fpinfomart.ca

Stop scaring away foreign
investment
National Post
Tue 17 Aug 2004

Page: A14
Section: Comment
Byline: Jack M. Mintz and Yvan Guillemette
Source: National Post

Many Canadians may have done a double take the morning
that "I am Canadian" Molson Inc. announced its merger plans with Adolph Coors
Co. of the United States. Is this a sell-out of another prominent Canadian
company?

It is a false concern founded on a hoary myth. No matter how you slice it,
Canada's problem is not that it has too much foreign direct investment, it is
that it has too little capital -- whether owned by Canadians or foreigners.
What Canada needs is a good dose of regulatory and tax reforms to improve the
economic climate for business investment. Otherwise we will fail to improve
our standard of living in the coming years.

The flow of foreign investment into Canada increased substantially in the
latter part of the 1990s as a part of a worldwide pattern of heightened
cross-border investment. During this period of unprecedented activity,
however, Canada attracted a declining share of global foreign direct
investment, implying that we were more the wallflower than the belle of the
ball.

Indeed, Canada's share of worldwide and North American foreign investment
has been falling for more than two decades and our corporate foreign-ownership
level remains virtually the same now as it was two decades ago.

At the same time, Canadian companies were investing abroad at an unusually
rapid rate, so much so that Canada is now a net capital exporter, reversing
its long history of being a net importer. This raises the question of why
Canadian companies have found it more profitable to invest abroad rather than
at home in an era when Canada's capital formation as a share of GDP is well
below that of many other countries.

Cross-border investment activities must be viewed in the context of greater
economic integration among countries. Foreign direct investment is
complementary to trade, and scores of economic studies show positive economic
gains associated with both inward and outward investment. To ensure that
Canadian companies can take full advantage of worldwide integration and have
access to the best technology and the largest pool of capital finance to
provide Canadian workers with the best jobs possible, the country must have
internationally competitive policies for inbound investments.

One problem is that, on the regulatory front, the OECD finds Canada has one
of the most restrictive regimes on foreign direct investment. Certainly,
Canada has been more timid than other OECD countries in reducing barriers to
cross-border capital flows in recent years. The Investment Canada Act, under
which large foreign investments must undergo screening to get approval,
contributes to this unfortunate position. The process is largely redundant --
no investment project has been rejected since its passage in 1985 -- and it
should be scrapped to save compliance and administrative costs.

More controversial are Canada's regulations that effectively prohibit
foreign ownership in certain strategic industries, such as banking,
telecommunications, the media and airlines.

As well, some industries -- power, automobile insurance and liquor -- are
dominated by Crown corporations, limiting their exposure to the creative
destruction arising from worldwide capital market discipline. Canadians should
carefully evaluate whether these restrictions are necessary, particularly
because protected industries have great difficulty accessing international
capital, managerial and technology markets.

Border regulations also inhibit foreign direct investment. Canada has
benefited substantially from North America economic integration, with many
companies able to penetrate the large U.S. and Mexican markets from
Canadian-based operations. If the Canada-U.S. border tightens up -- as
happened in the aftermath of the terrorist attacks of Sept. 11, 2001 -- many
companies that use just-in-time delivery models would find it disadvantageous
to work from Canadian sites.

Canada has successfully negotiated the Smart Border Declaration with the
United States, but it could do even better. Ottawa should seek reductions in
antiquated standards, tariffs and other regulations that serve little purpose
outside of impeding trade. If that were to happen, Canada would become a much
more attractive destination for foreign investors looking to establish North
American operations.

As with regulatory barriers, taxation is deterring foreign direct
investment in this country. Although Canada has reduced its corporate income
tax rate from the highest level among industrialized countries in 2000 (43%)
to fifth highest (35%), the rate is still well above the OECD average of
roughly 30%. And with inadequate depreciation and inventory cost deductions,
capital taxes and sales taxes on capital inputs, Canada imposes a relatively
high effective tax on capital investments, compared to most OECD countries,
including the United States.

As well, withholding taxes on dividend, interest, royalty and other income
raise more barriers to foreign direct investment. Canada's withholding tax is
an antiquated approach to tax policy because the country is now a net capital
exporter. By failing to negotiate reductions in withholding taxes with other
countries, Canada shoots itself in the foot by making it more difficult for
Canadian businesses to operate competitively abroad. Unlike many other
countries, such as Sweden, Denmark, Britain and the Netherlands, which have
negotiated bilateral reductions or elimination of withholding taxes on
dividends and interest, Canada clings to ancient policies that are no longer
sensible.

A case in point is Canada's current far-too-slow negotiation with the
United States on an agreement to eliminate withholding taxes on interest
income. While its Group of Seven peers have largely followed through with this
policy, Canada continues to act like a Third World capital importer by
imposing high withholding taxes on interest payments. As a result, Canadian
companies find themselves at a competitive disadvantage because U.S. tax
treaties deny benefits to those companies that reside in high withholding tax
countries.

Canadian companies thus face a 30% withholding tax on interest payments
made by Canadian subsidiaries located in the United States to Canadian
affiliates operating in third countries. The effect of this U.S. tax is to
reduce the stock market value of Canadian parents, hurting Canadian investors
and pension plans. Meanwhile, multinationals operating from other countries
face no similar restriction because their governments have negotiated low or
zero withholding taxes on interest.

Ottawa should re-examine its regulatory and tax policies to improve the
investment climate in Canada. Our problem is clearly not too much foreign
direct investment -- it is too little. Attracting more would generate capital
formation that would ultimately contribute to a higher standard of living for
all Canadians.

Edition: National
Story Type: Business; Opinion;
Statistics
Note: Yvan Guillemette is a policy analyst with the C.D. Howe Institute.
Jack M. Mintz is the president and CEO of the C.D. Howe Institute, and
is Deloitte & Touche Professor of Taxation at the J. L. Rotman School of
Management, University of Toronto. This article is adapted from a longer
essay, "A Capital Story -- Exploding the Myths Around Foreign Investment in
Canada," which may be downloaded at www.cdhowe.org.
Length: 1041 words