This Selected Issues paper reviews Canada’s business tax system, looking at the incentive effects of the country’s business tax regime and their implications for output and employment. It presents estimates of marginal effective tax rates on corporate-source income in Canada and comparator countries across sectors, asset classes, means of finance, and asset ownership. The paper also examines labor markets in Canada. It notes that unemployment rates in Canada have risen across all demographic groups, industries, and regions, although young and less-educated workers and workers in agriculture and primary industries have been most severely affected.

Abstract

This Selected Issues paper reviews Canada’s business tax system, looking at the incentive effects of the country’s business tax regime and their implications for output and employment. It presents estimates of marginal effective tax rates on corporate-source income in Canada and comparator countries across sectors, asset classes, means of finance, and asset ownership. The paper also examines labor markets in Canada. It notes that unemployment rates in Canada have risen across all demographic groups, industries, and regions, although young and less-educated workers and workers in agriculture and primary industries have been most severely affected.

VII. Developments in Canadian Trade Policy1

A. Introduction

1. This paper reviews developments in Canadian international trade and investment policies during 1996, including aspects of: (1) the Uruguay Round agreement and the World Trade Organization (WTO); (2) the North American Free Trade Agreement (NAFTA) and the Free Trade Agreement of the Americas (FTAA); (3) the domestic tariff system review; (4) the Asia-Pacific Economic Cooperation Forum (APEC); (5) trade preferences for developing countries; (6) foreign investment policies; (7) internal trade matters; and (8) other measures and issues.

B. Uruguay Round Agreement and the World Trade Organization

Implementation of Uruguay Round

2. At the Quadrilateral trade ministers’ meeting on September 26, 1996, Canada supported further consideration of a number of initiatives designed to maintain the momentum of market access liberalization.2 Initiatives considered included possible acceleration of Uruguay Round tariff reductions; the examination of zero for zero tariff packages,3 notably on information technology products; and active participation in sector-specific negotiations in financial services, telecommunications, and maritime transportation. Canada was a signatory to the WTO agreement on government procurement, which entered into force on January 1, 1996. It also endorsed within the Quadrilateral Group the initiative to launch broader negotiations among WTO members for an interim arrangement on transparency, openness, and due process in government procurement.

3. The Ministerial meeting of the WTO held in Singapore in December 1996 provided a forum to review progress in the implementation of the Uruguay Round agreement, to assess adherence to the so-called “built in agenda” and to review the status of sector specific negotiations.4 Canada encouraged further discussion of the report by the WTO Committee on Trade and Environment and supported the extension of the Committee’s mandate.

4. Canada has fulfilled its commitments under the Uruguay Round on Agriculture, although the high tariff rates on products coming under the supply-management system continue to limit the degree of liberalization achieved thus far. With respect to grain marketing, however, legislation currently is being drafted to modernize the governance structure of the Canadian Wheat Board, and a dual marketing system for barley may be introduced.

Dispute-settlement activity in the WTO

5. As of end November 1996, Canada had been involved in 16 cases brought to the WTO Dispute Settlement Body for consultations. Only one request concerned alleged Canadian practices; that request, which was filed by the United States, concerned Canadian practices regarding foreign periodicals. In eight cases Canada was either a sole or a joint complainant; in all other cases, Canada joined consultations initiated by other WTO members.

6. The Canadian Government approved legislation in December 1995 to impose an 80 percent excise tax on the advertising revenues of split-run editions of foreign magazines.5 The United States subsequently complained of discriminatory restrictions on foreign magazines, and initiated WTO dispute-settlement procedures against Canada.6 The Canadian Government has maintained that the excise tax is a domestic issue, it does not require invocation of the cultural exemption provisions of the NAFTA, and the legislation is WTO- consistent and does not violate Canada’s trade obligations with the United States. The United States requested in June 1996 that a WTO dispute-settlement panel be established after consultations failed to produce an agreement. The dispute-settlement panel released its interim report to the governments of Canada and the United States on January 16, 1997. The final report is expected to be released to WTO members on February 21, 1997.

7. Trade disputes brought to the WTO by Canada, or disputes brought by others in which Canada joined the consultations, include the following: (1) Japan’s taxes on alcoholic beverages (filed jointly with the United States and the EU); (2) EU duties on imports of cereals; (3) EU regulations concerning scallops (filed jointly with Chile, Iceland, Japan, and Peru); (4) two separate complaints against Brazil concerning trade and investment in the automotive sector (filed jointly with Japan in one case and the United States in the other); (5) EU measures affecting livestock and meat; (6) Hungarian agricultural export subsidies alleged to have exceeded WTO commitments (filed jointly with Australia, New Zealand, Thailand, and the United States); (7) the EU’s ban on imports of beef containing growth hormones; (8) Brazil’s export financing program for aircraft; (9) Korean measures affecting bottled water; and (10) Australian import restrictions on salmon.

8. With respect to Japan’s internal taxes on alcoholic beverages, Canada alleged that Japan improperly levied a substantially lower tax on certain domestically produced alcoholic beverages than on imported spirits. A panel was established under the dispute settlement system of the WTO and found the higher tax to be discriminatory. While Japan appealed the case, the appellate body upheld the panel’s conclusion that the Japanese Liquor Law was contrary to Japan’s national treatment obligations under Article 111:2 of GATT 1994.7 The decision was approved by the dispute settlement body of the WTO in November 1996, and in December 1996, Japan announced changes in its taxes on whiskey to satisfy the WTO complaint. Negotiations between Canada, the European Union, the United States, and Japan are underway to determine a reasonable period of time that Japan should have to implement the proposed changes.

9. Canada suspended its request for WTO consultations over the EU’s new system of wheat import duties, after the EU improved Canadian access by raising the duty rebate on high-quality wheat and lowering the quality threshold for durum wheat. The initial agreement, effective for six months until June 30, 1996, was subsequently extended through end- September 1996. Bilateral discussions are continuing. A bilateral agreement also has been reached over French regulations concerning scallops, under which France has agreed to modify the trade description requirements for imported products.

Antidumping and countervailing investigations

10. Canada initiated four antidumping investigations in 1996, and four final determinations were issued, three of which related to cases filed in 1995. In all four final determinations, there was no finding of injury, or the threat of injury, to domestic producers. Three of the four antidumping investigations initiated in 1996 have not resulted in final determinations. A countervailing duty investigation involving dry pasta from Italy, initiated in 1995, also resulted in a finding of no injury, or threat of injury, to domestic producers. However, an appeal to the Federal Court resulted in this decision being set aside and the injury issue has been sent back for redetermination.

C. The North American Free Trade Agreement and the Free Trade Area of the Americas

11. Canada has actively sought to broaden NAFTA membership and has recently concluded an interim bilateral trade accord with Chile that could be integrated into NAFTA. Under the accord, Canada and Chile will provide immediate duty-free access for most industrial goods (which account for 80 percent of Canadian exports) and Chile will eliminate its 11 percent import duty on almost all resource-based goods and a variety of processed agri- food products over five years. In a departure from the NAFTA, the agreement will phase in a mutual exemption from the application of antidumping duties for all goods by no later than 2003. A number of sensitive sectors (including the Canada-U.S. auto pact, Canadian cultural industries, and Canadian supply-managed agricultural products such as dairy, poultry and eggs) were omitted from the accord. The accord established side agreements on environment and labor that mirror those under NAFTA.

12. The NAFTA trilateral working group, established to recommend a new system of rules governing antidumping and countervail, has completed its work. The focus of the group has primarily been on antidumping, with the group waiting to see how the new WTO disciplines on subsidies operate. A final report, however, has not yet been made available to the public. Canada continues to be committed to reform in this area which will more adequately recognize the realities of integrated markets.

13. Canada continues to be committed to the creation of FTAA by 2005. The working groups that were established by the ministerial meeting in 1995 are scheduled to present their recommendations on appropriate procedures and strategy to establish a forum for formal negotiations in 1997.8

Trade disputes

14. To settle a long-running dispute between Canada and the United States on softwood lumber, an agreement between the two countries was signed on May 2, 1996. The agreement, retroactive to April 1, 1996 requires Canada to place fees on any softwood lumber shipped to the United States from its four leading lumber-producing provinces above 14.7 billion board feet annually, levied at a rate in two tranches of US$50 or US$100 per thousand board feet above the threshold. The threshold of 14.7 billion board feet is set below average Canadian exports to the United States over the period 1993 to 1995. In return, the United States agreed not to initiate any further trade actions on Canada’s softwood lumber.

15. Canada’s commitments on agriculture under the Uruguay Round, which resulted in prohibitively high tariffs (ranging from 175 percent to 350 percent) applied to a number of agricultural products (notably dairy, poultry, eggs, and barley), were challenged by the United States as violating NAFTA by reducing market access for U.S. producers. Following inconclusive consultations between the two countries, the United States requested the establishment of a dispute settlement panel in July 1995 under NAFTA Chapter 20 to examine Canada’s application of WTO tariff equivalents for these imports.9 The binational panel was established at the end of January 1996 and provided a preliminary decision in July. The panel found in Canada’s favor, determining that under NAFTA Canada and the United States agreed that Canada could maintain protection on supply-managed dairy, poultry, and eggs. While Canada’s compliance with WTO commitments to establish tariffs on these products changed the form or technique for maintaining limits on access to the Canadian market, it did not reduce market opportunities for U.S. producers.

16. In response to the enactment of the Cuban Liberty and Democratic Solidarity Act (also known as the Helms-Burton Law) by the United States in March 1996, Canada along with Mexico requested consultations under Chapter 20 of the NAFTA.10 The President of the United States declared a six-month moratorium from the act’s original effective date of August 1, 1996 on the right of U.S. citizens to sue in U.S. courts foreign nationals or entities that “traffic” in property previously confiscated from U.S. citizens. On January 3, 1997, the President extended the suspension of the right to sue for an additional six month period. However, the extraterritorial nature of the law has raised serious concerns and opposition from several countries.11 On September 16, 1996, the Canadian government introduced “An Act to Amend the Foreign Extraterritorial Measures Act” (Bill C-54). Under this bill, the Canadian Government would be authorized to issue a directive to “block” judgements under foreign laws that are deemed unacceptable by Canada. Foreign laws considered unacceptable would be included in a schedule attached to the Foreign Extraterritorial Measures Act. Consultations between Canada and the United States on the subject are continuing, as are consultations between Canada, Mexico, and the EU to coordinate a response to the U.S. law.

17. There are currently eight active panel reviews under Chapter 19, of the NAFTA, with only one of these (relating to refined sugar) being a review of a Canadian determination that U.S. producers were dumping in Canada. Two panels are currently reviewing antidumping duties imposed by Mexico on Canadian steel shipments.

D. Review of Import Legislation

18. Canada is currently engaged in a comprehensive review of its tariff regime with the intention of increasing transparency, simplifying the system, and streamlining legislation. The proposed tariff schedule incorporates tariff reductions on a wide range of manufacturing inputs classified under some 1,500 tariff lines. Following consultations with the private sector, the new proposals include the elimination or conversion of concessionary tariff codes; the termination of the Machinery Program; the conversion of some specific rates to ad valorem rates; and the elimination or replacement of tariff regulations. Many tariff rates are to be harmonized, and tariff lines amalgamated. Nuisance tariffs (defined as those that are below 2 percent) are to be eliminated, and decimal rates are to be rounded to the nearest half decimal point. The intention is to reduce the total number of ad valorem rates from over 200 to around 50. The Government is also proposing to accelerate to 1998 the implementation of the final Uruguay Round tariff reductions scheduled for January 1, 1999.12 Legislation is expected to be tabled by early 1997 for full implementation in 1998.

19. The legal framework for filing and processing antidumping complaints is provided for under the Special Import Measures Act (SIMA). Modifications were made to the act in January 1995 to bring it in line with the implementing provisions of the WTO agreement. A Parliamentary review of SIMA was undertaken in 1996 and a report recommending amendments to the law was tabled on December 11, 1996. The recommendations focus on fine tuning the law and strengthening its public interest provisions. The Government will table its response to the report in the Spring of 1997.

E. Asia-Pacific Economic Cooperation Forum

20. On November 25, 1996 at the APEC ministerial summit held in the Philippines, members reaffirmed the Group’s intentions to make progress toward the goal of “free and open trade and investment” in the region.13 To this end, each country submitted an action plan that laid out an agenda for further trade liberalization. The plans primarily covered the period up to 2000, and in most cases, countries moved beyond commitments made in earlier action agendas presented at the Osaka meeting in November 1995. The action plans cover 15 areas, including tariff and nontariff measures, intellectual property rights, product standards and conformance, and competition policy, with implementation of the plans expected to begin in January 1997. In addition, member countries committed themselves to work for an information technology agreement within the WTO that would substantially eliminate tariffs on such goods by 2000. Canada will host the 1997 APEC ministerial summit and strongly endorsed the initiative to eliminate tariffs on information technology products. Canada also agreed to ease restrictions on foreign investment in broadcasting and committed to discuss further liberalization on other products, including nonferrous metals, oilseeds, wood, and fish.

21. Canada believes that APEC offers a mechanism for consensus building on trade and investment liberalization, rather than a means of achieving commitments through negotiated accords. The approach has provided for unilateral undertakings, as well as multilateral actions in a number of cases, and provides a forum to advance a more open regional trading environment.

F. Trade Preferences for Developing Countries

22. The General Preferential Tariff (GPT) provides preferential tariff treatment for imports from developing countries and transition economies. A new schedule of GPT rates became effective on January 1, 1996, and it is scheduled to be fully implemented by 1998.14 The changes apply to 4,110 GPT rates. Included are around 3,000 reductions in existing GPT rates and 220 new GPT rates on tariff lines not previously included (primarily in agriculture and electrical machinery). The remaining 870 rates reflect zero rates where most-favored nation rates are already free as a result of the Uruguay Round. In most cases, the GPT rates are at least two-thirds of the applied MFN rate.

G. Foreign Investment

23. Member countries of the Organization for Economic Cooperation and Development (OECD) are negotiating a Multilateral Agreement on Investment (MAI), open to accession by all countries. The intention is to establish multilateral investment rules requiring, inter alia, the provision of equal treatment between foreign and domestic investors and investments, to allow the free transfer of funds, to limit performance requirements imposed on foreign investment, and to allow temporary entry of key personnel. With the objective of concluding an agreement by the Spring of 1997, negotiations have intensified. Canada’s goals in the negotiations are basically to replicate NAFTA rules on foreign investment, but to go beyond the NAFTA in certain areas. Canada seeks to make the MAI as attractive as possible to non- OECD countries to encourage accession at the earliest possible date. Reflecting the importance of foreign investment to the economy, Canada also is currently discussing investment issues within APEC and the Free Trade Area of the Americas and has been a major proponent of initiating a work program on investment within the WTO.

24. Until a universal multilateral investment accord is established, Canada will continue to negotiate bilateral Foreign Investment Protection Agreements (FIPAs), which are intended, inter alia, to prevent restrictions and expropriation of funds. Canada has negotiated FIPAs with 19 countries, including, the Philippines, Romania, South Africa, Ukraine, and Venezuela. Negotiations are currently taking place with a further 15 countries.

H. Other Measures and Issues

25. Canada signed a free-trade agreement with Israel on July 31, 1996. The agreement will eliminate tariffs bilaterally on virtually all industrial products effective January 1, 1997. In agriculture and fisheries, the agreement calls for duty-free access or low rates of duty for specific items. However, a number exemptions are provided in the agreement, including cultural industries, goods covered by the U.S.-Canada auto pact, and Canada’s supply- managed dairy, poultry, and egg products. The agreement provides for emergency safeguard actions during its first two years of implementation, and it includes provisions on competition law and policy to deal with anti-competitive and monopolistic actions by public and private parties.

26. Following the dissolution of the 17-nation Coordinating Committee on Multilateral Export controls in 1994, 31 countries, including Canada, agreed to launch a new export control regime, called the Wassenaar Arrangement.15 At the plenary meeting held in July 1996, member countries agreed to begin exchanging information on transfers of dual-use goods and technologies, as well as conventional arms. Currently, lists in particularly sensitive dual-use goods, armaments and technologies are being exchanged.

27. Canada maintains restrictions on payments and transfers to Iraq (since August 1990) and Serbia and Montenegro (since June 1993 and April 1993, respectively).

1

Prepared by Susan Prowse.

2

Members of the Quadrilateral Group are Canada, the EU, Japan and the United States.

3

A “zero for zero” tariff package refers to the possible adoption of zero most-favored nation tariffs on every item in an agreed set of goods by all members of the Quadrilateral Group.

4

The “built in agenda” refers to phased commitments to both further negotiations and implementation in specific Uruguay Round agreements.

5

Split-run magazines are those publications where the magazine’s editorial content is produced abroad and combined with Canadian advertising for sale in Canada. The introduction of the law coincided with the intention by Sports Illustrated to transmit its magazine electronically for printing in Canada, and thereby, sidestepping the previous tariff code restriction.

6

The U.S. complaint challenged not only Canadian excise tax policies, but also a Canadian postal subsidy (which allows Canada to offer reduced rates to certain Canadian periodicals), the commercial postal rates (under which foreign magazines can be subject to higher postal rates than Canadian magazines), and a tariff provision which prohibits the importation of splitrun magazines.

7

National treatment refers to the requirement that once a product has legally entered the territory of a country, that product be accorded treatment no less favorable than similar domestically produced goods.

8

For details of the working groups of the Free Trade Area of the Americas, see Canada Selected Issues, SM/96/69, March 20, 1996.

9

This was the first panel to be formed under the dispute settlement mechanism in Chapter 20 of the NAFTA.

10

For further information on the content of the law, see United States - Selected Issues, SM/96/169, July 8, 1996.

11

In May 1996, the EU formally requested consultations under the WTO dispute settlement mechanism.

12

This would not affect tariff reductions that go beyond 1999, mainly in the agricultural, textile, steel, and apparel sectors.

13

On November 15, 1994, at the APEC leaders meeting in Bogor, Indonesia, member countries issued a “Declaration of Common Resolve” to achieve “free and open trade and investment” by 2010 for industrial member countries and by no later than 2020 for developing member countries.

14

With the reduction in many most-favored nation (MFN) rates under the Uruguay Round agreement, this has eroded GPT margins of preference. The new scheme is intended to restore or, in some cases, widen these margins of preference.

15

The arrangement on Export Controls for Conventional Arms and Dual-Use Goods and Technologies was established in December 1995. It is based on a commitment by each country to enforce its own export laws.