LS-335E BILL C-67: AN ACT
TO AMEND THE BANK ACT, THE WINDING-UP AND COMMENTARY ON THE NOTICE
OF A WAYS AND MEANS Prepared by: LEGISLATIVE HISTORY OF BILL C-67
TABLE OF CONTENTS WAYS AND MEANS MOTION:
INCOME TAX RULES TRANSFER OF LOANS AND OTHER ASSETS DRAFT OSFI GUIDE TO FOREIGN BANK BRANCHING BILL C-67: AN ACT TO AMEND THE BANK ACT, THE WINDING-UP AND RESTRUCTURING ACT AND OTHER ACTS RELATING TO FINANCIAL INSTITUTIONS AND TO MAKE CONSEQUENTIAL AMENDMENTS TO OTHER ACTS AND COMMENTARY ON THE NOTICE OF A WAYS AND MEANS MOTION RESPECTING THE INCOME TAX RULES TO BE APPLIED TO AUTHORIZED FOREIGN BANKS AND THE DRAFT OSFI GUIDE TO FOREIGN BANK BRANCHING In the fall of 1996, both the House of Commons Standing Committee on Finance and the Standing Senate Committee on Banking, Trade and Commerce recommended that the federal government allow foreign banks to offer banking services in Canada without having to establish separate subsidiary banks in this country. Canada and Mexico were the only countries prohibiting foreign banks from doing so. Both Committees concluded that this prohibition served no policy or prudential rationale while needlessly restricting competition in the financial marketplace. Indeed, foreign banks (i.e., foreign bank subsidiaries) have been reducing their presence in Canada over the past decade as evidenced by the decline in the numbers of Schedule II banks and their diminishing market share. The federal government accepted these recommendations, which eventually found their way into Canada’s commitment to the World Trade Organization (WTO) Agreement on Financial Services, signed on 12 December 1997. Furthermore, a Task Force on the Future of the Financial Services Sector in Canada recommended in September 1998 that foreign banks be allowed to have direct branches in Canada. Bill C-67, which received first reading in the House of Commons on 11 February 1999, provides the legislative framework that would fulfil these commitments. One of the elements of this bill is the proposed extension of most favoured nation status to WTO member countries, much in the way that existing financial legislation offers such status to NAFTA countries. Most important, however, the bill proposes to offer foreign banks greater flexibility with respect to how they provide financial services to Canadians. Foreign banks would be allowed to establish direct branches in Canada, in addition to their current means of entry via foreign bank subsidiaries. These direct branches would be an extension of the foreign bank’s home operations, and be financed by the home capital base. (A summary table of the proposed similarities and differences between foreign bank subsidiaries and direct branches is appended to this document.) At present, foreign banks may operate in Canada only through the creation of foreign bank subsidiaries (Schedule II banks) in this country.(1) The bill proposes that foreign banks be given the opportunity to establish two types of direct branches: "full service" branches, which would offer loans and take "wholesale" deposits (i.e. those in excess of $150,000), and "lending" branches, which would not take any deposits and which could borrow only from other financial institutions. Foreign banks would have the option in Canada of operating one of these two types of branches, or a Schedule II bank, or a Schedule II bank and a full service branch. They could not operate both a lending branch and a full service branch, nor could they operate both a Schedule II bank and a lending branch. Both lending branches and full service branches would be able to offer a wide range of loans, big and small. Loan size limits would be based upon the foreign bank’s total capital, however; thus even a small operation in Canada would be able to make large loans in this country. This is quite different from the current rules governing a foreign bank subsidiary, which limit the size of Canadian loans according to the amount of capital the bank has in Canada. Under the existing regime, foreign banks’ subsidiaries in Canada are subject to the wide-ranging regulatory requirements of the Office of the Superintendent of Financial Institutions (OSFI). They must have a Canadian board of directors and a minimum of $10 million in regulatory capital in Canada. These elements constitute fixed costs which can be excessive for institutions doing only a small amount of business in this country. Moreover, the requirement for all Canadian businesses to be supported by capital resident in Canada leads to a certain amount of inflexibility. Lending opportunities that posed no threat to the overall corporate structure could nevertheless exceed the single-borrower limits for the subsidiary. Because the total business opportunities of the subsidiary might not warrant additional capital infusions, however, lending opportunities might have to be forgone. Another unnecessary cost for foreign banks relates to membership in the Canada Deposit Insurance Corporation (CDIC). As most of these foreign bank subsidiaries do not take retail deposits, this requirement has also imposed an unnecessary regulatory burden on these firms. They have, however, recently been granted the ability to opt out of the CDIC. The branching proposals contained in the Bill C-67 would enable the regulatory regime applied to these foreign banks to be lessened. These branches would be borrowing not from retail deposits but only from "financially sophisticated" lenders, larger individual and corporate depositors in the case of full service branches and financial institutions in the case of both lending and full service branches. Moreover, these foreign branches would pose no risk for the CDIC. There is some question, however, as to whether these proposed initiatives go as far as they could to increase competition. While the regulatory burden on branches would be lower than that now imposed on foreign bank subsidiaries, is there any prudential rationale for even a small amount of regulation, given the fact that the branches would not take retail deposits? Moreover, in many respects, these branches would be competing with unregulated institutions. The bill is intended to enhance competition in the Canadian financial sector. Existing Schedule II banks could be converted into foreign bank branches, thereby becoming more cost-efficient competitors, and new institutions that had previously found the foreign bank subsidiary route too onerous could now enter the country. This bill does not deal with the entry regime that would apply to the unregulated non-bank affiliates now operated by several foreign banks in Canada and offering a limited range of services. In the past, foreign banks have been able to make use of the section 521 exemption in the Bank Act to establish unregulated subsidiaries. The government proposal for a new entry regime in its June 1996 White Paper was seriously criticized because of its inconsistency; it would have treated various foreign entities differently from each other, and would have treated foreign entities differently from domestic entities, even though they might be offering the same services. In 1997, the government established an interim policy for new entrants; it will not present a final policy until it has a more comprehensive response to the 1998 Report of the Task Force on the Future of the Financial Services Sector in Canada. Bill C-67 would amend a wide range of Acts, including the Bank Act, the Winding-Up Act, and the Yukon Act. The new concept of "authorized foreign bank," which would be a foreign bank with permission to operate in Canada directly as a branch, is defined in clause 1. Residents of WTO Member nations are defined in clause 3. Provisions of the Bank Act and other financial sector legislation that currently refer to NAFTA residents would in future generally apply to residents of WTO Member nations. Clause 5 introduces a proposed Schedule III to the Bank Act, which would include those foreign banks allowed to operate in Canada as direct branches. Clause 10 would amend section 24(b) of the Bank Act, imposing a reciprocity requirement for residents of non-WTO Member nations. Clause 20, which would amend section 390(2) of the Act, would have the same effect. Clause 22 would amend the Act to implement Canada’s WTO commitment by replacing the reference to non-NAFTA bank subsidiaries with a reference to non-WTO Member bank subsidiaries. This clause would also allow Schedule II banks from WTO Member countries to open additional branches without ministerial approval. Section 508 of the Bank Act currently prohibits foreign banks from doing business in Canada and maintaining branches here. Clause 28 would amend the section so that it no longer applied to authorized foreign banks. Clause 30 would establish a new set of rules governing the types of investments that foreign banks could make in Canadian institutions. A foreign bank would be able to own a Schedule II bank in Canada at the same time that it operated a full service branch in Canada. A foreign bank that operated a lending branch in Canada could not own a Schedule II bank as well. It could, however, own a non-deposit-taking institution and hold other entities that banks are allowed to hold directly. This clause would also change how foreign banks hold subsidiary investments in Canada, which, with a few exceptions (trust companies, insurance companies and securities dealers), must currently be in their Schedule II subsidiaries. This clause would allow foreign banks to hold directly any entity that a Canadian bank may hold. Clause 35 of the bill would create Part XII.1 of the Bank Act, specifying the rules governing "authorized foreign banks." New section 524 would permit the Minister of Finance to authorize the establishment of a foreign bank branch in Canada. This could be a lending branch, which could borrow only from other financial institutions in Canada, or a full service branch, which would have greater opportunities to raise funds here. The Minister would have to be satisfied that the foreign bank could make a contribution to the Canadian financial system and that the home jurisdiction of the bank offered reciprocal treatment to non-resident banks. The Minister would also have to be satisfied about the quality of regulation in the home jurisdiction and that the institution was a bank according to Canadian standards. Other factors that the Minister would have to assess in approving a branch would be set out in new section 526. These would include: the soundness of the foreign bank, its financial resources and business record, and the best interests of the financial system in Canada. New section 529 would outline the transition rules governing a Schedule II bank that wished to convert to a foreign bank branch. Foreign banks would have a choice between two types of branches, a lending branch and a full service branch. Existing subsidiaries could be converted into branches, or the subsidiary could continue to operate and could set up a full service-branch as well. A foreign bank that wished to operate both a Schedule II subsidiary and a branch in Canada would have to have a full service branch, rather than a lending branch. A subsidiary bank that wished to convert to a lending branch would, however, be granted a transition period (two years with the possibility of extension for another five years), during which both types of operation could co-exist. After that period, the foreign bank would be not be allowed to hold a substantial interest in a subsidiary bank or a trust company in Canada. Authorized foreign banks would be required to deposit $10 million with a Canadian financial institution if they were setting up a full service branch, and $100,000 if they were establishing a lending branch (section 534(3)). New sections 538 to 554 would establish the powers of authorized foreign banks in Canada, which, other than the restriction on deposit-taking, would be largely similar to those of Canadian banks. They would include the granting of loans and the issuance of credit cards. In addition, these branches could, with the approval of the Governor of the Bank of Canada, participate in the clearing and settlement system. Full service branches would be restricted to taking "wholesale deposits" (those in excess of $150,000). New section 545 would stipulate that no more than 1% of deposits could be below this threshold, on average, during any 30-day period. This section would also require these banks to notify customers that they were not members of the Canada Deposit Insurance Corporation (CDIC). This legislation proposes that foreign banks would be able to operate in Canada as authorized foreign banks, as well as through Schedule II foreign bank subsidiaries, which could be members of CDIC. New section 547 would aim to ensure that consumers were not confused as to which entity was offering CDIC-insured products. Thus a full service branch would have to operate in premises distinct from the Schedule II bank, although the two could be adjacent. New sections 559 to 579, which would deal with tied selling, complaints handling, interest disclosure, privacy, etc., would require authorized foreign banks to be subject to the same rules regarding consumer protection as Canadian banks. Authorized foreign banks would, under new section 582, be required to deposit certain amounts in non-related Canadian financial institutions, in lieu of holding capital in Canada. A full service branch would have to deposit a minimum of $10 million, but the deposit could not be less than 5% of the liabilities of the bank, in respect of its Canadian operations. The deposit for a lending branch would be limited to $100,000, no matter how much business it did in Canada. New section 600 would enable the Superintendent of Financial Institutions to obtain any information about the branch that was deemed necessary. This provision is also consistent with that applying to Canadian banks. The powers that the Superintendent would have with respect to authorized foreign banks are set out in proposed sections 600 to 623. When an authorized foreign bank was subject to a winding-up order, unsecured claims on the branch would be subject to a particular order of priority as set out in new section 627; that is, in descending order: federal Crown, provincial Crown, deposit liabilities, fines and penalties. Secured claims would always have priority. Further Acts would be amended in the following ways: Clause 75: would add a Schedule III to the Bank Act, listing all authorized foreign banks. Clauses 76 to 92: would amend the Winding-Up and Restructuring Act. Clauses 93 to 97: would amend the Bank of Canada Act, to take into account the existence of authorized foreign banks. The Bank of Canada’s proposed powers in relation to full service branches, i.e. those that could take wholesale deposits, would be dealt with in clause 95. Clauses 98 to 109: would amend the Canada Deposit Insurance Corporation (CDIC) Act, and deal primarily with the circumstances in which an institution could opt out of CDIC coverage. Clauses 110 to 114: would amend the Canadian Payments Association Act. According to clause 110, lending branches could not be members of the CPA, while full service branches, on the other hand, could. Clauses 115 to 117: would amend the Cooperative Credit Associations Act. Clauses 118 to 126: would amend the Insurance Companies Act, and would generally implement Canada’s commitments to the WTO Financial Services Agreement. Under clause 124, some small insurance companies could increase their commercial lending as long as they were owned by a parent financial institution with more than $25 million in capital. Clauses 127 to 131: would amend the Office of the Superintendent of Financial Institutions Act. Under clause 128, the Minister of Finance would be able to enter into agreements with the provinces to have the OSFI supervise provincially incorporated financial institutions. Clauses 132 to 135: would amend the Payment Clearing and Settlement Act. Clauses 136 to 144: would amend the Trust and Loan Companies Act. These clauses would generally implement Canada’s commitments to the WTO Financial Services Agreement. Under clause 143, certain small trust companies could increase the amount of commercial loans in their portfolio, as long as they were owned by a financial institution with more than $25 million in capital. Consequential amendments would also be made to a wide variety of Acts, ranging from the Arctic Waters Pollution Prevention Act to the Canada Elections Act to the Yukon Act, by clauses 145 to 179. WAYS AND MEANS MOTION: INCOME TAX
RULES The establishment of foreign bank direct branches in Canada would pose a number of tax issues that the government plans to address via the Notice of Ways and Means motion tabled in the House of Commons on 11 February 1999. This motion is designed to ensure that direct branches would not enjoy a tax advantage over Canadian banks. The proposed tax changes are as important to the success or failure of this initiative as are the proposed changes to the Bank Act. Foreign branches operating in Canada would be subject to taxation here, based on the amount of their business in Canada. In determining their tax liabilities, the Canadian branches of authorized foreign banks would be able to deduct interest expenses related to their Canadian business, such as interest on funds borrowed from third parties (direct debt) as well as internal financing (allocated debt), which is essentially money borrowed from the head office. Direct debt, because it results from an arm’s length transaction, has a known interest rate, while allocated debt, which does not result from an arm’s length transaction, has an interest rate prescribed by regulation that will be applied against that debt for tax purposes. The indebtedness for which interest deductibility would be allowed could not exceed 95% of assets related to Canadian business. Subject to tax treaties, Canadian residents generally must pay a withholding tax on interest payments made to non-residents. The government proposes to amend the Income Tax Act to ensure that foreign branches would be treated as residents and would thus be subject to the same withholding tax rules as Canadian banks. Thus Canadians who borrowed from a foreign bank branch would not be subject to a withholding tax, but the foreign bank branch’s borrowings from non-residents would be subject to such a tax. The interest on allocated debt is not normally subject to withholding tax. As Canadian banks would be subject to this tax on their foreign borrowings, the government proposes to establish a new tax on 15% of the allocated debt of foreign branches in Canada. The tax rate would be the same as the applicable non-resident withholding tax; i.e., 25% or the rate set out in the applicable tax treaty. Canadian banks are subject to a tax on their regulatory capital. The branches of authorized foreign banks would not have regulatory capital in Canada; that is one of the features that would distinguish them from foreign bank subsidiaries. To ensure that these branches would not enjoy a capital tax advantage over Canadian banks, the government proposes to create a new capital base, equal to 10% of the risk-weighted assets of the authorized foreign bank’s branch assets in Canada, and subject this base to capital tax. Dividends remitted to parent corporations outside the country by Canadian residents are subject to a withholding tax. The Canadian branches of authorized foreign banks would not remit dividends to their home offices because, unlike subsidiaries, they would not be separate legal entities. Thus the government proposes to apply a branch tax to any earnings of such branches that were not retained in Canada. This tax would mimic the withholding tax treatment of dividends, and would thus be subject to the bilateral tax treaties signed by Canada. Canadians who pay taxes to foreign governments on income that is also subject to tax in Canada may claim a credit in this country with respect to the tax paid elsewhere. The government proposes not to extend this credit to foreign banks operating in this country, in order to preserve its own priority with respect to tax income earned in Canada. Double taxation on such income should be avoided by having the foreign bank’s home country provide the credit. The government would, however, be willing to provide a tax credit to offset a withholding tax paid by a foreign bank to another country with respect to income earned in Canada. It proposes to amend the Income Tax Act to make provision for doing so. TRANSFER OF LOANS AND OTHER ASSETS This Notice proposes that the transfer of a foreign bank’s assets from Canada to its home jurisdiction be deemed to take place at fair market value, subject to existing loss deferral rules. According to an analysis by the law firm of Osler, Hoskin and Harcourt, the conversion of a foreign bank subsidiary into a foreign bank branch could result in a substantial tax cost because gains would be deemed to have been realized on goodwill, loans, financial assets and real estate. The absence of a rollover mechanism for Schedule II banks wishing to convert to branches could constitute a barrier to such conversions. DRAFT OSFI GUIDE TO FOREIGN BANK BRANCHING The Office of the Superintendent of Financial Institutions (OSFI) has published a draft guide outlining how a foreign bank could establish a direct branch in Canada, the necessary steps in respect of applications, the information to be provided, the applicable fees, and so on. The draft guide also specifies a number of non-statutory criteria that would be taken into account in the approval process. A foreign bank wishing to gain approval for establishing an authorized foreign bank in Canada would have to satisfy the Minister and the Superintendent that it met a variety of criteria, as follows:
Finance Canada Comparison of Key Features between Foreign Bank Subsidiaries and Foreign Bank Branches
http://www.fin.gc.ca/newse99/data/99-016e3.html (1) There are two exceptions to this general rule. Some foreign banks have established limited purpose, unregulated subsidiaries in Canada that offer a small range of services not considered as needing regulation. The other exception is Wells Fargo Bank, which serves Canadians from the United States and is deemed not to be operating in Canada. | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||