w o r k e d together. He has the vision neces-sary to grow our organization and the proven ability to champion our culture and inspire our people.”

As part of that vision, Luongo aims “to promote Canada’s com-petitive advantage as an important guiding principle for my tenure. We are fortunate that Canada is such a great place to do business. Our country has incredible potential, and I’m confident that KPMG’s entrepreneurial and purpose-driven people will lead the way as we

work to better serve the evolving needs of our clients and commun-ities.”

Luongo has had a roughly 30-year career with KPMG. After joining the firm in Vancouver in 1987, Luongo took on progres-sively more responsibility, ultim-ately being promoted to managing partner for the Greater Vancouver Area in 2007. Most recently, he was the Canadian managing partner of KPMG’s tax practice, where he was

Mark that up as a mark to

market tax winBy LUIs MILLaN

Taxpayers are entitled to use t h e m a r k - t o - m a r k e t method to compute income

for federal tax purposes if it pro-vides a more accurate picture of a taxpayer’s income, the Federal Court of Appeal has recently ruled.

The decision bolsters the pos-sibil i ty for taxpayers to use methods to compute income that are not forbidden by the Income Tax Act, aff irms a Canada Rev-enue Agency administrative pos-ition that allows regulated finan-cial institutions to tax derivatives on a mark-to-market basis. It may open the door to allow financial accounting to become more influential in determining what constitutes an acceptable method of computing income from busi-ness, according to tax experts.

“The case confirms that tax-payers are to determine profit for tax purposes on the basis that reflects an accurate picture of the taxpayer’s income,” said James Morand, a Toronto tax lawyer with Cassels Brock & Blackwell LLP. “If mark-to-market presents a truer picture of a taxpayer’s income than realization or some other method of computation, it is preferable.”

Kruger Inc., a Montreal news-print and paper products manu-facturing company that generated approximately 80 per cent of its sales in the U.S., started a busi-ness during the 1980s that pur-

chased and sold foreign currency option contracts in order to reduce its exposure to foreign currencies. That line of business became so successful that it eventually became an industry leader in the Quebec options market, ranking among the top three or four non-banking enter-prises in Quebec. Beginning in 1997, Kruger began to account for its foreign exchange oper-ations using mark-to-market accounting. In 1998, Kruger’s

KPMG taps Elio Luongo to drive business forward

With so much more data now available to accountants, the challenge is not only understand it, but also to ‘recognize the various disrupters that will affect our clients,’ says Elio Luongo, the new CEO of KPMG Canada. He is seen above at the firm’s Toronto office.

www.thebottomlinenews.ca Vol. 32 No. 12 October 2016

The Independent Voice for Canada’s Accounting and Financial Professionals

The Independent Voice for Canada’s Accounting and Financial Professionals

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See Decision on page 8Photo courtesy KPMG Canada

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2 The Bottom Line October 2016N E W s

By DoNaLEE MoULtoN

Britain’s announcement this summer that it would exit the European Union after

43 years caused a global eco-nomic furor and dire warnings the country would falter. Those predictions have yet to come true, and new research out of Britain suggests that business confidence is buoyant. That same research also indicates increasing opportunities for accountants may result from going solo.

According to a new survey of investors and entrepreneurs from London-based Seedrs Limited, one of the largest equity crowd-funding platforms in Europe, over half of those polled believe that London will retain its pos-ition as a global centre for innov-ative new businesses post-Brexit. Only 16 per cent said they feel London will lose out to other international business hubs.

“Our research supports the view that London will continue to be one of the top destinations for entrepreneurs looking to set up a business,” said Jeff Lynn, CEO and co-founder of Seedrs in London, noting that, “We haven’t seen any slowdown in investment activity since the referendum, and we believe strongly that the U.K. remains highly attractive for inward investment.”

“Rome wasn’t built in a day, and London won’t stop being a major f inanc ia l hub in one either,” said Jaime Watt, execu-tive chair of Navigator Ltd., a public strategy and communica-tions firm in Toronto.

“London has a long history of

b e i n g a h u b o f t h e g l o b a l economy and has been a remark-ably stable place in spite of tur-moil elsewhere,” he added. “I suspect that the stability and friendly business environment the U.K. offers will allow London to remain an important hub.”

However, Pier re Cléroux, vice-president of research and

chief economist with the Busi-ness Deve lopment Bank o f Canada (BDC) in Montreal , sounded a caut ionar y note . “There is a risk London will lose its position as a central hub,” he said. “There is a lot of competi-tion … Paris is already lobbying companies to do business there.”

He points out that leaving the European Union would require that Britain renegotiate all the regulations in place regarding trade and business. “It won’t be a s e a s y t o d o b u s i n e s s i n London.”

The city has been an attractive location for companies, espe-cially from Canada and the U.S., looking to set up operations in Europe or expand to that con-tinent. The language of business is English and the country’s regulations have been flexible for new and g rowing f i rms. “ T h a t ’s w h y L o n d o n w a s impor tan t fo r dea l ing wi th Europe,” Cléroux said. “But if you’re no longer part of Europe, London may not be the best place to do business.”

Cer tainly business owners and executives have concerns about the future of London post-Brexit. However, according to the Seedrs survey, these are not focused on funding and capital. “Entrepreneurs’ biggest con-cerns post-Brexit are dominated by uncertainty about the future rather than by potential lack of access to business f inance,” Lynn said.

F o r t y - o n e p e r c e n t o f respondents said their major worry was regulatory change and the same percentage said it was los ing European t rade .

O t h e r i s s u e s i d e n t i f i e d by respondents included low growth levels (35 per cent) and loss of foreign direct investment (33 per cent). Only 15 per cent identi-f ied lack of access to business f inance as causing them sleep-less nights.

The emphasis on constancy is understandable, said Watt. “A

stable and pro-business eco-nomic situation is a major asset for any company.”

Ensuring such steadiness in the London marketplace is also good for Canadian companies, he added. “This, of course, is helpful for Canada as our rela-tionship is terrif ic and we have spent several years moving down a path of greater economic co-operation and expanded trade.”

In the short term, however, uncertainty will predominate as the terms of Brexit are negoti-ated, but this will be a temporary

hit, Navigator’s CEO believes, and he credits the British gov-ernment with doing a good job of showing the business com-munity that i t is focused on maintaining a low-tax, reliable economy that will enhance trade opportunities. “As the negotia-t i o n s a d v a n c e , i t w i l l b e important for the government to continue to express its prefer-ence for expanding trade oppor-tunities and maintaining a pro-business environment within the country,” Watt said.

As well, quelling concerns will be necessary to boost busi-ness conf idence in what lies ahead. “Uncertainty is the worst scenario,” said Cléroux. “This is not good for investment.”

The Seedrs survey also high-lights opportunities for growth, and the sector predicted by both investors and entrepreneurs to see the strongest growth over the next 12 months is professional services such as accountancy and law, cited by 29 per cent of respondents. The finding makes sense given the current land-scape, said Cléroux. “Now we are in a phase where nobody knows what is going to happen, but there is two years to exit. Finance and accounting services wil l be in demand to assess impact and negotiate a good deal.”

Anyone with the skill to help negotiate a new deal will be in demand, said Watt. “Much of the U.K.’s trade negotiation had been outsourced over the years of integration with the EU, and they are facing a very real shortage as they renegotiate one of the most major trade relationships in the world,” he noted.

Finance and other profes-sionals now on the ground in London, or looking to move there for permanent work, may face a waiting period for the job market to rebound. “In terms of accounting and legal profes-sionals, there may be a pause in growth while companies take stock of what Brexit means,” but the situation “should return to equilibrium in the near future,” Watt said.

Of course , des t iny is not determined exclusively by the British government and the busi-ness community. Expect push-back from the European Union, said Cléroux. “Europe wants to send the message that you cannot leave the union and have it be business as usual. There will be restrictions. Everybody will try to protect their interests.”

That pushback and the uncer-tainty that looms over London, at least for the next two years, has convinced Cléroux that the best place for business is not Britain. “If I were the CFO of a company looking to expand, I wouldn’t go to the U.K.,” he said, “but there would be no problem going to Europe. The market is coming out of the downturn.”

Business still bullish on U.K., survey says

NEWs

KPMG taps Elio Luongo to drive business forward . . . . . . . . . . . . .1

Mark that up as a mark to market tax win . . . . . . . . . . . . . . . . . . . . .1

Business still bullish on U.K., survey says . . . . . . . . . . . . . . . . . .2

accounting board tries innovative approach . . . . . . . . . . . . . . . . . . . 3

states’ disclosure rules mirror Canada’s . . . . . . . . . . . . . . . . . . . .4

U .s . banks join push for shell company transparency . . . . . . . . .5

More clarity wanted, but fear is of more clutter . . . . . . . . . . . . . . . . . .6

Ill trade winds may pose threat to Canada . . . . . . . . . . . . . . . . . . . . .7

IosCo survey reveals vital role of audit committee . . . . . . . . . . . . . .9

B .C . boom a bust . . . . . . . . . . . .10

More talk than walk in some quarters over risk . . . . . . . . . . . .16

FoCUs

Energy & Mining. . . . . . . . . . 11-15

CoLUMNIsts

Peter Merrick: Wrong strategy, big headache. . . . . . . . . . . . . . . . . . . . 16

Mort shapiro: ‘Lite’ is alright, but understand value . . . . . . . . . . . . . 17

Janet spence: Simple steps to a pain free audit. . . . . . . . . . . . . . . . . . . . 18

Vern Krishna: Nominal tax rates don’t tell whole story . . . . . . . . .19

saam Nainifard: Similar circum-stances, differing motivations . . .21

c O N t e N t s

departMeNtsFinancial Planning . . . . . . . . . . . . . .16Management . . . . . . . . . . . . . . . . . . .17Payroll . . . . . . . . . . . . . . . . . . . . . . . .18tax Practice . . . . . . . . . . . . . . . . . . .19tax Digest . . . . . . . . . . . . . . . . . . . . .20Legal . . . . . . . . . . . . . . . . . . . . . . . . .21

Cléroux

“There is a risk London will lose its position as a central hub. There is a lot of competition ... Paris is already

lobbying companies to do business there.”Pierre Cléroux, Business Development Bank of Canada

The Bottom Line October 2016 3N E W s

By JEFF BUCKstEIN

Th e I n d i a n a B o a r d o f Accountancy has taken a historic step in continuing

professional education (CPE) by giving its members an alternative to the traditional hours based pro-cess. Certified public accountants in Indiana now have the option of passing the ethics component of their licence renewal through hands-on competency based learning.

They are the first CPAs in the United States to be afforded this choice.

“A one-size-fits-all model of CPE is no longer appropriate to encourage and allow a profes-sional accountant to maintain and enhance their competence,” said Gary Bolinger, president and chief executive off icer of the Indiana CPA Society in Indianapolis.

He noted that the traditional approach to licence renewal for CPAs in the United States is now 50 years old.

“The system really needs to change — not only to accommo-date and recognize advances in technology and recognize differ-ences in learning styles. But as complexity in business increases, we’re seeing increased specializa-tion — deep specialization — and I’m not sure that the continuing education system as it exists rec-ognizes all of those changes,” Bolinger said.

Indiana CPAs need to earn an ethics credit that counts four hours toward the 120 total hours of CPE required to renew their licence every third year. The rule that was recently adopted by the Indiana Board of Accountancy allows a licensee to continue to use the traditional method of earning those four hours of CPE, or they can use a competency based approach to fulf il that ethics course requirement, said Bolinger.

Alternatively, they could serve in a voluntary ethics position in a trade or professional organization verif ied to fulf il their ethics requirement toward l icence renewal. One example of that would be if a member were to sit on the American Institute of Certi-fied Public Accountants’ (AICPA) professional ethics executive com-mittee, he noted.

“If that individual is actively engaged in that activity in terms of writing rules and writing interpret-ations, and then hearing cases about various ethics issues, they have to apply the code of conduct ethics on an ongoing basis. What better learning is there than serving in that kind of a capacity?” asked Bolinger.

Competency based learning opportunities do not apply to Indi-ana’s other course components for l i c e n c e r e n e w a l , s u c h a s accounting and auditing.

Bolinger said the competency based approach offers several advantages.

“The individual is required to be a bit more engaged. They can’t

just sit in a classroom and be dis-tracted and let their mind wander. They have to engage in the course,” he said.

“There are social learning ele-ments [and] gamification elements of the course that we’ve developed. One must participate in the learning experience in order to complete the course. They must express opinions on case studies. There are both technical and behavioural aspects of our course. So the individual who opts for the competency based learning has to demonstrate some competence in order to successfully complete the course, or else they don’t get the credit.”

The Bottom Line asked the AICPA for its reaction to Indiana’s groundbreaking approach to con-tinuing education.

“The AICPA believes in uni-formity in CPE requirements across all jurisdictions, as demon-strated by our support of the Uni-form Accountancy Act. However, following our issuance of the Future of Learning report [in 2014], we have encouraged stra-tegic pilot programs by state boards of accountancy that would move the CPE compliance model from time-based to more compe-tency-based measurements,” said Clar Rosso, the organization’s

vice-president of member learning and competency, who is based in Durham, N.C.

“As we continue to study the issue, pilot programs like Indiana’s will further the collection of data on the effectiveness of different methods. Our goal is to preserve the high degree of public confi-dence that CPAs are honing the skills they need to keep their learning and licences up to date,” Rosso added.

Tashia Batstone, senior vice-president of external relations and business development at CPA Canada in Toronto, said officials in charge of continuing profes-

sional development (CPD) for accountants need to consider sev-eral factors when deciding whether to use an output-based measure, s u c h a s c o m p e t e n cy - b a s e d learning, or an input-based measure like hours of study.

“If your objective is to demon-strate skills that are up to date, all the research shows that an output based measure is preferred. But it does present some challenges. It takes a s ignif icant ly higher amount of resources to manage that. It’s often difficult to try to measure it accurately. You’ve got

Accounting board tries innovative approach

See New on page 18

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By DoNaLEE MoULtoN

In an effort to crack down on corrupt practices, including bribery, diversion of funds

and facilitation payments, the U.S. Securities and Exchange Commission is now requiring mining and other extract ive resource companies to dig a little deeper into their f inancials and disclose expenditures made to foreign governments to grease the wheels of commerce in those countries.

Canadian companies doing business in the U.S. or affiliated with American f irms will also have to comply with the new rule. Their workload may be lighter, however. The Canadian government is already requiring companies here to report much of the required information.

“The underlying principle is if [companies] disclose what they’re paying to governments in various countries, it will make t h o s e g o v e r n m e n t s m o r e a c c o u n t a b l e ,” s a i d M a r k Wheeler, a lawyer with Borden Ladner Gervais (BLG) LLP in Toronto.

The new rule requires al l U.S.-listed oil, gas and mining companies to publicly release each year payments of at least $100,000 in all countries where

they operate. “This means com-panies must disclose their taxes, licence fees, bonuses, royalties and other payments for every project,” noted Jana Morgan, director of Publish What You Pay — Uni ted S ta tes , an in te r-nat ional advocacy g roup in Washington, D.C.

T h e S E C ’s r e g u l a t i o n s , approved this summer, will pro-vide investors with important facts they need to better assess and mitigate investment risks, she added. “This is crucial infor-

mation and has been called for by investors with nearly $10 tril-lion in assets under manage-ment.” All information collected wil l be posted in the SEC’s EDGAR online database and be available free of charge.

A two-year phase-in period has been put in place for com-panies required to comply with the new rule, which was man-dated under the Dodd-Frank Wall Street Reform and Consumer Protection Act , for the f iscal year ending Sept . 29, 2018. Extractive f irms must report no later than 150 days following the end of their f iscal year. Com-panies that file false information in their annual reports can be f ined by the SEC and will also open themselves up to civil suits.

A l t h o u g h m a n d a t e d b y existing legislation, the SEC’s r e q u i r e m e n t f o r e n h a n c e d reporting on financial payments is an international issue. “The U.S. legislation is in line with the legislation in Canada, in the U. K . a n d i n t h e E u r o p e a n Union,” said Wheeler. “The sig-nificance of the U.S. legislation is that the U.S. is the elephant in the room. If [American] com-panies were not required to make this disclosure, it would leave a gaping hole.”

The impact of the United States on extractive industries around the world is signif icant. Since 2011, for example, the country has been the world’s top producer of natural gas and, since 2013, the world’s top pro-ducer of petroleum hydrocar-bons, according to the U.S. Energy Information Administra-tion.

Oil , gas and mining com-panies can expect the new rule to add a new layer of paperwork and regulatory oversight. “It will certainly create an administra-tive tax burden to keep track of all their payments,” Wheeler said.

For U.S. companies doing business in Canada, that burden may be somewhat reduced. The Extractive Sector Transparency Measures Act, given royal assent i n 2 0 1 4 , m i r r o r s t h e S E C requirements — and calls for Canadian companies to comply earlier than the U.S. regulations. Much of the paperwork that will be required to disclose in Canada can be used to meet SEC require-ments when the time comes.

However, noted Wheeler, there is one anomaly. “In Canada, reporting is made slightly more complicated. Companies must report on a cash accounting basis

not an accrual basis.”The SEC regulation initially

met with resistance from the country’s extractive industries. In 2012, the organization intro-duced the f irst disclosure rule only to face a legal challenge from companies claiming the burden imposed was too great and sensitive information could be released. The U.S. District Court for the District of Col-umbia agreed, and the rule lan-guished . In 2014, however, Oxfam filed an action to compel the SEC to issue a revised rule as required under Dodd-Frank. Last year the SEC was court-ordered to f ile a plan for f inal-izing its rule.

The cur rent rule contains some differences from the ori-ginal. For example, in the f irst rule, the SEC did not def ine “project .” That term is now explained and mirrors the defin-

ition in Canada’s legislation. As well, the SEC previously

did not allow for exemptions; now the commission can con-sider exemptions on a case-by-case basis. “This does not align w i t h wo r l d w i d e r e p o r t i n g requirements, but we are confi-dent that no host-country pro-hibitions to reporting exist any-wh e r e i n t h e wo r l d,” s a i d Morgan.

The industry also expressed concerns about getting caught between transparency and pri-vacy laws. For example, if U.S. law required disclosure but the statutes of the country in which a company was operating pro-hibited such disclosure under privacy legislation, the enter-prise would have to breach at least one set of laws, likely those of the nation in which they are doing business. “That is cer-tainly a legitimate concern if it is real,” said Wheeler. However, he noted, an inventory of countries was conducted and no such pri-vacy legislation was found to exist.

Many mining, oil and gas firms actually support the intro-duction of disclosure rules. “A number of companies have pub-licly stated that they believe transparency is good for busi-ness. In fact, mining associa-

tions representing over 1,200 mining companies joined forces with publish What You Pay — Canada to actively petition the Canadian government” for legis-lation that would require greater transparency and disclosure, noted Morgan. That law ultim-ately became the Extract ive Sector Transparency Measures Act.

The impetus for suppor t , noted Morgan, is “the very real benef its of transparency.” She added, “payment disclosure will allow these companies to show their economic contributions to t h e c o u n t r i e s w h e r e t h e y operate.”

Indeed, the SEC rule, and similar legislation such as that in Canada, give mining, oil and gas companies the opportunity to demonstrate their contributions to the countries in which they operate, Wheeler said. “Com-panies like to report how pro-jects benef it local economies, but it’s virtually impossible to put real numbers on this. This [rule] will help quantify it. For the f irst time, industry will be able to say, ‘These are the direct benefits.’”

States’ disclosure rules mirror Canada’s4 The Bottom Line October 2016N E W s

PublisherAnn McDonagh

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THE BOTTOM LINE

Copyright © 2015 LexisNexis Canada Inc. All rights re served. No part of this publication may be reproduced in any material form (including photocopying or storing it in any medium by electron ic means and whether or not transiently or incidentally to some other use of this publication) without the written permission of the copyright owner or in the case of photocopying or other reprographic copying, a licence from CANCOPY (Canadian Copyright Licensing Agency) ex cept in accordance with the provisions of the Copyright Act. Applic ations for the copyright owner’s written permission to reproduce any par t of this publication should be ad dressed to the publisher. Warning: The doing of an unauthorized act in re lation to a copy-right work may re sult in both a civil claim for damage and criminal prosecution. The Bottom Line is published 16 times a year. send changes to: Subscriptions, 111 Gordon Baker Road, Suite 900, Toronto, ON M2H 3R1. Return postage guaranteed. Return undeliverable Canadian addresses to: Circ. Dept., 111 Gordon B a k e r R o a d, S u i t e 9 0 0 , To r o n t o , O N M 2 H 3 R 1 . e - m a i l : s c o t t . we l s h @ l e x i s n e x i s . c a Publications Mail Agreement Number: 40065517. ISSN 0831-5477 GST/HST/QST R100588607

Regional Correspondents Geoff Kirbyson (Western Canada); Jeff Buckstein (Ottawa); Luis Millan (Quebec);

donalee Moulton (Halifax); Special Correspondent: Gundi Jeffrey

Wheeler

“The underlying principle is if [companies] disclose what they’re paying to governments in various countries,

it will make those governments more accountable.”Mark Wheeler, Borden Ladner Gervais LLP

Morgan

“This does not align with worldwide reporting requirements, but we

are confident that no host-country prohibitions to reporting exist

anywhere in the world.”

Jana Morgan, Publish What You Pay – United States

The Bottom Line October 2016 5N E W s

By DoNaLEE MoULtoN

The global crackdown on anonymous shel l com-panies has gotten a thumb’s

up from the world’s largest com-mercial banks. In August, the C l e a r i n g H o u s e , w h i c h inc ludes Bank of Amer ica , Citibank and Wells Fargo among its members, wrote to the U.S. Congress in support of the Incor-poration Transparency and Law Enforcement Assistance Act.

The proposed U.S. legislation is intended to “help law enforce-ment crack down on human traf-f icking, ter rorism f inancing, money laundering, Medicare fraud, the narcotics trade, tax eva-sion, public corruption and a litany of other crimes in the United States and around the world,” according to Rhode Island Sen. Sheldon Whitehouse, who is helping to spearhead the legisla-tion, in a speech he gave to the U.S. Senate.

At present, f inancial institu-tions in the U.S. are required by federal law to know their cus-tomers and monitor account infor-mation. However, there is no requirement that benef ic ia l ownership information, data about those who own, control and profit from companies, be provided to a state at the time of incorporation. The proposed legislation would change this — a move banks in the U.S. are publicly applauding for the first time. “Financial insti-tutions are wholly committed to combating money laundering and terrorist f inancing activities,” New York-based Gregory Baer, president of The Clearing House, stated in his two-page letter.

That support, however, is not unconditional. The Clearing House is asking congressional lawmakers to go a step further and give banks access to information states collect on beneficial owners. “Under the current regime, many if not most of the resources devoted to identi-fying money laundering and ter-rorist f inancing are provided by f inancial institutions; denying them access to this important information would significantly undermine the goals of the bill,” Baer said.

Financial institutions in the United States are bearing the

burden of compliance. The new transparency legislation, still being hotly debated, coincides with the introduction by the U.S. Department of the Treasury of a customer due diligence rule that requires f inancial institutions, including banks, securities brokers and mutual fund dealers, to collect and verify the personal informa-tion of benef icial owners when companies open accounts.

Transparency in business ownership is not a new idea, but pressure on governments to crack

down on tax evaders, money laun-derers and others is growing in the wake of the Panama Papers scandal. “Every member of the European Union will be trans-parent by 2017. The United Kingdom and the Netherlands have even announced plans to make their corporate ownership registries available to the public,” Whitehouse noted. “With the light of transparency about to shine on criminal assets hidden in Europe, America should take swift action

to make sure that these assets don’t find a new hidden home in opaque American shell corpora-tions.”

Canada may also want to step into the light. Although the Finan-cial Transactions and Reports Analys i s Cent re o f Canada (FINTRAC), the country’s finan-cial intelligence unit, has regula-tions in place that require banks to collect customer information, check beneficial ownership and report suspicious transactions, comprehensive information is not

required, nor is updating. As a result, many consider this country a haven for shell companies. “Canada is probably worse than the U.S. in terms of how easily it is to set up a shell company,” said Dennis Howlett, executive director of Canadians for Tax Fairness in Ottawa.

According to a letter sent to the country’s premiers by Canadians for Tax Fairness and four other national advocacy organizations, the “complex and opaque system” that exists here is one of the key reasons why the country was mar-keted by Mossack Fonseca, the law firm at the centre of the Panama Papers, as a good place to incor-porate an anonymous shell com-pany and why a risk assessment conducted by the Department of Finance Canada identif ied Can-adian corporations and trusts as highly vulnerable to money laun-dering and terrorist financing.

Only three provinces, Alberta, Manitoba and Quebec, come close to meeting international standards for transparency of benef icial ownership, Howlett said. “There needs to be some due diligence.”

In the open letter to premiers sent this summer, Canadians for Tax Fai r ness , Transparency International Canada, the Can-adian Labour Cong ress and others stressed the cost of shell companies on citizens’ quality of life and the national economy. Vancouver and Toronto a re

feeling the direct effects of cor-porate secrecy as numbered shell compan ie s “ sna t ch up r ea l estate, turning neighbourhoods where Canadians used to raise their families into vacant areas

used to park offshore cash,” the letter stated.

The problem is significant, the authors added. “In 2013, Global Financial Integrity estimates that over $1 trillion in illicit funds crossed borders, while Canadians for Tax Fairness estimates that provincial and federal govern-ments in Canada lose $8 billion a year to tax havens.”

The solution to shell com-panies is a public registry, said Howlett. Provinces could regulate the registry in their jurisdiction, but there would be national stan-dards that everyone had to meet. “This enables the public to hold companies accountable,” he noted. “It would make it easier for com-panies to get reliable data on other companies they are dealing with.”

The request will not be easily dismissed. Thanks to the Panama Papers and other tax scandals, the public is better informed — and angry — about loopholes that allow individuals and corporations to avoid paying their fair share of tax as well as other illegal activ-ities. The issue is also on the inter-national policy agenda, and now banks around the world are step-ping up to support greater trans-parency. CIBC, for example, sent a note to some customers with a c c o u n t s i n t h e C a r i b b e a n requesting proof the account holders had informed tax author-ities about the money, noted Howlett. As many as one-third of these accounts were subsequently frozen or closed, he said. “The tide has turned.”

U.S. banks join push for shell company transparency

Small state, big tax breaksLooser regulations in cer-

tain jurisdictions unfurl a welcome mat for shell

companies. The state of Delaware is one

of the most well-known havens. According to U.K. media outlet The Guardian, the Delaware loophole, which allows firms to move money from other states and receive big tax breaks in return, has enabled tens of thou-sands of companies, including

those registered by Hil lary Clinton and Donald Trump, to avoid hundreds of millions of dollars in tax.

Among the details reported:• The North Orange Street

office of the Corporation Trust Centre in Wilmington is the legally registered address of more than 285,000 companies

• The number of companies, including 378 registered to Trump, is the single greatest

registry on the planet• According to off icial rec-

ords, the Wilmington off ice is home to Apple, American Air-lines, Coca-Cola and Walmart among dozens of other Fortune 500 companies

• It is estimated Delaware’s relaxed taxation rules have cost other states US$9 billion in lost taxes over the last 10 years.

• Donalee Moulton

hoWlett

“Under the current regime, many if not most of the resources devoted to identifying money laundering and

terrorist financing are provided by financial institutions; denying them access to this important information would

significantly undermine the goals of the bill.”Gregory Baer, The Clearing House

It would make it easier for companies to get reliable data on other

companies they are dealing with.Dennis Howlett, Canadians for Tax Fairness

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6 The Bottom Line October 2016N E W s

By GUNDI JEFFREY

To help i t wr i t e be t t e r accounting standards, the U.S. Financial Accounting

Standards Board wants to change the part of its conceptual frame-work that deals with how items are presented in financial statements. Meanwhile, the International Accounting Standards Board is working on a similar project, but with a somewhat different slant. Hans Hoogervorst launched his second term as IASB chair — which began July 1 — with a pro-ject aimed at improving the effect-iveness of f inancial statement communication overall.

“Valuable information gets drowned out by ‘tick the box’ dis-closures and voluminous, but poorly organized and presented, financial statements,” Hoogervorst said in a recent speech in Zurich. “For the investor, it is often diffi-cult to see the woods through the multitude of information trees.”

For his part, FASB chair Rus-sell Golden said, in a statement, “The conceptual framework is the f o u n d a t i o n f o r r e s o l v i n g accounting and reporting ques-t i ons . These p roposa l s a r e intended to provide direction, structure and a basis for consistent board conclusions when making standard-setting decisions related to presentation.”

According to Linda Mezon, chair of Canada’s Accounting Standards Board: “Both standard setters are pondering how to make f inancial statements more rel-evant. The problem, as everyone sees it, is disclosure overload — there’s too much disclosure in financial reporting. But, if you sit down with users and ask them about a specific disclosure, they’ll say ‘no, you can’t take that away.’ If you suggest a new type of dis-closure, they say ‘oh, that would be great.’ So what do you do? That’s what both the IASB and FASB are thinking about, but how they choose to think about it may not necessarily be the same.”

And the difference may be moot. Sandy Peters, head of finan-cial reporting at the New York-based CFA Institute, points out that the FASB proposals are part of its conceptual framework pro-ject. “It’s to help them in the way they think about things. It won’t really change anything in the immediate future. It’s only about how it helps them make decisions. It’s not like companies are going to change classifications based on this.”

Neil Robertson, chair of FEI Canada’s committee on corporate reporting, believes that, in any case, Hoogervorst’s effort may not have a huge impact in Canada. “He is dealing with a global audi-ence , where the regu la tor y environment is not standard across the IASB’s various jurisdictions. While there is always room for improvement, there is a pretty strong backbone to the regulatory env i ronment in Canada for

investors and other f inancial reporting stakeholders. I believe that the securities regulators would be of the same opinion.”

The FASB exposure draft, Conceptual Framework for Finan-cial Reporting: Chapter 7: Pres-entation, describes proposed con-cepts for presenting information about items that have been recog-nized in a financial statement. The proposal is intended to provide the FASB with a framework for

developing standards that sum-marize and communicate informa-tion on financial statements in a way that best meets the objective of financial reporting. Ultimately, it will underpin the board’s efforts when c rea t ing presen ta t ion requirements in future accounting standards.

The current proposals follow on the heels of Concepts State-ment 5, Recognition and Measure-ment in Financial Statements of

Business Enterprises , which addresses the recognition, meas-urement and certain concepts for presentation of information on the face of financial statements. The FASB concluded the discussion of presentation could be further improved with the objective of providing a foundation for future standards that enhance financial statement users’ abilities to assess

prospects for future cash flows by addressing how to group indi-vidual recognized items into line items and subtotals and clarify the relationships among an entity’s assets, liabilities and equity, and the effects of related changes of those assets and liabilities on comprehensive income and cash flows.

The proposal, says the FASB, will help it make consistent deci-sions when determining how to present information in financial statements. In particular, it would give the FASB a framework for developing standards that sum-marize and communicate informa-tion in f inancial statements in a way that enhances the relevance of the information and helps ensure it is faithfully represented.

In his speech, Hoogervorst said, “We must recognize that pre-parers sometimes experience financial reporting as too much of a compl i ance exe rc i se and investors sometimes believe that the f inancial statements depict performance in an insufficiently clear manner.” Worse, he added, “increasingly, preparers present their investors alternative per-formance measures which are not based on IFRS standards. This information is easier to consume by users, but it almost always paints a rosier picture than reality and can be highly misleading. In addition, many companies present non-financial information on, for example, sustainability issues.”

He feels, therefore, the IASB needs to do more work to increase the communication effectiveness of financial statements. “For this reason we have decided that ‘better communication’ will be a

central theme of our work in the coming years. To make sure finan-cial statements communicate as clearly as possible, we will take a fresh look at how financial infor-mation is presented, how it is grouped together and in what form it is made available.”

The project, he said, will bring toge ther a number o f work s t r e a m s , i n c l u d i n g o n e o n

improving the organization of financial statements — statements of f inancial position, f inancial performance and cash flows; the IASB’s disclosure initiative — improving the quality and useful-ness of f inancial disclosures through amendments; clarifying the definition, presentation and disclosure requirements for finan-cial instruments with the charac-t e r i s t i c s o f equ i ty ; fu r the r developing the IFRS taxonomy to

e n s u r e i t m e e t s e l e c t r o n i c reporting needs and remains f it for purpose; and assessing the strategic challenges and exploring any potential future role that the board may play in the area non-financial reporting.

“Better communication” as a theme for the board’s work, responds to much of the feedback received through the 2015 Agenda Consultation, said Hoogervorst, and should del iver mater ial

improvements to users’ ability to make economic decisions from financial information.

Duane Kennedy, an associate account ing professor a t the Ontario’s University of Waterloo, says both boards have conceptual framework projects on the go. In fact, he says, “the FASB and IASB conducted a project from 2004 to 2010 to revise and converge their

conceptual frameworks. In 2010, the boards decided to focus on other joint projects and subse-quently agreed to discontinue work on their conceptual frame-works on a joint basis. Each board is continuing to work on revisions to its individual conceptual frame-works and each sets its own prior-ities but there is communication with a goal of avoiding inconsis-tent outcomes.” The FASB, he notes, reactivated its conceptual framework project with a focus on presentation and measurement, which resulted in the current exposure draft. “The exposure draft contains more detailed dis-cussion of presentation issues than appear in the IASB’s conceptual framework but it does not go against the principles of IFRS.”

He adds the proposed concepts do not relate to what should or should not be recognized in finan-cial statements, rather the pro-posed concepts focus on how the information should be presented. “The FASB proposals will not have a direct, immediate impact on financial statement presenta-tion; rather the impact will be through their influence on the FASB as the board sets future standards. I think that the pro-posed factors are quite basic so we will not see significant changes in financial statement presentation. Instead, I think that the impact will arise from obtaining greater consistency in presentation rec-ommendations in future stan-dards.”

One area the FASB project is not focusing on is non-GAAP measures, which seem to worry Hoogervorst a great deal because their use, he feels, almost always gives a better picture to investors. That shouldn’t happen in Canada, says Robertson. “The securities regulators have given us some very strong rules around the use of non-GAAP measures — we are even ahead of the U.S. in this area.” And, he points out, “at the end of the day, non-GAAP meas-ures are an effective way of com-municating with stakeholders as long as they are used properly — as required by the securities regu-lators. They are an effective way to give information to stake-holders in balance with general purpose financial statements.”

Mezon says: “Everybody is worried about the fact that pre-parers will use measures that make their numbers look better. As a preparer, I had a tendency not to use a lot of non-GAAP information. If I did use it, I made sure that it was consistent and computed the same way over every period.” And that, she adds, is required by Canadian securities laws in any case.

As for the two projects, she points out, the two boards are clearly thinking about the same issues. “What they are talking about is the presentation of infor-mation in the f inancial state-ments.”

Push on for clarity but fear is of more clutter

Mezon

“Valuable information gets drowned out by ‘tick the box’ disclosures and voluminous, but poorly organized

and presented, financial statements. For the investor, it is often difficult to see the woods

through the multitude of information trees.”Hans Hoogervorst, IASB

hoogervorst

“Everybody is worried about the fact that preparers will use measures that make their numbers look better.

As a preparer, I had a tendency not to use a lot of non-GAAP information.”

Linda Mezon, Accounting Standards Board

The Bottom Line October 2016 7N E W s

By JEFF BUCKstEIN

Whether Hillary Clinton or Donald Trump emerges triumphant in November

to become the 45th president of the United States, there appear to be clear signs the next U.S. administra-tion will be less amenable, if not downright hostile, toward inter-national free trade deals.

Not only would that represent a sharp break from White House policy over the past 30 years, there could be a signif icant negative impact on Canada, as America’s lar-gest trading partner.

“Even people who have been reliable pro free traders and inter-nationalists have become demon-strably more protectionist, and that’s disturbing,” said John Baird, a Toronto-based senior adviser at the law firm Bennett Jones LLP.

Baird, Canada’s minister of external affairs under former prime minister Stephen Harper, said there has been a growing protectionist attitude in the U.S. emanating from both the left and right wings of the political spectrum.

“Regardless who becomes president, it’s going to be a lot harder to solve the bilateral trade irritants, because the president won’t either have the inclination or the capacity, let alone the ability to be able to address them,” he said.

Republican candidate Trump, in particular, has attacked recent trade deals as being bad for the U.S., and is arguably most critical of the 12-nation Trans-Pacific Partner-ship (TPP), drafted in October 2015 by the trade team of President Barack Obama.

The TPP requires ratification by countries representing at least 85 per cent of the 12 participating nations’ collective GDP, com-prising the United States, Canada and Mexico, Chile, Peru, Australia, New Zealand, Japan, Malaysia, Singapore, Vietnam and Brunei. The U.S. produces more than half of that group’s GDP, so failure of the U.S. to sign on would kill the deal as currently constituted.

Trump has also been highly critical of the North American Free Trade Agreement (NAFTA), signed in 1994 by President Bill Clinton, husband of the Demo-cratic candidate.

Keith Head, a professor of eco-nomics at the University of British Columbia’s Sauder School of Busi-ness in Vancouver, noted that Hil-lary Clinton was involved in nego-tiating the TPP agreement during her term as secretary of state. (She served in the first Obama adminis-tration between 2009 and 2013).

Head no ted tha t C l in ton appeared to change her position as the TPP became unpopular with some grassroots members of her party during the Democrat presi-dential primaries.

“She has to sort of disavow it, I think,” said Head, who considers it unlikely that Clinton could turn around and implement the TPP if elected.

However, Head does not expect

Clinton to backtrack on previous agreements such as NAFTA.

Paul Ferley, the Toronto-based assistant chief economist for Royal Bank of Canada, said another big unknown affecting free trade will be the composition of the new Congress, and whether members of the Senate or House are going to be sympathetic toward or philosophic-ally opposed to free trade agree-ments such as the TPP.

Cyndee Todgham Cherniak, founder of LexSage Professional Corporation, an international trade law and sales tax firm in Toronto, doesn’t expect the U.S. will ratify the TPP before the election. But she pointed out that the best chance of doing so might be right now while President Obama, who nego-tiated the agreement, remains in office facing a Congress controlled by Republicans, a party that has historically supported free trade.

If that happened, the newly

elected president would be backed into a corner because they would be bound by the agreement unless they took steps to undo it, she noted.

Moreover, once ratif ied by enough countries with the requi-site percentage of GDP to put the TPP in force, Canada and the other participating countries would get the benefit of the TPP and reduce the likelihood of the United States withdrawing and being the odd country out, Todgham Cherniak added.

The fate of NAFTA, which has been in force for more than two dec-ades, could be more complicated.

“I don’t believe that either

Trump or Clinton is going to rip up NAFTA,” said Todgham Cherniak. “I think that both will ultimately realize what’s in the best interests of the U.S. economy and U.S. busi-nesses is to ensure that goods flow freely across the border, and to expand the free movement of busi-ness persons across the border,” she added.

But Todgham Cherniak also noted how the U.S. has been making adjustments to NAFTA for many years, citing the example of softwood lumber.

“The Softwood Lumber Agree-ment that Canada signed (in 2006) i s n o t c o n s i s t e n t w i t h NAFTA. Article 309 of NAFTA prohibits restrictions on exports. Article 314 prohibits export taxes and charges on exports of any good to the territory of another party. Canada was forced to restrict exports of lumber, impose export charges on softwood lumber and

allow the U.S. to keep a lot of money that should have been refunded when we won the anti-dumping/countervailing duty cases,” she said.

Head doesn’t believe there are any obvious tweaks for NAFTA that would be open for renegotiation unless the U.S. was no longer inter-ested in free trade with Canada or Mexico. He noted that NAFTA is basically the Canada-United States Free Trade Agreement, which was signed in 1989, extended to Mexico.

Many lawyers are asking whether, if the U.S. backed out of NAFTA, it could revert back to the Canada-United States Free

Trade Agreement, said Todgham Cherniak.

Should that occur, “I believe that Canada and the U.S. would be well served to inter pret the Canada-U.S. free trade agreement provisions as reviving … and the duty-free treatment and the bene-fits continue,” she said.

The issues that have turned many Americans away from supporting free trade are complex, say experts.

“There are very signif icant communities that have been pretty hard hit by the decline of manufac-turing. The huge growth of Chi-nese exports to the U.S. does appear to be strongly implicated in the decline of manufacturers in the U.S. And that decline has hurt some communities much worse than others. There are people that are really suffering,” said Head.

Growing isolationism “cer-tainly doesn’t bode well for those of us who extol the virtues of free

trade,” said Baird, who noted that while some Americans believe globalization may be virtuous for the U.S. overall, they worry about things like stagnant wages and loss of manufacturing jobs affecting them directly.

“The same sort of sentiment that you see among the supporters of Brexit in the United Kingdom, you see in the United States,” he said.

Baird said the challenge is not exclusively globalization, but also advances in technology and robotics, which have come at the same time as free trade and contrib-uted to the reduction of jobs.

Political statements about

altering or discarding agreements such as NAFTA, or refusing to ratify the TPP raise concerns about increased wariness among the U.S. electorate who are not seeing the benefits of free trade. That is resulting in pushback and support for candidates who are inclined to pull away from free trade, said Ferley.

“Free trade agreements are, on net, a positive for an economy, with the benefits of greater access to foreign markets outweighing the costs of greater domestic competi-tion from foreign imports. How-ever, it is important that policies are put in place that counter these costs, with workers being provided with the means to transition to those areas of the economy that benefit from free trade,” he added.

It is hard to predict now how vul-nerable Canada might be under a new U.S. administration that is less supportive of free trade, say experts. However, clear concerns have been expressed. In the Chartered Profes-sional Accountants of Canada’s Business Monitor Q2 2016 survey, 69 per cent of respondents holding senior positions in industry said they were worried that the new U.S. president, whoever is elected, will enact more restrictive trade policies with Canada.

“We are hopeful that after the U.S. election, the new leadership will become more pragmatic and focus on how to strengthen that trading relationship rather than weakening or threatening it . Working together can lead to more jobs and greater prosperity on both sides of the border,” said Nicholas Cheung, CPA Canada’s Toronto-based vice-president of member services.

Head noted that Trump has also spoken about potentially pulling the U.S. out of the World Trade Organ-ization (WTO), which should be concerning for Canada because the WTO constitutes the framework for all international trade.

“If the U.S. were to drop out of that, and therefore not to have to live by any of its WTO obligations, Canadians would be in a much weaker [position] in terms of any kinds of negotiations between the U.S. and Canada,” said Head.

“I don’t believe that either Trump or Clinton are going to take irrational, illogical actions,” said Todgham Cherniak. “During elec-tions, a lot of things are said. Once someone has power, and has smart advisers looking carefully at the issues, saner heads prevail.”

Todgham Cherniak stressed that the U.S. needs to participate in world markets and the country is not an island onto itself that is capable of manufacturing every-thing Americans need within its own borders.

“I believe that regardless of whether it’s Clinton or Trump they will take action that is in the best interests of the U.S. economy and the U.S. workers, and those actions will be to stay in NAFTA and to stay in the WTO,” she said.

Ill trade winds may pose threat to Canada

Republican U.S. presidential candidate Donald Trump, left, and his Democratic opponent Hilary Clinton, right, are worrying Canadian business observers because they are both displaying a hostility to, and mistrust of international trade deals.

“The same sort of sentiment that you see among the supporters of Brexit in the United Kingdom,

you see in the United States.”John Baird, Bennett Jones LLP

8 The Bottom Line October 2016N E W s

foreign exchange operations claimed a loss of approximately $91 million, which the CRA denied. In Kruger Inc. v. Canada 2016 TCC 14, Tax Court Chief Justice Gerald Rip denied the mark-to-market losses on option contracts written by Kruger. Although he found that the mark-to-market method was consistent with well accepted business prin-ciples and generally accepted accounting principles (GAAP), Chief Justice Rip (now in private practice) held that “a general principle of taxation is that nei-ther profits nor losses are recog-nized under the [Income Tax] act until realized except if the act provides an exception to the real-ization principle.”

Mark-to-market accounting is an accrual method of accounting where the option is valued at market value as at the balance sheet date, and any change in the market value from the beginning to the end of the period is recog-nized as a gain or loss in the income statement for the period. In contrast, under the realization method of accounting, a trans-action is recognized as complete when an entity has a claim to be paid in cash or an obligation to pay cash. The realized value is certain, and not subject to any estimate of value.

But the appeal court, in over-turning Chief Justice Rip’s deci-sion, rejected the notion the real-i z a t i o n p r i n c i p l e i s a n “overarching” one that applies in

the absence of a provision author-izing or requiring the application of a different method. Such an approach flies in the face of established case law and runs counter to decis ions by the Supreme Court of Canada, said Chief Justice Marc Nöel in a unanimous 34-page ruling in Kruger Inc. v. Canada 2016 FCA 186.

The Supreme Court held, in Canderel Ltd. v. Canada [1998] 1 S.C.R. 147 and in Ikea Ltd. v. Canada[1998] 1 S.C.R. 196, that the realization principle can give way to other methods of com-puting income (pursuant to s. 9 of the act) “where these can be shown to provide a more accurate picture” of the taxpayer’s income for the year. In another decision issued some 50 years ago, the SCC held in Canadian General

Electric Co. v. M.N.R. [1962] S.C.R. 3 that gains and losses on income account resulting from foreign currency fluctuation may be recorded on an accrual basis for tax purposes.

“The decision reinforces the possibility for a taxpayer to use any method that is not forbidden by the act or rules of law,” noted Louis Tassé, a tax lawyer with EY Law LLP, who successful ly pleaded the case. “Our position from the beginning was that Kruger was allowed to use mark-to-market as it gave a clearer pic-ture of its income and was not otherwise forbidden by the act or by case law. The decision is a simple application of the princi-ples outlined by the SCC in Can-derel. It might serve as a healthy reminder of such principles.”

The appeal court also noted there is “broad recognition” of mark-to-market accounting for the purpose of computing income from dealing in foreign exchange options. Uncontested evidence revealed that banks, f inancial institutions and mutual funds which deal with foreign exchange options have been given the green light by the CRA to report their income using the mark-to-market method, pointed out the appeal court. It is also a method that is “consistent” with well-accepted business principles, GAAP and international accounting, added the appeal court.

“This is an important case because it signif icantly extends the SCC decision in the Canadian General Electric case,” said Neal

Armstrong, a Toronto tax lawyer with Davies Ward Phillips & Vine-berg LLP. “Until the Kruger case people thought that Canadian General Electric was restricted to the foreign exchange situation. Kruger extends mark-to-market accounting to a broader range of matters where the instruments are held in an income account.”

The appeal cour t decision seems to suggest that a taxpayer who has derivatives, other prop-erty or obligations acquired or incurred on income has the option to report gains or losses on those holdings on a mark-to-market rather realization basis for tax purposes if, under GAAP, the tax-payer prepares f inancial state-ments on a mark-to-market basis, added Armstrong.

But taxpayers cannot switch between mark-to-market and real-

ization tax accounting methods depending on whether they have accrued losses, said Paul Ryan, a M o n t r e a l t a x l aw ye r w i t h Ravinsky Ryan Lemoine LLP. The courts and the CRA require that taxpayers use a consistent method of computation from year to year, added Ryan. “There has to be con-sistency as the federal appeal court decision points out,” said Ryan. “A taxpayer cannot choose one method when he has suffered losses, and another method when he’s making gains. That is very important.”

Some have suggested the appeal court decision may have wider implications. In a bulletin PwC said it is possible the Kruger decision “will start a trend” in which f inancia l account ing becomes more influential in deter-mining what constitutes an accept-able method of computing income from a business.

Tassé says only time will tell. Morand believes the courts will continue to rely on the guidance set out by the Supreme Court in Canderel and Ikea — which is, determining prof it for tax pur-poses on a basis that reflects the most accurate picture. “This may be consistent with f inancial accounting but the fact that it is will not be determinative of whether it should be used for tax profit computation,” said Morand. In a similar vein, Armstrong said that while accounting principles do have some relevance, they are certainly not binding. “And the Kruger case hasn’t changed that,” added Armstrong.

Decision will not be ‘determinative’ resultContinued from page 1

Accounting first analytics business, says new CEOresponsible for leading more than 1,000 tax professionals across the country. He has, according to Thomas, “an innate ability to recog-nize trends and guide clients adapting to changing landscapes.”

“This is a people business in all respects, and I love helping people succeed in their careers and in their business,” Luongo says. Job one will be “to talk to all of my partners and listen to what their concerns are and, more importantly, what their clients’ concerns are. To learn what we can do in a collaborative way to help our business, help our clients and also help create a phenomenal career for our people.”

There’s no doubt the accounting profession has changed dramatic-ally over the 30 years he has been part of it. “We were the original data and analytics profession,” he says. “We look at information to see what it tells us. We look at a balance sheet or income statement to under-stand the story it tells. But the amount of information now avail-able to help people understand their business has increased exponen-

tially — and continues to do so at an ever-increasing velocity. The new data tells a lot more of the story not only about their business, but also about trends affecting it. That helps business owners and everyone else who is interested in their business.”

The amount of data and the accuracy of that information are reshaping what accountants do, Luongo adds. “It’s no longer recon-ciling debits and credits: it’s helping our clients interpret data, to see trends, to give them the tools and services to extract that data in a way they can understand. Our profes-sion is changing in the way we respond and do our work. We have to become much more tech savvy, more innovative and much more agile as our clients’ businesses evolve.”

More and more, he says: “We have to adapt and recognize the various disrupters that will affect our clients and adjust our service offerings to help them deal with the changing and evolving business platforms that are out there. If you look at technology risk — just think about the impact of cyberattacks on

one’s business and what that can do. The reliance on IT systems and what happens if they go down. That can really impede a business and its operations going forward. It is up to us to help our clients understand all the business risks and protect their systems from outside attacks.”

Luongo also points to changing political and economic dynamics and how that can affect business

operations. “We are seeing that business is very much global now, and any geopolitical change in another country can have a dra-matic impact on business here at home.”

He’s also seeing a trend to increasing corporate reporting and the rise of greater transparency. “Both domestic and foreign reporting requirements continue to grow — especially for companies operating internationally. We have to make sure that we can help our clients identify how to be in com-pliance with all the global require-ments.” And that is where being a part of the KPMG family is such a big advantage, he says, “we have a global footprint and can help clients all around the world.”

C a r e e r d eve l o p m e n t f o r KPMG’s people is another big focus for Luongo. “Giving our people experiences in a way that they can develop their passions is absolutely critical. The best learning is experiential — trying out dif-ferent things. We focus on giving our people the opportunity to taste all the different disciplines in our f irm, whether it’s in audit, tax,

advisory or private company ser-vices. This helps our people grow and become more well-rounded business advisers. I want us to be known for helping our clients be the best they can be and one sure way to achieve that is to be the best busi-ness advisers possible to help them achieve their goals, not only in Canada but around the world.”

Part of that is continuing the vision Thomas laid out during his tenure as CEO. “Over the past two years we have adopted a new global vision: to be the clear choice. All KPMG member firms have adopted this vision — to be the clear choice for our people, for our clients and for the communities we work in. This is something that Bill started and is something we worked on together when I was on his execu-tive team. It’s a natural evolution of our strategy and culture.

Clearly, says Brian Rogers, chairman of KPMG’s board, “We have selected a strong and accom-plished leader and we are confident in his ability to lead KPMG into a new chapter of growth and evolu-tion for both our profession and the business community as a whole.”

Continued from page 1

tassé Morand

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The Bottom Line October 2016 9N E W s

By GUNDI JEFFREY

The audit committee plays a crucial role in overseeing the audits of public com-

panies almost all over the world, says a recent report from the Inter-national Organization of Securities Commissions (IOSCO). The report comes 10 years after IOSCO last took stock of what was happening in this area and confirms the value of audit committees for investors and other stakeholders in the world’s capital markets.

Auditors should be subject to appropriate oversight, stresses the report in its conclusions. “Effective oversight of those performing audit services is critical to the reliability and integrity of the f inancial reporting process and helps reduce the risks of financial reporting and auditing failures in the public securities market. The ultimate purpose of such oversight is to pro-tect the interests of investors and further the public interest in the preparation of informative, true, fair and independent audit reports.”

The findings and conclusions are described in the Survey Report on Audit Committee Oversight of Auditors, released earlier this summer, which also aims to iden-tify what audit committee practices might help improve audit quality at listed companies.

“In Canada, we already have in place many elements that were subject to the IOSCO survey,” says Hélène Marcil, the chief accountant of the Autorité des marchés finan-ciers (the Quebec securities com-mission). “We are pursuing our reflection of these elements in light of this survey to ensure that the regulatory framework in Canada reflects IOSCO world-class princi-ples.”

The report summarizes the results of a survey of IOSCO mem-bers on the existing legal, regula-tory and other requirements related to audit committee oversight. The report also tells interested stake-holders and IOSCO members what kind of audit committee require-ments are in force in different w o r l d j u r i s d i c t i o n s . In many countries, says the report, the audit committee of a publicly listed entity plays a key role in appointing external auditors and overseeing the financial reporting process and external audits. The survey results indicate that 96 per cent of the 47 responding jurisdic-tions require public companies to establish an audit committee or similar governance body that is separate from executive manage-ment and acts in the interest of investors.

According to the report, at least one member of the audit com-mittee has to be independent of both management and the auditor in 100 per cent of responding juris-dictions, and 76 per cent of the respondents require a majority of audit committee members or all audit committee members to be independent.

As businesses become more

complex, globalized and increas-ingly face new risks, the skills needed by audit committee mem-bers have also increased. At least one audit committee member is, therefore, required to have special skills or experience in 87 per cent of responding jurisdictions. Some respondents require expertise in

accounting or finance, while others require that audit committee mem-bers have only an ability to read and understand basic f inancial statements. A small number of respondents also indicated that audit committee members need some knowledge of auditing in addition to accounting and finance.

More than 90 per cent of the respondents require that the audit committee be explicitly respon-sible for assessing the auditor’s independence. Considered in this assessment is auditor provision of non-audit services to public com-

pany clients. Although there are restrictions on the types of non-audit services that auditors may provide to such clients in 94 per cent of the responding jurisdic-tions, the methodology for deter-mining which services are pro-hibited varies. Some regulators

provide specific lists of prohibited non-audit services, whereas others use a more qualitative assessment of the likelihood that provision of a specific service could affect the auditor’s independence.

Audit committees are also asked to make periodic assessment of auditor performance by 71 per cent

of the respondents, although the guidance provided to audit com-mittees for assessing auditor per-formance varies significantly from country to country.

Communications from the aud-itor to the audit committee are mandated by 80 per cent of respondents. The content and fre-quency of these communications are generally specified in a juris-diction’s auditing standards. In a number of countries — mainly within the European Union — aud-itor communications to audit com-mittees are also regulated by stat-

utes or other regulations. The communications usually cover a wide variety of matters, from audit planning through audit execution, to key auditor findings and conclu-sions made.

Requirements that audit firms provide transparency reporting

exist in 61 per cent of countries with developed capital markets, while 15 per cent of growth and emerging market jurisdictions have this requirement.

The survey also highlighted a notable increase in the role and responsibility of the audit com-mittee related to auditor oversight

since 2004, when IOSCO last looked at audit committee require-ments. There have been changes in the composition of the audit com-mittee; increases in the number of members who are required to be independent of the entity and the auditor; and enhancements made in the specific skills or experience of audit committee members.

Audit committees have also increased their role in assessing auditor independence since the 2004 survey, as well as being more involved in initial selection and subsequent reappointment of the

auditor and the determination of the audit fee.

According to Hugh Bolton, chair of the WestJet Airlines Ltd. audit committee, “These findings are consistent with the Canadian experience. In fact, I would ven-ture that we are ahead of the curve

in these matters as we now have suggested best practice of one-year annual reviews of audit firms by the audit committee and a detailed, comprehensive review of those f irms every f ive years. In addition we have an agreement wherein the Canadian Public A c c o u n t a b i l i t y B o a r d h a s developed a protocol which will enable them to share information gathered from their inspections with specific audit firms and their audit committees. Previously, CPAB only published a rather generic public repor t, which frankly was not much help to audit committees in specific situations.”

Brian Hunt, CPAB’s CEO, agrees that, in Canada, the annual assessment and five-year compre-hensive review of the external aud-itor “are increasingly becoming important tools to assist the audit committee in performing its over-sight role, and we are seeing more audit committees undertaking this work.” As well, CPAB’s Protocol for Audit Firm Communications of CPAB Inspection f indings with Audit Committees “has helped to improve transparency between audit firms and audit committees regarding CPAB inspection find-ings, which we believe also assists audit committees in the perform-ance of their oversight role.”

But, he adds, “CPAB believes audit committees could further enhance their oversight of the external auditor by moving along a continuum from pure compliance — approval of f inancial state-ments, periodic/quarterly meetings with the auditor, etc. — to a stronger governance role — under-standing key audit risks, oversight of management and the auditor, etc.”

Hunt acknowledges “this evolu-t ion must be anchored in a common understanding of current responsibilities. Many of the audit committees we have spoken to are interested in receiving information and tools that will assist them as they move along the continuum and CPAB continues to support this effort.”

He adds that “an expanded aud-itor’s report may also enhance communications regarding a com-pany’s financial statements among the audit firm, management and audit committees.” This type of report, “which could come to Canada by 2018, is expected to have additional commentary on key audit matters, providing aud-itors with an opportunity to better communicate the audit issues they confront and the work they per-form to address them.”

Marcil concludes that “audit committees play a key role in the financial reporting supply chain and are in a position to influence audit quality. We embrace the Canadian and international audit quality initiatives as we recognize that auditors are the gatekeepers to identify material misstatements in reporting issuers’ f inancial statements.”

IOSCO survey underscores vital role of audit committee

MarCilBoltonhunt

“In Canada, we already have in place many elements that were subject to the IOSCO survey. We are pursuing

our reflection of these elements in light of this survey to ensure that the regulatory framework in Canada

reflects IOSCO world-class principles.”Hélène Marcil, Autorité des marchés financiers

“These findings are consistent with the Canadian experience. In fact, I would venture that we are ahead

of the curve in these matters as we now have suggested best practice of one-year annual reviews of audit firms by the audit committee and a detailed, comprehensive

review of those firms every five years.’’

Hugh Bolton, WestJet Airlines Ltd.

10 The Bottom Line October 2016N E W s

By JEFF BUCKstEIN

Vancouver’s position as a prominent Canadian global f inancial centre helps to

attract skilled jobs, foreign direct investment, venture capital and other economic perks, says a Con-ference Board of Canada report. But could there also be a dark side of unintended consequences attached to this success?

The British Columbia govern-ment recently slapped a 15 per cent property transfer tax premium on foreign purchasers of residential real estate in Vancouver to make real estate less attractive to foreign investors. This measure is also designed to make home ownership more affordable as booming house prices have created a serious shortage of affordable housing.

“While investment from outside Canada is only one factor driving price increases, it represents an additional source of pressure on a market struggling to build enough new homes to keep up. This addi-tional tax on foreign purchases will help manage foreign demand while new homes are built to meet local needs,” said B.C. Finance Minister Michael de Jong.

At the same time as the govern-ment announced the 15 per cent tax, it also introduced a Housing Priority Initiatives Fund. An initial invest-ment of $75 million will be pro-vided for provincial housing and rental programs, toward which a portion of revenues from the new tax on foreign buyers will be ear-marked.

Alex Hemingway, public finance policy analyst for the Canadian Centre for Policy Alternatives (CCPA) in Vancouver, said housing shortages exist across the province.

“In B.C. we have almost 150,000 people in core housing need, meaning that 30 per cent or more of their income is going to housing, or they’re living in overcrowded or substandard housing. That’s a major backlog in terms of affordable housing. And that’s a consequence in part, of the major run-up in housing prices,” he said.

There is both a foreign and domestic element to that, with a lot of speculative investment chasing homes, added Hemingway.

According to the Real Estate Board of Greater Vancouver, the Multiple Listing Service home price index composite benchmark price for all residential properties in Metro Vancouver was $930,400 in July 2016. That was up 32.6 per cent compared to July 2015.

Although Hemingway views the new foreign buyer’s tax in Van-couver, using the property transfer tax system, as a positive step, he doesn’t believe it goes far enough.

“We’ve been saying at CCPA that we ought to be using the tools of taxation to cool that high end of the overheated housing market, and put those revenues straight into building affordable housing on a large scale. We can do a lot on the property tax side,” he said.

“Take the property taxes that we

have now, and design them so they’re progressive, so you pay more on higher value properties. You can shield a lot of folks from that by having it kick in at the $2 million [or] $3 million level,” Hem-ingway said.

Dan Baxter, policy development director at the B.C. Chamber of Commerce in Vancouver, said that in addition to the value provided by being an important Canadian finan-cial centre, the city’s prosperity is also enhanced by the presence of engineering services needed to sup-port the development of abundant natural resource wealth in the B.C. interior.

He also recognizes that some

residents are struggling just trying to find a place to live.

“From the B.C. Chamber of Commerce’s point of view, housing affordability is very much an issue. Our members are saying that to us … and asking us to talk to govern-ment on this issue. We just had our (annual meeting) in Kelowna, and passed two resolutions — one dealing with ‘how do we increase supply for market housing’ as well as ‘how do we increase the rental stock,’ ” Baxter added.

However, he believes it is too early to assess any potential correl-ation between strong economic growth in some sectors, and housing affordability in Vancouver,

the nation’s third largest urban area behind only Toronto and Montreal, respectively.

“There is probably an impact,” said Baxter. “But in terms of how that’s driving the market, from the B.C. Chamber’s point of view it really does come down to data. We need to get more data around who’s buying and what’s being bought. From there we can start to really assess what the impacts are, and then [determine] the right policy tools we should be pulling to help maintain housing affordability,” he explained.

Colin Hansen, president and chief executive officer of Advan-tage BC, a not-for-profit society

with a mandate to promote British Columbia as a favourable location for international business, said Van-couver’s position makes it as a key magnet for wealthy investors, mostly from Asia and particularly China.

Advantage BC helped fund the Conference Board of Canada report titled Stronger Together: The Strengths of Canada’s Four Global Financial Centres. “The report overall stresses the fact that Canada has a real global strength when it comes to financial services,” said Hansen, a former provincial cabinet minister.

“The purpose of this research was so that we could better under-stand the makeup of that strength, city by city. Previously we had lots of excellent national data on the Canadian financial services sector. But this is the first time that we’ve actually tried to look at the relative strengths of the four financial cen-tres in Canada,” he added.

Hansen said although it is too early to draw any definitive conclu-sions about the effectiveness of the new foreign buyer tax, he believes there have been some early results.

“I think that it has already been successful in taking out some of the hyper energy that was there. We saw that housing prices were going up because buyers had this firm belief that the prices were just going to continue to go through the ceiling, and therefore [felt] that they’d better buy today, no matter what they had to pay to get into the market.”

A B.C. Ministry of Finance spokesperson, speaking on back-ground, said the ministry expects that some transactions will proceed, with foreign residents paying the new tax, but that other transactions will be deterred in future as a result. The government will collect data through property transfer tax returns in order to monitor this activity and assess its effect.

b.c. boom a bust for homebuyers

OSFI warns of rising lending risks The affordable housing

shor tage in Vancouver might be part of a larger

problem with rising housing prices and a potentially over-heated market.

The Office of the Superintendent of Financial Institutions (OSFI) has responded to the current situation by issuing an open letter to all federally regulated financial institutions, emphasizing the need to reinforce prudent residential mortgage risk management and warning about the rising risks and vulnerabilities asso-ciated with household lending.

“Persistently low interest rates, record levels of household indebted-ness and rapid increases in house prices in certain areas of Canada [such as Greater Vancouver and Toronto], could generate significant

loan losses if economic conditions deteriorate,” said the letter, signed by superintendent Jeremy Rudin.

The Bank of Canada’s overnight interest rate remains at 0.5 per cent (it has been at or under 1 per cent since 2010). According to Statistics Canada, Canadian household debt was at just over 165 per cent (meas-uring debt to disposable income, excluding pension entitlements) after the first quarter of 2016.

Michael Dolega, a senior econo-mist at TD Economics in Toronto, agreed that with the price of access to the housing market rising so rapidly, particularly in Vancouver and Toronto, the situation merits attention.

“Many people or households have increasingly leveraged them-selves, and the levels of indebtedness

have been rising … to the point where it is definitely a concern. Things are obviously being helped by low interest rates, because the carrying cost of this debt is relatively low,” he said.

However, a future increase in the interest rate would put significant pressure on some of the households that have leveraged themselves sig-nificantly, Dolega added.

The OSFI letter reiterates that it expects all financial institutions to exhibit rigour in the verification of a borrower’s income, noting that it is aware of incidents where institutions have encountered misrepresentations of either income or employment, or both. It also stressed that a thorough due diligence needs to be conducted when borrowers rely on income from sources outside Canada.

OSFI said, in regard to debt ser-vice ratios, that relying on the pre-vailing posted five-year mortgage rate to test a borrower’s ability to ser-vice their obligations will not repre-sent a sufficiently conservative stress test when interest rates start to rise.

“I think it’s important to highlight the fact there is a risk that interest rates rise faster than we currently anticipate, and banks and other lenders should allow for that possi-bility when making lending deci-sions,” said Dolega. “I think this is a welcome letter that shows the regu-lator is looking at these issues pretty closely, and wants to ensure that the lenders that it regulates follow these guidelines, and don’t sort of let things slip,” he added.

• Jeff Buckstein

“From the B.C. Chamber of Commerce’s point of view, housing affordability is very much an issue.

Our members are saying that to us … and asking us to talk to government on this issue.”

Dan Baxter, B.C. Chamber of Commerce

The Bottom Line October 2016 11F o C U s

By JoHN GRIEVE

The halcyon days of profit and expansion in the oil-patch in Alberta are a fond

but distant memory. How long the depressed market

will last is anyone’s guess and how much damage it will do is equally unpredictable. There are no doubt bargains to be had for astute investors, but staying the course in the continued depressed market is becoming more and more difficult.

From Calgary to Dallas to Wall Street, lenders have lost their patience and borrowers are feeling the squeeze. With each passing day it is becoming more obvious that oilpatch borrowers will not likely be able to simply wait out a return to a buoyant energy market; they will have to be creative, as will their stakeholders.

I predict there will be more and more protective filings under the Companies’ Creditors Arrange-ment Act, or perhaps the Canada Business Corporations Act, as time runs out for borrowers, patience runs out for lenders and the market continues to slump.

Buying runway may be a pos-sible strategy, but if there are con-tinued losses it simply will not work in the long term. “Extend and Pretend” is not working the way it did a year or two ago.

At some point, even if lenders are going to realize a significant loss, their patience reaches an end and they will take steps to recover what they can and move on to more profitable, stable business. This is not something that is

unique to the oil market (it hap-pened to the mining industry sev-eral years ago and to the auto-motive industry and the high tech industry before that) and it will have a continuing and significantly detrimental effect on the oil and gas market in Alberta until world prices return to something approaching their pre-slump prime and stabilize there.

Why is Alberta’s oilpatch now a briar patch? Primarily world mar-kets. Overproduction and political strife in Africa, South America, the Middle East and Russia have ham-mered oil prices. There continues to be a glut on the market, and this will continue to keep prices down.

The U.S. Energy Information Administration estimates the price of West Texas intermediate crude oil at a benchmark $52.15 in 2017. Oil hit that price several months ago; and in August it dropped back to below $40 a barrel. Many ana-lysts see oil remaining below $70 a barrel into 2018 and investors in the oil and gas market would be prudent to err on the side of cau-tion. In addition, friction over get-ting Alberta crude to market through a series of as of yet unapproved pipelines isn’t helping things. Neither is the mayhem caused by the Fort Mac fires and now floods.

On the flip side, although the industrialized world’s reliance on oil and gas is slowly waning, it is not likely to signifi-cantly diminish a n y t i m e soon and

appetite is likely to continue to grow in emerging economies. The profitability of any given oil and gas company depends on its expenses in bringing crude to market. However, $60 a barrel oil is not generally thought of as being profitable in Alberta. Formal oil and gas company insolvencies in Alberta abound and many of the smaller companies have fallen prey to receiverships or liquida-tions where the lenders, perceiving no end in sight, simply want to move on. This appears to be the case with Calmena Energy Ser-vices, Spyglass Resources, Endur-ance Energy, Parallel Energy, Pal-liser Oil & Gas, Kinwest 2008 Energy and ATK Oilfield Ser-vices to name but a few.

However, the larger players are looking to reorganize, rec-ognizing that value can be

Time not on the side of struggling oilpatch

See Albertans’ on page 15

The Bottom Line October 201612 F o C U s

By WEs PRIEBE

After dealing with sus-tained low oil and gas prices, cancelled projects

and signif icant job losses, it’s becoming increasingly clear that the oil and gas industry cannot rely on a return to the oil heydays of years past any time soon.

According to the 2016 Ser-vice and Supply Outlook Report, (http://insights.grantthornton.ca/ i /651954-service-supply-2016-outlook-report), an average of 43 per cent of service and supply companies considered collaboration strategies to cut costs in 2015 — and this may just be the beginning. A funda-mental change is on the horizon for this resource-based industry as companies f ind themselves r unning out of cos t cut t ing options within their organiza-tions. So what now?

Recently, a group of industry thought leaders joined Grant Thor n ton and JuneWar ren -Nickle’s energy group to discuss exactly that. They explored how the oil and gas sector could i n n ova t e a n d r e d e f i n e t h e industry in an effort to reach a new, more sustainable, level of success. The conclusions suggest that collaboration may ultimately be the key to a prosperous future, for those willing to shift their thinking and adapt to new real-ities.

Remaining at the status quo is not a viable option. So how can service and supply companies col laborate and innovate to permanently lower costs and increase profit margins? Here are some key points taken from our discussion

Consider strategic alliancesCombine fixed cost centres to

lower overhead costs. This can range from offering unused shop space to a complementary ser-vice provider at a reduced rate, to sharing resources or equip-ment.

Team up with complementary service providers to expand ser-vice offerings and leverage each other’s networks to gain access to new markets and customers.

Cons ide ra t ion shou ld be given to joint bids to reduce bid-ding wars and ineff iciencies. This adds signif icant value to both the bidding company and the end customer.

Consider giving a poorly per-forming division of the company to a strategically chosen com-petitor in exchange for a per-centage of the revenue they gain from it.

This strategy can solve a cash flow issue, reduce price compe-tition and create goodwill.

adopt an open, honest strategy Strong relationships allow for

frank communication about price and margins. Be clear about expectations and be prepared to either take a hit or walk away. Connect often to get a full under-standing of a customer’s busi-

ness. Use this insight to tailor service offerings to their needs.

Always put customers f irst.

Innovate with their needs in mind to create a win-win situation.

Ask customers if the current service offering is still meeting their needs, or whether there may be an opportunity to provide additional services to them. Con-sider offering a bundled package,

possibly at a lower price, in return for the additional busi-ness.

Think beyond t radi t ional invoicing and payment struc-tures. Consider offering credits forward and applying them to

future projects, or set up a master service agreement or subscrip-tion type model where customers have monthly access to services.

Avoid asking valued suppliers for price reductions to increase trust and willingness to collab-orate.

tackle challenges as united front Be active in industry associa-

tions that regularly lobby for c h a n g e , wh e t h e r p o l i t i c a l , environmental or regulatory. However, don’t rely on industry associations alone. Contact local

provincial and federal govern-ment representatives yourself, to ensure your voice is heard.

Don’t underestimate the power of idea-sharing with industry peers.

Don’t wait for change. Focus on doing business with companies that value more than the lowest price. Bidding wars only drive the market down further.

Collaboration, communicationStor my seas make be t te r

sailors. Be open with employees to address fears but don’t dwell on the negative.

All departments should have an understanding of the man-dates of the organization, the roles people play and how they fit into the big picture — as well as the overarching strategy and vision for the organization.

Take advantage of idle time. Train less experienced workers so you can f ill the knowledge gap and be ready when the market improves . Keep key employees engaged during idle times by considering job-shad-owing and cross-depar tment lear n ing oppor tun i t ies . For e x a m p l e , a n e x p e r i e n c e d foreman could also be a know-l edgeabl e s a l e spe r son t ha t “talks-the-talk and walks-the-walk.”

Empower decision making at all levels, not just in the board-room. Shared leadership creates an environment where everyone is fully invested — resulting in better decisions all around.

Seek input from those directly affected by decisions to uncover innovative ideas.

Consider a non-commission-based sa les envi ronment to e n c o u r a g e a c o l l a b o r a t ive mindse t tha t i s focused on serving customer needs versus making the sale, resulting in improved customer satisfaction.

Look at process and strategySimplify processes. It’s hard

for a team to adapt to a changing environment when there are too many processes — or if those pro-cesses are too complicated. Furthermore, opportunities are lost when it takes too long to react.

Restructure departments and divisions to be collaborative and productive.

Overhead costs can be lowered by considering outsourcing such services as logistics, marketing or accounting. Consider hiring an outside project management com-pany to optimize efficiency. The cost to outsource this function may be less than the cost of the

Moment right to embrace innovation

A fundamental change is on the horizon for this resource-based industry as companies find themselves running out

of cost cutting options within their organizations.Wes Priebe, Grant Thornton Corporate Finance Inc.

PrieBe

Strong relationships allow for frank communication about price and

margins. Be clear about expectations and be prepared to either take a hit

or walk away. Connect often to get a full understanding of a customer’s business.

Wes Priebe, Grant Thornton Corporate Finance Inc.

See Stay on page 15

The Bottom Line October 2016 13F o C U s

By RHoNDa sIsCo

The Canadian oil and gas sector is struggling to sur-vive what is undoubtedly

one of the worst downturns on record. Global suppliers are suffering a similar fate due to vola-tile markets with little to no relief in sight. With capital expenditures in Canada continuing to decline, what can energy companies do to find new opportunities and increase profits?

Innovation is an important factor. Although companies work to differentiate themselves through product and service offerings, innovation and improved efficien-cies are critical to market expan-sion. Breaking into new territories can also hold enormous opportun-ities to leveraging capabilities and innovative technologies in a bid to grow the bottom line. For Canadian service providers, the safest option for expansion may be Canada’s lar-gest trading partner — the United States.

For companies with strong bal-ance sheets, this downturn can be an opportunity to leverage unique, cost-effective operating methodolo-gies by selling services to com-panies struggling to improve their bottom line. Niche supply com-panies can use superior technology to help ailing companies while growing themselves. Given that U.S. natural gas production grew from 70.8bcf/d (billion cubic feet per day) to 84.4bcf/d between 2009 and 2014 — equalling Canada’s total annual gas production — the U.S. market can be seen as prom-ising based on sheer size alone.

That said, expansion into the U.S. is still not for the faint of heart. Despite a fairly robust economy overall and a strong dollar, the oil and gas sector south of the border is also seeing its fair share of strug-gles similar to our own market. Oil prices across North America declined from an average US$4.40/mmBtu in 2014 to $2.80mmBtu in 2015, negatively affecting com-panies on both sides of the border, and the impact is spreading to industries beyond oil and gas.

So what should Canadian com-panies consider before making the move down south?

Check agreements To start with, ensure the com-

pany is permitted to do business in the U.S by checking partnership, dis t r ibut ion and technology licensing agreements.

It would be unfortunate to invest significant resources, time and energy into penetrating the U.S. market, only to find out there are legal barriers due to tech-nology agreements or differing regulations between the two coun-tries .

Investigate U .s . tax system Proper planning before a move

can reduce overall tax exposure and increase tax savings. Canadian companies that have never ven-tured to the U.S. before are often surprised to learn that corporate tax rates are much higher than

those in Canada and differ from state to state. The levels of com-plexities Canadian corporations need to consider are immense, making it especially vital that all

areas of Canada’s tax treaty with the U.S. are examined thoroughly to determine if there is a U.S. fed-eral tax liability. These complex-ities can be compounded by the fact that states are not bound by the Canada-United States Tax Conven-tion, and many key states, such as

California and New York, do not follow the treaty. This can give rise to multifaceted compliance issues.

The U.S. generally imposes cor-porate income tax on non-U.S. cor-porations which are “engaged in trade or business” within the U.S. The treaty regularly overrides cer-tain domestic U.S. (and Canadian) tax laws and provides rules to resolve certain conflicts between each country’s domestic tax law.

A resident of Canada will be taxable in the U.S. only if the Canadian company carries on a business in the U.S. through a “permanent establishment.” The states have a similar concept called “nexus” which is a much lower threshold.

Choose your location carefullyIncome tax rules can vary sig-

nificantly from state to state, so it’s important to consider all aspects of potential locations before setting down roots. Each state has dif-ferent mechanisms of capturing tax — some follow the Canada-United States Tax Convention while others do not. Some states tax on a stand-alone basis, some on a combined basis and others on

a consolidated basis. Under-standing what those terms mean and how state tax regimes can impact the bottom line is an important factor in deciding which state to operate from.

Employee income tax f iling obligations will also need to be examined. Determining which country and state/province they will be required to file in — and any costs associated with that filing (or multiple filings) — will also need to be accounted for.

Enter directly or set up subsidiaryThe implications of deciding

whether to enter the U.S. directly or set up a U.S. subsidiary can be complex and wide-reaching and should not be taken lightly.

In determining which structure to pursue, think about what the business operations will look like, how to fund the U.S. operations, where the employees will reside and what the exit strategy will look like. Considerations will also have to be made with regard to any U.S. tax liabilities. An expansion may result in the Canadian company having to file a U.S. tax return, and it will need to be determined whether income will be subject to U.S. federal tax as a result of the Canada-United States Tax Con-vention.

Use transfer pricing strategies As U.S. corporate tax rates are

significantly higher than current Canadian rates, it’s imperative to ensure that the costs are in the right jurisdiction to minimize the global tax footprint. Transfer pricing is one mechanism to assist companies in properly pricing their cross-border intercompany transactions between related g roups , inc luding ser vices , product sales, technology royalties and financing rates. Establishing and documenting proper transfer pricing policies at the outset can significantly mitigate tax risk and help reduce any tax inefficiencies related to cross-border expansion.

All in all, making the leap to enter the U.S. marketplace can hold tremendous opportunity, yet it’s important to make the move wisely. With precise and careful pre-planning, expert tax advice and research, an expansion south can result in a prof itable and rewarding venture.

Bringing 18 years of US tax experience, Rhonda Sisco, CPA, CA, advises corporate clients looking to expand their busi-n e s s . W h e t h e r t h e e n e rg y, mining, manufacturing or tech-nology industries, she provides the expertise needed to help them navigate the complexities of U.S. tax.

expansion to U.s. may be worth risk

sisCo

Breaking into new territories can also hold enormous opportunities to leveraging capabilities and innovative

technologies in a bid to grow the bottom line. For Canadian service providers, the safest option

for expansion may be Canada’s largest trading partner — the United States.

Rhonda Sisco, Grant Thornton LLP

In determining which structure to pursue, think about what the business operations will look like, how to fund

the U.S. operations, where the employees will reside and what the

exit strategy will look like. Rhonda Sisco, Grant Thornton LLP

The Bottom Line October 201614 F o C U s

By JaRRaD soNNENBERG

As the mining industry con-tinues navigating through a n u n s t a b l e m a r k e t ,

miners are seeking ways to streamline processes and gain a better understanding of their financial future.

The mining community has continued to embrace the concept of enterprise resource planning (ERP) systems, as they simplify the reporting process and provide a clear picture of where revenue and costs are going to and coming from. The foundation of any ERP for a mining company is the chart of accounts (COA).

When implemented correctly, a C OA w i l l h e l p o rg a n i z e finances, segregate expenditures, revenue, assets and liabilities, providing management with a comprehensive understanding of their company’s financial health. Though developing a COA is not an exact science, the numbering and the structure of the COA will determine how effective it will be in reporting operational costs and rolling into financial statements and should be designed with care to ensure it best matches an organization’s needs.

A number of general guide-lines relate to the numbering, seg-ments and size of the segments and the way the chart relates back to other components of the busi-ness, such as mining operations versus mining maintenance. Taking the time to properly struc-ture a COA will provide added control, streamline the reporting process and provide the critical information a mining organiza-tion needs to optimize its business and make accurate assessments regarding its operations.

The following provides a gen-eral framework for developing a best-practice COA, applicable regardless of technology limita-tions. Incorporating such a frame-work will support a mining organ-i z a t i o n i n o p t i m i z i n g i t s o p e r a t i o n a l a n d f i n a n c i a l reporting.

Define key segmentsThree key segments should

always be used within a mining COA: cost centre, activity and natural account.

• Cost centre: Identifies func-tional areas of the business, such as geology or engineering

• Activity: Identifies the func-tion performed, such as grade control or administration

• Natural account: The detailed breakdown of the cost/account, such as fuel, labour or PPE con-sumables.

T h e s e s eg m e n t s p r ov i d e mining organizations with the

ability to define costs in a logical manner and thereby develop reporting to analyze these costs. It is generally recommended that these elements are four charac-ters long, though multinational companies can also add two digit region codes if desired.

Once a cha r t a ccoun t i s developed, the actual accounts themselves create relationships.

Developing re la t ionships b e t we e n t h e e l e m e n t s a n d def ining the characteristics of those elements allows the chart to be dissected based upon logic. This then allows an organization to develop cost models and intel-ligence reporting with ease and in a controlled manner.

The following is an abbrevi-ated example of a costing struc-ture for geology and engineering for an open pit mine:

• O p e n P i t O v e r h e a d s (Heading)

• Geology (Cost Centre) > Mine Geology (Activity) > Grade Control (Act ivi ty) > Admin (Activity)

• Engineering (Cost Centre) > Mine Planning (Activity) > Mine Engineering (Activity) > Survey (Activity)

Each element must adhere to individual numbering. Both cost centre and activity would be a number between 0000 and 9999.

Us ing the four-charac te r system, it’s possible to develop a relationship within the num-bering so the chart flows logic-ally. The structure for a cost centre would be represented in four digits, geology would be 1010, and engineering 1020.

• 1 represents open pit mining• 0 represents overhead cost

centres.• 1/2 represents geology/

engineering as a cost centre.• 0 leaves space for additional

cost centres and activity def in-ition.

The activity for mine geology could then be def ined as 1011, grade control as 1012 and so on. The structure of each element allows for the activity to be rela-tional up to the cost centre. If the

natural account for wages was 5055, then the GL string would be 1010-1011-5055 for Mine Geologist wages.

This is done for two reasons; it allows the chart to report at either the cost centre or activity level based upon its numbering, and it forces activities to roll up to the cost centres through the account

creation process to provide a framework for costing.

avoid repetition In designing a COA, some

users are inclined to repeat ele-ments such as wages to reflect operational wages, admin wages, director wages, etc. Once a natural account has been defined, there should be no repetition. These ele-ments should be defined once and the logic behind the cost centre and activity that proceeds the nat-ural account will set the lineage.

For example, it is not neces-sary to define ‘Wages• Geology’ and ‘Wages• Geology Admin’ as natural accounts. Instead, the ele-ment of Wages (5055), would be used for both accounts but with d i ff e r ing ac t iv i t i e s : Wages Geology would be 1010-1011-5055 and Wages Geology Admin would be 1010-1013-5055.

Avoiding repetition ensures the size of the chart and its tem-plate is limited to a manageable number of accounts while pro-viding the necessary granularity behind the account structure.

Using subledgers Subledgers function as sub-

groups of the general ledger (GL) and can be used to link multiple accounts back to the same GL account. They are an effective way to limit who can access what infor mat ion in the GL. For example, a vendor should not appear within the GL as a GL account, but as a vendor record within accounts payable. Any details that are required for this vendor from a reporting perspec-tive should be obtained directly

from the accounts payable module based on sort fields and the setup of the vendor’s naming conven-tion. Subledgers can also be used to gain insight into equipment maintenance and operation costs and provide companies with the ability to measure against budgets at the equipment, fleet and depart-ment levels.

Leave room for growthAcquisition of projects or

expansion through exploration is common in mining. With this in mind, it’s important to leave room when designing a COA.

Using four characters in the cost centre, activity and natural account elements supports expan-sion and the numbering sequences greatly impact the flexibility of the chart. Using grinding media as an example, assume that one country in a global operation reports their grinding media by size at the natural account level. Separating the general grinding media account by units of f ive allows for sizing to be included as additional natural accounts (i.e., Grinding balls – 5510, Grinding rods – 5515, Fine grinding media ceramic – 5520).

There are many other mining-specif ic areas to consider when implementing or redesigning a COA, including locations, equip-ment and inventory grouping. Mining organizations must care-fully look at their unique struc-ture and factor in potent ia l g rowth in order to bui ld an effective and consistent COA.

Though maintenance is always an ongoing process, when exe-cuted cor rec t ly, the t imely, accurate and insightful data gained from an effective COA will provide the information mining companies need to make informed strategic decisions.

For more resources relating to the mining sector, Chartered Pro-fessional Accountants of Canada (CPA Canada) has developed Viewpoints: Applying IFRSs in the Mining Industry — a series of non-authoritative accounting guidance and support papers, dedicated to helping resource-constrained junior mining com-panies. Download the free view-points from www.cpacanada.ca/viewpointsmining.

Jarrad Sonnenberg is a man-ager at BDO Canada who has more than 15 years of experience working with mining organiza-tions worldwide. He specializes in developing business processes and ERP systems to deliver solu-tions that add value and reduce cost. Contact him at 424-213-0401, jsonnenberg@bdo.ca and bdo.ca/solutions.

Tracking mining success with chart of accounts

sonnenBerg

The Bottom Line October 2016 15F o C U s

preserved by keeping the organiza-tion together and operating. Thus there have been CCAAs of a number of oil and gas companies (for example, Sanjel Corporation, Connacher Oil and Gas Limited and GasFrac Energy Services) and there will likely be many more.

There are numerous oil and gas companies or service companies in the industry whose credit rating has been downgraded by the rating agencies and appear to be facing very difficult economic times. In recent weeks, a number of rela-tively significant companies that operate within the Alberta energy market have issued news releases acknowledging defaults. According to Insolvency Insiders’ watch list form July, these include Twin Butte E n e r g y L t d . , L i g h t s t r e a m Resources Ltd., Questfire Energy Corp., Tesla Exploration Ltd., Target Capital Inc. and many other corporations.

How can this all be turned around? The simple solution, of course, is a sharp rise in world prices. However, we can’t count on that. There will, in all likelihood, be a recovery but it will almost cer-tainly be slow. The more realistic solution is patience. Not just patience of lenders, but patience of t r a d e c r e d i t o r s , s u p p l i e r s , employees, pension funds, regula-tors and finally, the courts.

How do oilpatch borrowers con-vince capital lenders to be more patient? The obvious strategies of cost cutting, sale of non-core assets, increased fees and capitalization of interest payments are getting some traction, but not enough. What abou t no r ma l a r m’s l eng th creditors? Well, they are suffering too. Employees, landlords, sup-pliers, service providers and the tax man all need to be paid. Regulators

simply can’t be ignored and the courts have to be educated.

How any given constituent weathers this storm depends entirely on where they sit on the spectrum. New York funds need to answer to their investors and need to have at least the prospect of payment of additional profits when the market returns. Many of them will end up being the owners of these com-panies as shares are exchanged for debt so that the debtor can react to an expanding market without eating up all their capital through high interest payments.

If there is any hope of preserving value, traditional bank lenders need to be equally patient and need to look at alternative forms of remuneration. Employees will simply have to lower their expecta-tions. Perhaps they too could be offered a stake of some kind in the company. The same goes for sup-pliers and service providers.

As for the regulator, the recent debacle arising from the Redwater Energy Corporation case in which the Alberta Energy Regulator sought to gain priority over first pri-

ority secured lenders to fund remediation costs is for abandoned wells was, in this observer’s view, the worst way to go about stimu-lating the market. It is very unfortu-nate that cash-strapped oil and gas companies cannot afford to remediate their sites, but some of those royalties that have swelled Alberta’s coffers over the past decade or more should have been preserved for this purpose rather than picking the pockets of arm’s length lenders.

There is no one panacea for the crisis in the Alberta oil and gas industry. Austerity, patience, good luck in the markets and thoughtful focus are all important.

However, what there is and what has been demonstrated time and time before is the resilience of Albertans. Look no further than Fort McMurray to see what Alber-tans are capable of. I believe the courts will be equally resilient and patient. The courts are prepared to give substantial debtors a chance to

work things out with their stake-holders. The judges of Alberta’s court of Queen’s Bench have seen this movie before and they know that prices will come back and a scorched earth policy will ultim-ately help no one.

Expect them to continue to be as patient and thoughtful as they can possibly be, holding creditors at bay for a reasonable length of time to provide breathing space and negoti-ation room. However, at some point denying the right of secured creditor to realize on its security will have even more disastrous consequences to the Albertan and indeed Can-adian economies.

There will be instances of certain

participants seeking to profit from this sustained downturn and in some instances that may be entirely appropriate. However, as the old saying goes, “pigs get fat, hogs get slaughtered” and profiteering will not be viewed kindly by the industry or the courts.

Time will tell where this energy

market takes us, but there is cau-tious optimism that profitability will slowly return and a more mature and sensible market will emerge.

This will not be the last time there is a slump in this or any other commodity market. Let us hope, however, that all the participants in this industry are more measured in their approach to good times and more conservative in their prepara-tion for the bad times, that will inevitably come again.

John Grieve is the leader of Fasken Martineau’s global insol-vency and restructuring group. His practice is focused on complex com-

mercial reorganizations. His insol-vency and restructuring expertise has been recognized in Chambers Global, Euromoney, Best Lawyers in Canada, Who’s Who Legal, Lex-pert, Benchmark and Martindale Hubbell. Please contact him at jgrieve@fasken.com or 604-631-4772.

Albertans’ resiliency reason for optimismContinued from page 11

Stay true to your culture, long term goals i ne ff i c i enc i e s / l o s se s o f an improperly managed project.

Consider building an advisory board to optimize operations and provide strategic direction.

Stay true to business values and culture. While strategic plans may shift during a downturn, decisions should still reflect long-term goals.

Recognize power of informationUse an enterprise resource

planning system to analyze the cost of labour, supply and materials

to understand the true cost of doing business.

Adopt CRM software. This will help keep track of customers and to analyze purchasing habits. Antici-pate need and customize your product or service accordingly.

Be open about your true cost of

doing business. Customers will be more willing to work with you if they understand the correlation between cost and price.

S a l e s e f f o r t s s h o u l d b e focused on management or the owner(s) rather than with pro-curement, which is typically

solely focused on price.If ever there was a time to be

collaborative, innovative, open and agile, it’s now. Embrace creativity, partnerships and networks; con-n e c t a n d c o l l a b o r a t e w i t h employees and customers; refine processes, efficiencies and tech-

nology; take the time to learn and apply that learning to build new and innovative solutions which in turn will drive opportunity.

Together, oil and gas companies can drive industry-wide change to reduce the effects of pendulum pricing. Now is not the time to do nothing.

Wes Priebe is managing dir-ector with Grant Thornton Cor-porate Finance Inc. in Alberta. He works with mid-market companies in the oil and gas sector, assisting with mergers, acquisitions, divesti-tures and sourcing capital.

Continued from page 12 Don’t wait for change. Focus on doing business with companies that value more than the lowest price.

Bidding wars only drive the market down further.Wes Priebe, Grant Thornton Corporate Finance Inc.

grieve

How can this all be turned around? The simple solution, of course, is a sharp rise in world prices.

However, we can’t count on that.John Grieve, Fasken Martineau

There will be instances of certain participants seeking to profit from this sustained downturn and in some

instances that may be entirely appropriate. However, as the old saying goes, “pigs get fat,

hogs get slaughtered” and profiteering will not be viewed kindly by the industry or the courts.

John Grieve, Fasken Martineau

16 The Bottom Line October 2016F I Na N C I a L P L a N N I N G

We all need to sharpen the blade and recently I did this myself by attending

a seminar by Kelly Ehler, a char-tered professional accountant.

He organizes seminars and webinars specifically dealing with the issues that covers capital gains exemptions, succession planning, rectification, estate freezes and tax restructurings just to name a few. What I liked especially about this one in particular was that the theme covered a real life example — as business owners grey across our nation, more and more tax and accounting practitioners will run into as businesses go through the succession transition.

The seminar began by bringing to our attention the details of con-tinuous tightening of tax rules, increased compliance require-ments and the need to take advan-tage of all opportunities to save tax.

Take the simple case study of Barbara, Andrea and Dave, share-holders of BAD Inc. which was a wholesaling company catering to millennials. The basic facts are Barbara owns 60 per cent, Andrea 25 per cent and Dave 15 per cent. They own the shares personally, they all live in Ontario and are all Canadian residents. The shares have nominal ACB (adjusted cost base) and PUC (paid up capital)

and three were the original share-holders. They have operated the business since 2001 and have suc-cessfully grown the business to $20 million in revenues and $500,000 of pretax profits, after each takes a salary, on average, of $200,000 per year.

Over the past few years there has been growing disagreement as to the direction of the company. Dave’s views are not being met by Barbara and Andrea and it reached a point that the three agreed Dave’s shares should be redeemed. Bar-bara and Andrea agreed they did not want to buy the shares and that if the company redeemed the shares Barbara would have 60 of 85 shares and Andrea would have 25 of 85 shares.

The parties have agreed that $720,000 is a fair price for his shares plus a two-year earnout. BAD Inc. will redeem the shares.

Dave, Barbara and Andrea have all heard about the capital gains exemption and thought since Dave was selling his shares that he would get the money tax free. BAD Inc. didn’t have sufficient surplus cash to redeem the shares but had an unutilized line of credit to draw on. The transaction was papered and the shares redeemed because the shareholders thought the transaction was so simple and didn’t need any external advice.

Much to everyone’s shock, in

February, the firm’s accountant, having learned of the transaction after the fact, advised the parties Dave has to be given a T5.

The accountant explained that the redemption is in fact treated for tax purposes as a deemed divi-dend under 84(3)(a). As they are all Ontario residents, and the busi-ness operated solely in Ontario, the tax rate of the dividend, as an ordinary dividend (an assumption here), in 2016 could be up to approximately 45.30 per cent for a tax bill of approximately $326,160. Needless to say Dave is not too happy and asks if he can fix the issue since he thought this capital gains exemption should apply since he sold the shares. Andrea and Barbara want to know what should have been done differently because one day they might be in the same position.

The accountant responds with the following comments. To “fix” the transaction one has to consider whether “rectification” is possible. The accountant explains that to get rectification you need to prove you were in complete agreement on terms of the transaction but by an error wrote them down wrong. In this case there was complete agreement as to strategy. It was just the wrong strategy, thus there was no written error to correct. Rectif ication can’t be used to rewrite the deal.

As to what should be done dif-ferently, the accountant provided the following analysis and steps should have been taken. To be eli-gible to claim the capital gains exemption, BAD Inc. must be a small business corporation (SBC) which is a Canadian Controlled Private Corporation (CCPC). The accountant advises BAD Inc. meets this criterion.

The next set of tests that BAD Inc. must meet are as follows:

• Based on fair market value, all or substantially all (90 per cent or more) of the assets of BAD Inc. must be used principally in an active business carried on pri-marily in Canada (at the dispos-ition date).

• Again, based on fair market value (FMV), more than 50 per cent of the assets must be used principally in an active business carried on primarily in Canada throughout the 24 months prior to the sale, and

• The share cannot have been held by an unrelated person during the 24-month period prior to disposition.

The accountant advises that the 90 per cent rule above has been derived from court cases and tax rulings. The accountant also notes that FMV includes good-will, which would not be recorded on the balance sheet, but poten-

tially very relevant. Each asset of the company has to be evaluated in this test.

The accountant performs this test over the past 24 months and concludes the company meets the 90 per cent criteria and the 50 per cent, 24-month asset test. Since all three shareholders have held their shares since 2001, they meet the 24-month ownership test. The accountant also explains that if any of the shareholders had CNIL (or cumulative net investment losses) or ABIL (allowable business investment losses) they would reduce the capital gain exemption. The accountant concludes , af ter analysis of the facts, ABIL and CNIL do not apply.

Since the company and share-holders could have structured the transaction to take advantage of the capital gains exemption, what would some of the benefits have been? Dave could have received tax free proceeds using the capital gains exemption. Barbara and Andrea, depending on how the transaction was structured, would end up with the additional shares and a higher cost base for their shares.

So how to do this? I will cover this in future articles and explore what can go wrong when tax planning is not done correctly.

Wrong strategy, big headacheNeedless to say Dave is not too happy and asks if he can fix

the issue since he thought this capital gains exemption should apply since he sold the shares. Andrea and Barbara

want to know what should have been done differently because one day they might be in the same position.

Peter Merrick, TheIceSolution.com

MerrickWealth

By PeterMerrick

Peter J . Merrick, Ba, FMa, CFP, tEP, FCsI is a trust and estate prac-titioner a consultant at TheIceSolu-tion.com, an exit planning firm in Toronto. He is the author of ASK - Advisors Seeking Knowledge, The TASK – The Trusted Advisor’s Sur-vival Kit and The Essential Individual Pension Plan Handbook. He can be reached at Peter@TheIceSolution.com or 416-854-1776.

More talk than walk in some quarters over riskBy DoNaLEE MoULtoN

Accountants, their clients a n d t h e i r c o m p a n i e s o p e r a t e t o d ay i n a n

environment where risk is being redefined and assuming greater importance than ever before. Being prepared for the “what-ifs” of business is essential.

Now a report from the Char-tered Professional Accountants (CPA) Canada and Financial Executives International (FEI) Canada has found that even though the majority of companies surveyed have plans in place to mitigate their risk most still do not feel prepared to deal with the unintended.

Only 20 per cent of the more than 320 financial executives sur-veyed said they did not have a documented risk management strategy in place, and most of those without a plan were smaller

or more nimble organizations, noted Carol Raven, a principal in CPA Canada’s research, guidance and support group in Toronto. However, she noted, two-thirds of respondents described themselves as only “somewhat conf ident” their organization could actually manage their risk.

According to the State of Enterprise Risk Management in Canada, understanding of risk and knowledge of the plan throughout the organization is the biggest concern. “Overall, respondents generally believe that their boards understand the risks — both posi-tive and negative — facing their organizations, have even more confidence in their senior man-agement’s awareness of risk but notably less conf idence in the front line employees’ under-standing of risks facing the com-pany,” the report authors stated.

This lack of understanding and awareness is linked to company size. “The disconnect happens in the mid-size companies,” noted

Laura Pacheco, vice-president of research with FEI Canada in Toronto. “For large organizations, they are able to make the invest-ment in communications and roll-out. For smaller organizations, you have the watercooler talk. Where this starts to come apart is the mid-size organization with 100 to 500 employees.”

The f indings of the CPA/FEI Canada survey reflect the on-the-ground reality that Leah White, a par tner with Grant Thornton LLP’s operational advisory ser-vices group in Halifax, sees daily. “The concern is that the informa-tion isn’t necessarily being passed to those who need it or it is going unrecognized. A formal process should address both of those issues.”

In order for organizations and their accountants to effectively manage risk, that risk must be well

known at all levels. Risk awareness needs to be pervasive, stressed Raven, a chartered professional accountant. “The whole organiza-tion needs to understand what is going on.”

That means senior management and boards of directors must have a shared assessment of what con-stitutes risk for the organization and how those risks can be effect-ively addressed. At the same time, individuals and units within the f irm must be aware of the risks facing the firm and have a process in place for alerting the C-suite about risks identified at the front line. “You need to think about risk from a holistic level, not depart-ment by department,” said White, a chartered professional accountant.

CPA/FEI Canada’s 42-page report found that only 31 per cent

See Assess on page 17

raven

The Bottom Line October 2016 17M a NaG E M E N t

A reader asked the fo l -lowing: “Your practice management advice is

helpful, but is often a challenge to implement. Aren’t there some easy, simple strategies that will have a significant positive impact on our practice?”

This request reminds me of today’s merchandising strategies. We’re bombarded with “lite” ver-sions of products and “basic” ser-vice packages. These stripped down versions of “the full ser-vice” are appealing because they are, so we’re told, both “easy and simple.” We’ve become condi-tioned to expect simplif ied ver-sions of most everything, which incorporate options that we could pay for of course, but which require more time, money, effort and skill. These expanded ver-sions, so we’re told, will deliver more in-depth functionality, enjoyment and payback than their lite version cousins.

In that spirit, I offer the fol-lowing “lite” version of various practice management strategies.

In order to keep our practice management simple, we f irst develop some universal, simply stated goals: increase revenues; improve prof itability; enhance eff iciency; develop more pro-

ductive staff; achieve a more acceptable quality of life. Then we quantify these goals in simple terms.

‘Increase revenues’ may trans-late into a minimal, readily attain-able goal such as “a 3 per cent increase in billings during the coming 12-month period.”

‘Enhanced efficiency’ may be expressed as: “each partner over-sees a book of business of $600K instead of $550K.” And so on.

Jessica and her partners had been generating revenues of $1.4 million. Keeping it simple, they set a goal to increase f irm rev-enues to $1.475 million for the cur rent f iscal period. They’d determined that their billing real-ization rate (actual billed to stan-dard) was approximately 93 per cent. Their simple strategy was “let’s bill more aggressively and increase the realization rate to 95 per cent which would (automatic-ally) result in our simply stated, ta rgeted, increased revenue number.”

Bob and Joe, partners in a fast growing practice, decided that if they increased the book of busi-ness they each handled by $50K then it stood to reason that they’d have to be operating more eff i-ciently: “simple logic” they declared. And so each of them simply increased their personal workloads as the practice grew.

These scenarios illustrate cer-tain realities:

• It’s possible to establish and implement relatively simple prac-tice management strategies;

• It’s possible to set goals that will achieve the simply stated goals and will generally be attain-able: revenues will likely increase; realization rates will probably be improved; billings managed per partner will grow.

However, as is often the case when we strive for simplicity, there are inevitable complications: simplicity leads to consequences that will ultimately need to be addressed.

The underlying f irm level problem is that various operating characteristics do not stand alone, there are connections. Perform-ance strategies impact on one another: one can increase the book of business handled without an increase in cost to service — but one’s quality of life may deteri-orate; realization rates can be improved by billing more aggres-sively — but write-offs may increase or client unhappiness will result and lead to an eventual loss of revenue.

Most specific indicators (rev-enue, clients serviced, realization rates) are simply one cog in a complex set of interrelationships. Generally, a change in one factor

will influence a change in one or more other factors. Understanding these relationships is at the heart of the practice management deci-sion-making challenge.

One must recognize the fact that these impacts will occur regardless of the firm’s deciding that they won’t impact one another or even ignoring them altogether. For example: a growth in the client base (more clients; more work) can affect hours of work (simply add the new service requirement to the already existing client base); OR it may ultimately require an increase operating costs (hire more staff); OR it may require the “firing” of clients (so as to free up capacity). More likely, the impact will be a com-bination of such consequences.

Because the interconnected-ness of these “lite” strategies exists whether or not management recognizes the underlying rela-tionships, the lite, simple strategy is in reality a strategy that defers the impact of our actions (the well-worn “pay now or pay later” mantra).

If you want to anticipate how you will need to move on from a “lite” strategy to a fuller version (more time, more energy and more cost), here are some factors to consider:

• Financial — will the chosen (lite) strategy: require f inancial

resources; deplete f inancial resources; have an impact greater than one period?

• Human resources — will the chosen (lite) strategy: require spe-cial training; involve hiring new employees or terminating existing employees; utilize excess capacity or require capacity that does not exist?

• Marketing — will the (lite) s t r a t eg y : g e n e r a t e s e r v i c e demands which we will be unable to accommodate; consume other-wise chargeable hours; require an ongoing investment of t ime, energy and money to maintain?

• Technology — will the (lite) strategy: satisfy the needs and desires of the younger people in our firm; keep us in sync with our more progressive clients; outpace our firm’s skill base?

There is important learning in this overview of a lite approach to practice management: many of the goals which are established can only be achieved on an ongoing basis if all of the connecting rela-tionships are considered at the outset.

The problem with the taking the “pay later” approach is that it usually costs more later on than it does earlier and the lite approach often digs one into a hole from which it is difficult to escape.

So “lite” is alright — but know the consequences.

‘Lite’ is alright, but understand valuethe Mortexchange

By MortShapiro

Mort shapiro, FCPa, CMC, is a practice management consultant who advises and coaches accounting f irms and individual accountants throughout Canada. He can be con-tacted at 647-203-8766 or at: msha-piro @shapiro-inc.ca.

We’ve become conditioned to expect simplified versions of most everything, which incorporate options

that we could pay for of course, but which require more time, money, effort and skill.

Mort Shapiro, practice management consultant

Assess situation by measuring firm appetiteof respondents be l ieve tha t employees have a solid grasp of the opportunities and threats rel-evant to their organization, a siz-able difference compared to senior management and directors (80 per cent and 72 per cent, respectively). “This may reflect a communica-tions gap from the top of the organization to other levels,” the authors concluded.

Engag ing and in fo r ming employees at all levels is critical to preparing a risk management plan that is both comprehensive in scope and that can be effectively rolled out should a risk be real-ized. Cineplex Inc., one of Can-ada’s largest entertainment com-panies, for example, brings its front line theatre staff together to discuss what they are seeing and hearing from customers at ground level. “When you’re sitting in the ivory tower, it’s hard to know what

is going on at the front lines,” noted Raven.

Risk alignment is also a critical issue that must be addressed by organizations of all sizes. The enterprise risk management report found this was not always the case. Overall, 72 per cent of the finan-cial executives surveyed stated that their risk strategy and risk appetite are mostly or fully aligned in their organization. That align-ment, however, was linked to size. Those organizations with more than 500 employees reported the greatest synergy (81 per cent) while small organizations, those with less than $100 million in annual revenue, were the least aligned (69 per cent).

The discrepancy between larger and smaller organizations reflects communications within the organ-ization. Is someone designated to communicate with all employees about risk strategy and risk appe-tite? If so, this may mean that

other employees don’t feel risk is t h e i r r e s p o n s i b i l i t y, n o t e d Pacheco, a chartered professional accountant. “You need all eyeballs on the same thing. The collective mind will have a better outcome. You can only play Russian roulette so many times.”

The State of Enterprise Risk Management in Canada report said where there is a lack of under-s t a n d i n g e m p l oye e s m i g h t inadvertently accept risks that the organization wishes to avoid or vice versa. “It is imperative there-fore that all employees understand the risk appetite of the organiza-tion, both in qualitative and quan-titative terms, but more import-antly that the organization act on its words as it def ines its risk strategy,” the authors stated.

White recommends that organ-izations assess their risk appetite, which should be the first step en route to developing a risk strategy, by asking and answering one

critical question: What risks does your organization face and how prepared are you to accept those risks? She noted that a govern-ment agency that relies on public support and goodwill may be less willing to take reputational risks whereas a new technology com-pany may be more ready to take risks generally. “Knowing your risk appetite doesn’t necessarily limit risk. It enables you to assess the risks you are willing to take,” said White.

Organizations should begin their risk management planning by identifying existing risks and assessing whether they fall outside the current risk appetite, she added. “If so, decide how they can be aligned. This may be external actions or internal control.”

It is also important to assess the type of risk an organization is facing. The CPA/FEI Canada report identified four types. Stra-tegic risks are those linked to busi-

ness decisions and include brand perception and changing customer needs. Operational risks reflect a company’s procedures, people and systems while external risks are associated with factors outside of the organization and often outside the organization’s control, such as a natural disaster. Finally, there is financial risk.

St ra tegic r i sks posed the greatest threat, according to the repor t , wi th 55 per cent of respondents, saying this would have a major impact on their organization. Operational risks came second (47 per cent) fol-lowed by financial risks (40 per cent) and external risks (33 per cent). Ultimately, said White, risk needs to be viewed as an inte-grated issue. “You need to look at enterprise risk management as part of the fabric of the organiza-tion. People need to think about risk with every decision they make.”

Continued from page 16

18 The Bottom Line October 2016PaY Ro L L

Audit. How can such a simple f ive-letter word cause payroll practitioners

to cringe? The mere thought of going through an audit can be very stressful. The reality is, if you are responsible for payroll, chances are you will be audited. However, if you are compliant, keep up to date with changing legislation and maintain complete and accurate records, your audit should be a piece of cake.

Following these simple steps may help mitigate the risk of non-compliance, penalties and fines.

Getting readyTypically, there are three types

of audits that payroll professionals may encounter: an internal com-pliance audit, an external audit and a government audit.

A government audit is per-formed by an agency responsible for overseeing a particular area of legislation. Government regula-tory bodies including Canada Revenue Agency (CRA), workers’ compensation boards, the Min-istry of Finance and the Ministry of Labour conduct audits on a regular basis. For organizations that do business in Quebec, R ev e n u Q u é b e c ( R Q ) a n d CNESST (Commiss ion des normes, de l’équité, de la santé et

de la sécurité du travail) may also conduct audits at any time.

Audits can be administered on-site or at a third-party’s establish-ment. They are carried out to ensure that organizations satisfy their obligations related to the employment of workers, payment of salaries and wages, the collec-tion and remittance of statutory withholdings and the accuracy of annual returns. To ensure a smooth audit, you are recommended to prepare information ahead of time, co-operate with the auditor and be available for any questions they may have.

Be proactiveBeing proactive and keeping

complete and accurate records is the best approach to ensuring a smooth audit.

Follow best practices for a smooth audit including ensuring that employee records are set up properly (e.g. tax brackets, pen-sion setup); conducting a self-audit to ensure a reasonability test is complete (e.g. are all the taxable benefits and allowances on the payroll register reported on the T4 in the appropriate boxes?); confirming that all tax-able benefits are set up correctly; verifying that all taxes are with-held and remitted on time and that you balance back to your required f inancial reports (e.g. general ledger); and conducting

monthly or quarterly Pensionable and Insurable Earnings Review (PIER) testing.

Taking these steps will help you determine if you need to make additional changes to your organ-ization’s processes to mitigate any further risks from non-compliance.

Documents requiredDepending upon who is con-

ducting the audit, any of the fol-lowing records may be requested for review:

• Payroll records; registers and supporting documents (e.g. time and attendance);

• Financial statements;• General ledgers; • Payment records including

cancelled cheques;• Accounts payable records

including payments to contractors;• Records of any independent

operator rulings issued by CRA, RQ or a workers’ compensation board;

• T4, T4A slips and summaries and other information returns filed with the CRA;

• RL slips and summaries filed with RQ;

• Clearance certificates for the year(s) under review in a workers’ compensation audit;

• Organization meeting minutes and other governance/managerial records; and/or

• Files and working papers used to calculate payroll remittances.

The auditor will contact you in writing to indicate the place of the audit and which records they require. Therefore, it is essential to keep a detailed paper trail or traceable transactions of your payroll from start to finish.

Employment Standards gives inspectors wide ranging powers r e l a t e d t o i nv e s t i g a t i o n s , including the ability to enter and investigate without a warrant; examine records; require produc-tion of relevant documents; take records or any other relevant documents; and question any person, including employees.

The most common records that inspectors investigate include time records, vacation records, the different employee positions in the workplace and payroll rec-ords.

A list of the “Top 10 Audit Adjustments by the CRA” is available on the CPA’s website at www.payroll.ca.

Records retentionRegardless of which type of

audit is being conducted, there will be a requirement to produce organ-ization documents for review. It is the responsibility of the organiza-tion to maintain and store accurate records.

For example, the CRA requires that organizations must make the records available and permit the auditor to make or receive copies,

as requested. Electronic records are allowed, as long as they are supported and maintained in an accessible and readable format. All backup copies must be stored, preferably, at a Canadian site other than the operations location.

If you deduct Canada/Quebec Pension Plan (CPP/QPP) contribu-tions, Employment Insurance (EI) and Quebec Parental Insurance (QPIP) premiums and income tax from remuneration or other paid amounts, your records must include the following:

• Hours worked by employees;• Amounts withheld for CPP

and QPP contributions, EI and/or QPIP premiums and taxes;

• TD1/TP1015.3-V forms;• CRA Letters of Authority to

reduce tax deductions for certain employees for a specific year;

• All issued information slips;• All filed returns; and • Registered Pension Plan

(RPP) information. (For RPP members, this is required even if there are no statutory deductions.)

CRa and Revenu Québec Records of an employee’s gross

earnings, CPP/QPP contributions, EI and QPIP premiums and income tax (payroll register) must be kept for six tax years plus the current year. Records must also be kept of the remittances paid to the CRA, and RQ for the same period of time, as well as T4 and RL-1 filing.

Simple steps to a pain free audit Payrollconnection

By Janet Spence

Janet spence, CPM, is manager, compliance programs and services for the Canadian Payroll Association and can be reached at janet.spence@payroll.ca. Visit online at www.payroll.ca.

Regardless of which type of audit is being conducted, there will be a requirement to produce organization documents

for review. It is the responsibility of the organization to maintain and store accurate records.

Janet Spence, Canadian Payroll Association

New learning model called ‘wave of future’to have a good tool and a good monitoring process in place to do that,” she said.

Batstone likes the approach Indiana is taking, by trying out the competency-based learning model in a very narrow scope with just its ethics course to see how that works, rather than applying it broadly to all of its p r o f e s s i o n a l d ev e l o p m e n t learning.

“I think it’s interesting and very positive to see an organiza-tion moving in this direction. I will be interested in seeing what their experience is with that as they go forward. It’s a relatively newer approach to assessing learning, so I applaud them for moving in this direction, because I believe it’s the wave of the future,” said Batstone.

With respect to the traditional

hours-based approach to con-tinuous learning, she cited several advantages, including ease of measurement, assessment and being understandable for the members to repor t . From an accounting organization’s per-spective, it provides an easily quantifiable record of the mem-ber’s continuing education partici-pation. It is also relatively cheap to implement and maintain.

But there are also downsides.An i npu t ba sed measu re

doesn’t quantify whether any real learning has occurred. It doesn’t measure things like whether the continuing education course has led to a change in behaviour, or had an impact on the member’s job, or on the organization they are working for, said Batstone.

The Canadian CPA continuing p r o f e s s i o n a l d ev e l o p m e n t requirements are administered by the CPA provincial bodies and

are in the process of being har-monized across the country.

Currently, continuing educa-tion for professional accountants in Canada is all hours based, with

a requirement of 120 hours over a three-year period, 60 of which need to be verifiable. In any indi-vidual year, the member must have at least 20 hours of con-tinuing education. Some jurisdic-tions feature a rolling three-year cycle, while others have a f ixed three-year cycle.

Batstone said CPA Canada rec-ognizes the potential merits of allowing for a competency-based option as Indiana has done and is examining the idea.

“There’s a fair degree of invest-ment that has to go in that , because you have to spend a lot of time thinking about ‘What are the measures that you’re going to be tracking?’ And ‘what are the tech-nologies that are required to be able to do the tracking?’ We’re monitoring what’s happening,” she added.

There is no right or wrong answer as to which approach is

best. It depends on what the indi-vidual member and the associa-t ion body want to ach ieve , stressed Batstone.

“A c o m p e t e n c y - b a s e d approach really does require a fair degree of investment in your pro-fessional learning and develop-ment. So if you’re just doing this for compliance and basically all you want to do is go in and take enough courses that you meet your 120 hours so you can be recertif ied, then I don’t think competency based learning is going to be of interest to you,” said Batstone.

In contrast, the competency-based option could be a highly valuable tool for a person who wants to excel in their current role or move to a new career phase and is motivated to invest in acquiring the new ski l l s necessary to achieve either of those objectives, she added.

Continued from page 3

Batstone

The Bottom Line October 2016 19ta X P R aC t I C E

Recent revela t ions that Apple Sales International paid an effect ive cor-

porate tax rate that declined from 1 per cent in 2003 to 0.005 per cent in 2014 on its profits in Ireland caught many lawmakers by surprise.

Apple rightly asserts that a company should be taxed only in the country where it creates value, and that it complied with all Irish tax laws and rulings. Tha t , however, i s no t good enough for the European Union, which is now seeking retroactive payback.

Only two variables directly determine the amount of rev-enue a tax system raises: tax base and tax rate. The interplay between these two variables, however, is not as simple as it appears. Nominal tax rates are not the same as effective rates and can be adjusted by special concessions, credits, exemp-tions, incentives and exclusions. Thus, we must consider three different tax rates — marginal, average and effec t ive — to determine their real effect on taxes.

The marginal tax rate is the level of tax that applies on the top dollar of taxable income. As marginal rates rise, the total tax payable increases by a rate that is more than proportional to the increase in income. Thus, in Canada we have progressive individual marginal rates, which in 2016 are as follows:

• On first $45,282 of taxable income: 15 per cent

• On next $45,281 of taxable income: 20.5 per cent

• On next $49,825 of taxable income: 26 per cent

• On next $59,612 of taxable income: 29 per cent

• On $200,000 of taxable income and over: 33 per cent

Thus, an individual who earns $30,000 taxable income will pay basic federal tax at a federal marginal rate of 15 per cent. In contrast, an individual who earns taxable income of more than $200,000 will pay at a federal marginal rate of 33 per cent, or a combined federal/provincial rate, for example, of 53 per cent in Ontario.

The marginal rate is important in tax planning because it tells us how much a taxpayer can save in taxes for every dollar reduc-tion of income.

We obtain the “average rate” of tax by dividing the total tax payable by the tax base. The a v e r a g e r a t e r e f l e c t s t h e weighted average of all of the marginal tax rates. Hence, an individual’s average rate of tax is always lower than his or her marginal rate.

For example, the average fed-eral tax rate of an individual who earns taxable income of $30,000 is $4,500, that is, 15 p e r c e n t . I n t h i s c a s e , t h e average and the marginal rates are equal because only one fed-eral marginal rate (15 per cent) applies to all of the income.

An individual who earns tax-able income of $210,000, how-ever, must pay federal tax of $ 4 9 , 6 1 7 , wh i c h m a ke s t h e average rate of tax 24 per cent — that is, 9 per cent lower than the individual’s federal marginal rate of 33 per cent.

The “effective rate” of tax is the total tax payable divided by income, be fore exc lus ions , credits, and exemptions. For example, since only one-half of capital gains are taxable, the effect ive tax rate on capital gains is only one-half of the tax-payer’s marginal rate.

In the above example, assume that an individual with $210,000 income earned $60,000 of cap-i t a l g a i n s i n t h e ye a r. B y excluding one-half of the capital gains, the individual reduces his o r h e r t a x a b l e i n c o m e by $30,000.

The individual’s effective federal tax rate is the actual tax payable of $40,517 divided by his “real” economic income of $210,000. Thus, the effective tax rate is only 19 per cent, as opposed to the nominal federal marginal rate of 33 per cent.

Effective tax rates are the only meaningful yardstick for comparing taxes between indi-viduals, and between different countries. Every exemption and credi t reduces the tax base, which, in effect , lowers the effective tax rate. Thus, one can broaden the tax base and lower the tax rate to promote fairness and achieve economic eff i -ciency.

In international comparisons, in par t icu la r, marg ina l and average rates of tax are not helpful because they do not take into account the differences in calculating the taxable base to which one applies the actual rate. For example, Canada’s cor-p o r a t e s t a t u t o r y t a x r a t e (including subnational taxes) in 2015 was 26.3 per cent, but its effective rate (including subna-tional taxes) was only 12.3 per cent. Similarly, in the same year,

the s tatutory tax rate in the United States was 39 per cent, whilst its effective tax rate was 18.1 per cent. The differences arise in individual and corporate rates because of allowances, exemptions, credits or deferrals, which will vary between coun-tries.

T h e s e v a r i a t i o n s a r i s e because of various tax conces-sions. For example, assume that Country A taxes net income at 40 per cent, whereas Country B taxes net income at 35 per cent. On the surface, it appears that Country A has the higher tax rate. If , however, Country A allows generous deductions for depreciation or interest expenses i n c o m p u t i n g i n c o m e t h a t Country B does not permit, the effective rate of tax in Country A may actually be lower than in Country B. We see this in the

deduction for personal mortgage interest and proper ty taxes , which the United States allows that Canada does not.

In political terms, raising top marginal rates is more impressive than adjusting effective tax rates, because it gives the impression that the government is hitting the rich (the so-called 1 per cent) hardest, which appeals to the

remaining 99 per cent. Con-versely, eliminating an exemption or credi t is a subt le way of increasing taxes, because i t increases the effective rate of tax, without actually adjusting rates.

Apple’s effective tax rate was considerably lower than Ire-land’s nominal statutory rate of 12.5 per cent, which has irked the high tax countries of the EU. In exchange, however, Apple created 6,000 jobs in Ireland, which was good for the domestic economy.

Nominal tax rates don’t tell whole storyEffective tax rates are the only meaningful

yardstick for comparing taxes between individuals, and between different countries. Every exemption

and credit reduces the tax base, which, in effect, lowers the effective tax rate.

Vern Krishna, TaxChambers LLP

taxVieWs

By VernKrishna

Vern Krishna, CM, QC, is Of C o u n s e l , Ta x C h a m b e r s L L P (Toronto) and professor of law, Uni-versity of Ottawa. E-mail him at vern.krishna@taxchambers.ca; www.vernkrishna.com

In political terms, raising top marginal rates is more impressive than adjusting effective tax rates,

because it gives the impression that the government is hitting

the rich (the so-called 1 per cent) hardest, which appeals to the

remaining 99 per cent.Vern Krishna, TaxChambers LLP

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ISBN: 9780433488316

The Law of Charitable and Not-for-Profit Organizations, 5th EditionDonald J. Bourgeois, B.A. (Hons.), LL.B.

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• The Canada Revenue Agency’s (CRA) developing role as a primary regulatory body governing charitable organizations

• The use of “Enterprise Risk Management” (ERM) as a critical method to address risk

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FEDERaL INCoME taX - Computation of tax - Corpora-tions - tax credits - scientific research and development tax credits . Application by AFD Pet-roleum for judicial review of a decision of the Canada Revenue Agency (CRA) rejecting its claim for Scient if ic Research and Exper imenta l Deve lopment expenditures incurred in 2012. The applicant submitted a Form T661 and related schedules in respect of the claim for the expenditures. The respondent found that although the applicant had submitted the claim on the last date for f iling it, the CRA only received two of the seven pages that then comprised Part 2 of the Form. The CRA thus rejected the claim because the pre-scribed information was not filed within 12 months after the due date for f iling the relevant tax return. HELD: Application dis-missed. The Court had jurisdiction to hear and decide the application for judicial review. The issues raised by the applicant advanced cognizable administrative law claims. The CRA’s determination that the Form as submitted by the applicant could not be accepted because not all prescribed infor-mation had been provided was reasonable. The information the applicant did submit did not pro-vide the prescribed information. The pages of the Form containing lines 242 and 244 were not com-pleted at all, or even submitted by the applicant, and there did not appear to be any information in line 240 that specifically supplied the requested and missing infor-mation. The applicant had not spe-cifically identified any informa-tion in the Form it submitted that addressed these two missing areas of prescribed information. The CRA’s determination not to accept the Form T661 as submitted by the applicant was not procedurally unfair. It did not wrongfully con-vert an appealable claim into a non-appealable non-f iling. The Minister did not deprive the appli-cant of any procedural rights because the applicant could have f iled the Form some 12 months earlier than it did when it filed its income tax return for 2012. aFD Petroleum Ltd . v . Canada (attorney General), [2016] F .C .J . No . 514, Federal Court, Boswell J ., May 16, 2016 . Digest No . 3044-001

GooDs aND sERVICEs taX

(Gst) - Input tax credits - Commercial activities - Rea-sonable expectation of profit . Appeal by the taxpayer, Living Fr i ends Tree Fa r m (L iv ing Friends),from a reassessment made under Part IX of the Excise Tax Act (ETA), denying input tax credits (ITCs) in the amount of $15,689 for the period June 29, 2009 to December 31, 2009 (reporting period). Agnes and Eldon Dahl purchased 160 acres of land in 2009. They planned construction of a greenhouse, barn, and eventually, a house. Of the total acreage, 150 acres were for personal use. Living Friends was registered as a partnership for GST/HST purposes by the Dahls on June 29, 2009 to operate a Christmas tree farm on the remaining 10 acres. The Dahls hired tradespeople in September 2009 to complete the preparatory work. In March 2010 serious deficiencies were discovered fol-lowing inspection which resulted in lawsuits against various con-tractors. By the end of 2011, the barn was completed. The Dahls resided in the upper level of barn in 2012, 2013, and part of 2014. They relocated to their house when it was completed in 2014. Living Friends filed a return for the reporting period claiming nil GST/HST collected and ITCs of $15,689, resulting in a net tax credit of $15,689. The ITCs claimed related primarily to the construction of the barn, roads, walls, soil sampling, utilities, and legal expenses. The Minister of National Revenue denied the claim for ITCs on the basis that the Dahls did not operate a tree farm or any other business as L iv i n g Fr i e n d s d u r i n g t h e reporting period. Living Friends appealed. HELD: Appeal dis-missed. Living Trees was not entitled to ITCs because it was not engaged in a commercial activity for GST purposes with a reasonable expectation of profit. A tree farm had an initial start-up phase that was substantially longer than many other commer-cial enterprises due to the length of time it took for trees to reach maturity. However, the Dahls had yet to formulate clear positive steps in establishing the future path of their tree-growing oper-ation as a potentially viable com-mercial endeavour in the years to come. Although the intent existed from the outset to operate a tree farm, that goal had been for all

intents and purposes shelved by the Dahls. There had been no sales to date s ince the f i rs t planting of 50 saplings in 2010 and presently less than half of the 10 acres had been planted with saplings. There was no business plan or partnership agreement. The eligibility of expenses that gave rise to ITCs in the start-up phase of any business required that the taxpayer show not only a clear intention to commence commercial enterprise but also evidence of steps taken in sup-port of that stated intention. The Dahls had an intention to com-mence a Christmas tree growing operation in 2009 when the prop-erty was purchased. However, it was intermingled with a lifestyle that the Dahls envisioned for themselves surrounded by nature, particularly trees and wildlife habitat. Those personal object-ives were so co-mingled with the business goals that the actual split between personal and busi-ness could not be determined. Some preparatory costs of roads, fencing and utilities performed on the property may have been in respect of personal use. The barn was used for both business and personal purposes, but there was no evidence as to percentage b r e a k d ow n . A c o m m e r c i a l endeavour with a goal of actively pursuing prof it did not exist. ITCs could not be allowed where, from the overall totality of the relevant facts, there was no evi-dence of the indicia of commerci-ality. Living Friends tree Farm v . Canada, [2016] t .C .J . No . 92, tax Court of Canada, Camp-bell t .C .J ., May 11, 2016 . Digest No . 3044-002

FEDERaL INCoME taX - Business and property income - a c c o u n t i n g - a c c r u a l accounting - Losses - Business loss . Appeal by Kruger Incorpor-ated from a Tax Court decision allowing in part its appeal from reassessment. The appellant manufactured newsprint and other paper products. A signifi-cant portion of its receivables was denominated in US dollars, leading the appellant to buy and sell foreign currency option con-tracts to hedge its exposure to currency fluctuations. The appel-lant became one of the top non-banking purchasers of derivative products. In 2002, the Minister of National Revenue denied busi-ness lo s ses o f $91 mi l l ion

claimed by the appellant in the 1998 taxation year. The losses arose from dealing in foreign exchange options. At issue was the method used to compute income from dealing in foreign exchange options. The Tax Court rejected the appellant’s use of m a r k t o m a r k e t a c c r u a l accounting as the acceptable c o m p u t a t i o n m e t h o d a n d accepted the Minister’s conten-tion that profit or loss could only be recognized when realized. The Tax Court accepted, in part, the appellant’s alternative argument that foreign exchange option con-tracts were inventory that could give rise to a recognizable loss based on year-end values. The appellant took issue with the Tax Court’s conclusion regarding the computation method. Both par-ties challenged the Tax Court’s f indings regarding whether the contracts constituted inventory. HELD: Appeal allowed. The Tax Court’s decision failed to adhere to the established framework of analysis set out in the Supreme Court of Canada decisions, Can-derel and Ikea, by treating the realization principle as an over-arching principle. There was no authority for the Tax Court’s proposition that the principle of realization applied to the exclu-sion of mark to market accounting unless the Act provided other-wise. The appellant prima facie established that mark to market account ing was an accurate reflection of its income based on evidence that mark to market method was consistent with well-accepted business principles, was GAAP’s p re fe r red bas i s o f accounting for foreign exchange option contracts and was con-sistent with the US Financial Accounting Standards Board and international accounting prac-tices. The evidence did not sup-port a f inding that the Minister discharged its onus of showing that realization procured a better picture of the appellant’s income. In the alternative, it was not open to the Tax Court to hold that any o f t h e a p p e l l a n t ’s f o r e i g n exchange option contracts consti-tuted inventory as defined by s. 248(1) of the Income Tax Act, as none of the options to which the appellant was a party were held for sale or purchased for resale. The matter was refer red for reconsideration and reassessment on the basis that the appellant was enti t led to compute the

income derived from its foreign exchange option contracts in accordance with the mark to market method of accounting. Kruger Inc . v . Canada, [2016] F .C .J . No . 665, Federal Court of appeal, Noël C .J ., scott and de Montigny JJ .a ., June 22, 2016 . Digest No . 3044-003

FEDERaL INCoME taX - Charities - Revocation of regis-tration . Appeal by Credit Coun-selling from a decision of the Minister of Revenue annulling the appellant’s registration as a registered charity. The appellant’s objects were to provide profes-sional financial and debt counsel-ling in the community and to pre-vent poverty. For several years the appellant provided credit counselling services, an educa-tion outreach program and a debt management program. The Min-ister determined that the pur-poses and the activities of the appellant were not exclusively charitable, as the prevention of poverty was not a recognized charitable purpose. The Minister determined that since the appel-lant’s services were not limited to individuals who were poor, its services were more properly clas-sif ied as relating to the preven-tion of poverty rather than the relief of poverty. HELD: Appeal dismissed. The activities of the appellant could best be described as related to the prevention of pover ty. The appe l lan t was assisting many consumers who were employed and who had assets and therefore would not necessarily, as of the time of receiving the assistance, be con-sidered to be in poverty. The appellant had not established that its services, aimed at the preven-tion of poverty, would benefit the community in a way that was considered charitable. It seemed clear that those individuals who had been assisted in paying down their debts and better managing their finances had benefited, but it was not clear why this was not a private advantage enjoyed by these individuals or how this would be beneficial to the com-munity in a way that the law regarded as charitable. Credit Counselling services of atlantic Canada Inc . v . Canada (Min-ister of National Revenue - M .N .R .), [2016] F .C .J . No . 704, Federal Court of appeal, Webb, scott and de Montigny JJ .a ., June 24, 2016 . Digest No . 004

The Bottom Line October 201620

tax DIGesta ROUNDUP OF ReceNt tax cases FROm caNaDa’s cOURts

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The Bottom Line October 2016 21L E G a L

In Poulin v. Canada 2016 TCC 154, the Tax Court of Canada heard two appeals from two

unrelated taxpayers. Both indi-viduals appealed a reassessment f r o m t h e C a n a d a R eve n u e Agency denying their claim for the lifetime capital gains exemp-tion (CGE) on a disposition of shares pursuant to the same cor-porate reorganization.

The reassessment was based on the application of the surplus stripping rule in s. 84.1 of the Income Tax Act. Interestingly, the Tax Court allowed one appeal and dismissed the other. In doing so, the Tax Court provided wel-come clarity on the application of s. 84.1 of the act.

Section 84.1 of the act is intended to prevent tax-free dis-tributions of corporate surpluses in the form of capital gains. The rule is necessary because all or part of a capital gain may be shel-tered by the CGE.

Section 84.1 generally applies where an individual transfers shares of a corporation (the sub-ject corporation) that are held as capital property by the individual to another cor porat ion with which the individual does not deal at arm’s length (the pur-chasing corporation) and fol-lowing the transfer, the pur-chasing corporation controls or holds more than 10 per cent of the votes and value of the subject cor pora t ion . A capi ta l ga in arising in these circumstances is deemed to be a dividend pursuant to s. 84.1 of the act.

In Poulin, Poulin and Turgeon (together, the taxpayers) were the two largest shareholders in Les Constructions de L’Amiante Inc. (Amiante), a Canadian-controlled private corporation. After years of friction between the taxpayers, Poulin decided to gradually sell his shares in Amiante and exit the business over a five-year period.

Poulin’s common shares were converted into freeze-type pre-ferred shares and then sold to a holding company wholly owned by Turgeon (T-Ho ldco ) . I n exchange for the preferred shares, T-Holdco issued Poulin a promis-sory note bearing 5 per cent interest, which was to be repaid over a five-year term from distri-butions received by T-Holdco from Amiante.

Similarly, Turgeon sold certain of his preferred shares to a sep-a r a t e h o l d i n g c o m p a n y (H-Holdco) in exchange for a

note bearing 4 per cent interest per annum, which was also to be repaid from distributions received by H-Holdco from Amiante. However, the promissory note issued to Turgeon did not include any repayment period.

It is important to note that sec-tion 84.1 of the act only applies when the individual and pur-chasing corporation do not deal at arm’s length. The surplus strip-ping rule does not apply to an arm’s length transfer of shares, where an individual and pur-chasing corporation have sep-arate economic interests and where their actions resemble ordinary commercial dealings between self-interested parties. Pursuant to paragraph 251(1)(c) of the act, it is a question of fact whether unrelated persons are dealing with each other at arm’s length.

An individual and purchasing corporation will generally not be dealing at arm’s length where, among other factors, they are acting in concert and without

separate interests. Thus, the cen-tral issue before the Tax Court was whether the taxpayers were dealing at arm’s length with the respective holding companies.

The Tax Cour t found that Poulin and T-Holdco had separate in te res t s — namely, Poul in wanted to retire from the busi-ness and maximize the value of his holdings by structuring the sale of his shares in a tax-eff i-cient manner. Reciprocally, Tur-geon wanted increased control of Amiante.

In the Tax Court’s view, the long history of conflict between the taxpayers was an important factual consideration in this regard (although not a determina-tive one). Furthermore, the five-year term to repay the promissory note held by Poulin represented ord inar y commerc ia l t e r ms between self-interested parties.

In light of the evidence, the Tax Court held that Poulin and T-Holdco were dealing at arm’s length with each other and s. 84.1 of the Act did not apply to the sale of Amiante shares by Poulin to T-Holdco.

Interestingly, the Tax Court reached the opposite conclusion with respect to Turgeon’s sale of Amiante shares to H-Holdco. In the Tax Court’s view, Turgeon’s sale to H-Holdco had no purpose other than the tax-free distribu-tion of corporate surplus of Ami-ante. This was made apparent to the Tax Court because H-Holdco bore no risk and received no benefit.

This finding was supported by the repayment terms of the prom-issory note issued to Turgeon. Whereas the Poulin’s note bore a def ined repayment term, the repayment terms of Turgeon’s note was open-ended, which indicated that T-Holdco only was a par ty to the transaction to accommodate a tax-free distribu-tion of surplus of Amiante.

In the Tax Court’s view, the Turgeon note did not represent the type of consideration that an independent party dealing in a commercially reasonable manner would ordinarily agree to. In light of the evidence, the Tax Cour t held that Turgeon and H-Holdco were not dealing at arm’s length and s. 84.1 applied to the sale of Amiante shares by Turgeon to H-Holdco.

In the result, the Tax Court reached two fundamentally dif-ferent conclusions even though both dispositions by the tax-payers were made on similar terms, arose from the same cor-porate reorganization, and were under the direction and advice of common tax p ro fess iona l s . Poulin received consideration of $450,004.00 on a tax-free basis through the CGE, whereas Tur-geon’s proceeds of disposition of

$388,861.00 were deemed to be d iv idend income and taxed accordingly.

As the Tax Court confirmed, indicators of a non-arm’s length relationship include characteris-tics that do not reflect ordinary commercial dealings between persons; a person’s failure to act in their own interest; and con-duct that suggests that a pur-

chas ing cor porat ion had no independent role other than accommodating a tax-driven reorganization.

The analysis of the Tax Court in Poulin provides an excellent example of application of the surplus stripping rule in s. 84.1, especially in light of the tax-payers’ common circumstances but differing motivations.

Articl ing student Timothy Jones assisted with this piece.

Similar circumstances, differing motivationsaird & Berlistaxline

By Saam Nainifard

saam Nainifard is an associate at the tax group at Aird & Berlis LLP. He can be reached at 416-865-3070 or by e-mail at: snainifard@aird-berlis.com

Section 84.1 of the act is intended to prevent tax-free distributions of corporate surpluses

in the form of capital gains. The rule is necessary because all or part of a capital gain may be sheltered

by the (capital gains exemption).

In the Tax Court’s view, the Turgeon note did not represent

the type of consideration that an independent party dealing

in a commercially reasonable manner would ordinarily agree to.

Saam Nainifard, Aird & Berlis

Saam Nainifard, Aird & Berlis

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The Bottom Line October 2016 23N E W s

By JEFF BUCKstEIN

Material changes could be on tap when the Task Force on Climate-Related

Financial Disclosures publishes its final report, including specific rec-ommendations for voluntary disclo-sure, scheduled for the end of 2016. The accounting profession awaits the verdict to find out whether cli-mate-related disclosures become more a part of mainstream financial filings.

“I’ve been encouraged by the work of the task force to date. [It] has really elevated the conversation in an unprecedented way on climate-related disclosures,” said Sarah Keyes, principal of sustainability at CPA Canada in Toronto.

The mission of the task force, which was established in December 2015 by the Financial Stability Board (FSB), at the request of the G20 nations, is to “develop volun-tary, consistent climate-related financial risk disclosures for use by companies in providing information to investors, lenders, insurers and other stakeholders.”

The task force released a prelim-inary report (called Phase 1) last March which noted that users of cli-mate-related financial disclosures currently encounter major obstacles when trying to incorporate climate-related risks as considerations in investment, credit and underwriting decisions. Common barriers include inconsistencies in disclosure prac-tices, different reporting that cannot be compared, along with a lack of context for information.

The Phase I report asserted that “enhanced disclosures on climate-related risks that are used by investors, creditors and underwriters can improve market pricing and transparency and thereby reduce the potential of large, abrupt corrections in asset values that can destabilize financial markets.”

KPMG International, along with the United Nations Environment Programme, the Global Reporting Initiative and the Centre for Cor-porate Governance in Africa, pub-lished a report in May 2016 that examined global trends in sustaina-bility reporting regulation and policy. It identified nearly 400 sus-tainability regulations, guidelines, codes of conduct and other reporting instruments of both a mandatory and voluntary nature, in 64 coun-tries.

“The good news is that this type of reporting is much more on the agenda. But the problem is that there’s just such a range of reporting requirements that the results become non-comparable,” said Bill Murphy, national leader for climate change and sustainability services at KPMG LLP in Toronto.

Under Canadian securities regu-lation, public companies must dis-close information that is material to investor decision-making. That includes material environmental matters, encompassing climate change impacts, in securities filings, said Keyes.

The Canadian Securities Admin-

istrators (CSA) published CSA staff notice 51-333, Environmental Reporting Guidance in 2010.

CSA 51-333 established five major categories of risk that need to be covered. They include physical risk, such as the impact of extreme weather events. Regulatory risk includes the actual or expected impacts of current and likely environmental regulation on busi-ness strategy. Litigation risk covers factors such as the anticipated lia-bility exposure if the issuer has been a party to environmental litigation.

Business model risk covers the potential impact of business oper-ations on the environment as a result of legal, technological, political and scientific developments. Have such developments created new material opportunities or risks for the issuer?

Reputational risks relate to per-ceptions of how the firm reacts with respect to environmental issues. “How an issuer addresses environ-mental matters can have a positive or

negative impact on core intangible assets such as brand value, con-sumer confidence, employee loyalty, ability to attract financial capital and obtaining regulatory approval of projects,” the CSA said in staff notice 51-333.

Also in 2010, the United States Securities and Exchange Commis-sion issued specific interpretive guidance with respect to climate change disclosure. The SEC said cli-mate change might trigger disclo-sure requirements in the following areas: impact of legislation and regulation, impact of international accords, indirect consequences of regulation or business trends and the physical impacts of climate change.

The task force, chaired by former N ew Yo r k m ayo r M i c h a e l Bloomberg, has announced several fundamental principles that its mem-bers believe are critical for an effective climate-related financial disclosure regime, including the

need for consistency over time, com-parability among companies within a sector, industry or portfolio and information that is reliable, verifi-able and objective, among others.

The Phase I report stated that the task force has conducted a high-level review of existing climate-related disclosures to identify com-monalities, as well as gaps and areas for improvement. But despite progress by governments, stock exchanges and nongovernmental organizations, among others, cli-mate-change related disclosures remain fragmented and incomplete. Only a limited number of reporting regimes currently focus on the financial risks posed by climate-related impacts, it said.

Henry Stoch, a Deloitte LLP partner and national leader of the firm’s sustainability and climate change group in Vancouver, said he thought the biggest challenge identi-fied in the task force report was lack of clarity about what constitutes

material climate-related risk and how to translate that into meaningful disclosure.

Just having boiler plate informa-tion to state what the business is exposed to in terms of climate change risk is insufficient compared to providing specifics such as identi-fying particular business lines that are affected, geographic exposure and where potential opportunity and uncertainty exists, said Stoch.

Moreover, corporate reports to stakeholders should discuss not just how to mitigate climate change risk, like reducing emissions, but also how to adapt the business in a stra-tegic way, said Stoch.

“Make it easily understandable for people who are not living and breathing climate change related matters,” he advised.

The global scope of the task force’s work means it isn’t tied to a specific financial reporting frame-work, such as international financial

reporting standards, said Keyes.“So the fact that it’s voluntary

makes a lot of intuitive sense, because what they are intending to do is create a set of principles and guidelines for considering how best to disclose these matters if they are material to your business,” she added.

Murphy said there is logic behind asking for a voluntary, rather than a mandatory approach to climate change related disclosure. A manda-tory approach would raise the ques-tion of who had the international authority to issue global standards in the first place. At the national level, where such authority does exist, there are timing challenges in terms of when such standards would take effect.

“As an analogy, if you look at the EU non-financial disclosure direc-tive that was issued in 2014, that is still working its way through into the individual country reporting stan-dards. So it can take years if you try

and go down the required versus voluntary path,” he elaborated.

A second challenge with manda-tory reporting is the view that the statutory aspects associated with mandatory disclosures might increase the reporting issuer’s lia-bility. This tends to increase legal language and boiler plate content, said Murphy.

“I would say a third factor they’re banking on is that business has become proactive in this space and to some degree, is showing a will-ingness to be ahead of regulated requirements. The view is that if more consistent and harmonized guidelines are put in place for busi-ness, the leaders in business will adopt those and through peer pres-sure will then expand into their indi-vidual industries,” added Murphy.

Murphy said business may encounter certain barriers with respect to climate change disclosure. One obstacle some businesses

struggle with is determining the potential impact of climate change on their sources of revenue and cap-ital.

For example, “From the sources of revenue perspective, they’re dealing with what I would label as fickle consumers in terms of the willingness of consumers to priori-tize and pay for products and ser-vices that contribute to a reduction in the man-made portion of climate change,” said Murphy.

There is also a broader question of whether increased disclosure requirements actually drive an underlying business strategy designed to more substantially address climate change. Mixed results have been observed with respect to that over the past two dec-ades, Murphy said.

Gigi Dawe, principal of corporate oversight and governance at CPA Canada in Toronto, said that when the task force releases its f inal report, she would like to see specific guidance with respect to the role of the board of directors.

“In order to enhance climate change related disclosure, com-panies require boards and executives who are committed to better disclo-sure. I believe the task force should provide specific guidance to better inform boards about the issue and guide them about what they should look for in disclosure. The board is a necessary friend or influencer of the CEO and organization in climate change disclosure. The more informed they are the better they can influence disclosure,” she said.

“If the board doesn’t have the requisite knowledge they can’t set the right goals or ask management the right questions about their dis-closure,” added Dawe.

Climate report may spur big changes

MurPhy daWeKeyes

“I’ve been encouraged by the work of the task force to date. [It] has really elevated the conversation

in an unprecedented way on climate-related disclosures.”Sarah Keyes, CPA Canada

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