Cheetos, iPods and retroactive taxation

When the media discusses the problems plaguing Canadian business, we typically talk about the fluctuating loonie, soft demand from the United States and Europe, bureaucratic red tape and a mismatch between open jobs and worker skills. An issue that receives less attention, but is no less important, are taxes that are being charged retroactively by the government on businesses. Retroactive taxation in Canada goes beyond the occasional isolated incident and has economic consequences.

There have been at least three significant examples in 2013 where Canadian businesses allege that they have been assessed taxes retroactively. The first is the well-known iPod tax dispute where a consortium of television importers claim (with a great deal of supporting evidence) that they were told they could import televisions duty free without obtaining end use certificates, but were later charged back duties for failing to have those very same certificates. The importers believe the Canada Border Services Agency (CBSA) knowingly created a retroactive tax, citing a CBSA internal e-mail that states  ”I believe that the above statements in the ruling and the fax should not deter us from re-assessing the importers.”

The second is another dispute between the CBSA and an importer.   For a number of years, Frito-Lay Canada Inc. imported Cheetos duty free under the tariff code 4819.10.00.  Unfortunately 4819.10.00 is the code for “Cartons, boxes and cases of corrugated paper or paperboard”; in other words, the tariff code for the boxes that Cheetos were packed in, not the Cheetos themselves. Frito-Lay discovered their error in 2007 and took the necessary steps to retroactively classify their products under the correct code 1905.90.90.10 “[c]orn chips and similar crisp snack foods.” Since the Cheetos are manufactured in the United States, they should enter Canada duty free under NAFTA. Since both tariff treatments (the erroneous one and the correct one) cause the product to enter Canada duty free, this mistake should be of little consequence.

The CBSA, however, did not see it that way.  They retroactively assessed Frito-Lay the MFN tariff rate of 11 percent on the grounds that Frito-Lay had missed a “one-year filing time limit” to claim preferential treatment under NAFTA.  Frito-Lay Canada challenged the CBSA’s action to the Canadian International Trade Tribunal (CITT) and won. In a harshly worded decision, the CITT wrote that “no authority was provided for such a purported “one-year filing time limit”, and the Tribunal knows of none.” They went on to add that “Frito-Lay met its burden of proof; the CBSA, for its part, did not tender evidence in opposition of that provided by Frito-Lay” and that the CITT was “of the view that the CBSA has given no cogent reason whatsoever as to why the corrections were simply not accepted as such or why they were treated in the five different ways that follow.”

The final (potential) retroactive tax is an arcane GST dispute involving the Finance Department and the insurance industry worth an estimated one billion dollars. The heart of the issue is whether the GST should be charged on cross-border reinsurance contracts; the history behind the dispute is given by an excellent PwC primer.  In 2003 the CITT ruled that cross-border reinsurance contracts fell under the class of financial transactions that were exempt from GST.  In 2005 the Finance Department announced, via press release, that they would introduce a “new system” to tax imported services and that tax would be “retroactive to the date of the release”. Changes in this area were not made law until years later, specifically the passage of the 2010 Budget in July 2010. However, according to the PwC primer “nothing in the Department of Finance releases, or any published releases by the CRA, specifically identifies that the rules may now apply to cross-border reinsurance contracts.”The primer is less than impressed by this move, stating “[t]he magnitude and extensive retroactivity of the resulting assessments will certainly put Canada on the global taxation map in a notorious way, and send a discouraging message to global investors.”

It is difficult to generate much sympathy for large television importers such as Sony and WalMart, snack food manufacturers and insurance companies, which makes them ideal targets for retroactive taxes. We should care, however, as this issue affects all of us. Confusing, arbitrary regulations are bad enough, but the spectre of retroactive taxation makes Canada a riskier place to invest or start a business. Money spent by companies fighting retroactive taxes is money not invested in equipment or staff or returned to investors. The other party in these disputes, such as the CBSA, have expenses as well and we cannot forget the dollars spent for adjudication (the CITT’s net cost of operations was over $12 million last year). Those are costs paid for by all of us.