Resource sector to feel squeeze as overseas employment tax credit fades to black

(As originally published in Business in Vancouver, 1 May 2012)

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By Bruce Sprague, Partner, Tax Services, EY and Jonathan Leebosh, Senior Associate, Egan

The March 2012 federal budget sent shockwaves through Canada’s resource sectors when it announced the scheduled phase-out of the overseas employment tax credit (OETC) by 2016.

Now Canadian companies undertaking resource exploration or exploitation abroad — as well as construction, installation, agricultural or engineering activity, and any activity under contract with the United Nations — will have to think creatively when it comes to attracting talent and keeping their growth strategies on schedule over the next four years.

The OETC is a long-standing targeted personal tax incentive that provides significant tax savings to Canadian residents working overseas for Canadian companies in the resource sectors at no additional cost to the employer. But the OETC was not created solely as a recruitment tool.

The credit was first introduced in the 1979 federal budget to improve Canadian companies’ international competitiveness by enhancing their ability to recruit skilled workers to positions that were otherwise difficult to fill. Canadian companies expanding into relatively inaccessible areas of the world that have limited pools of skilled labour face the difficult task of reassigning their workers to these locations on both a temporary and a permanent basis. The government recognized this challenge and created the OETC, which currently eliminates 80% of Canadian income tax on the first $100,000 of remuneration earned from qualifying overseas employment.

While the phase-out of the OETC may come as a shock, it isn’t necessarily a surprise. Corporate tax rates have fallen considerably since the OETC’s inception, relieving the financial pressure on companies in Canada’s resource sectors. Not only that, in the minds of many, Canada’s mining and metals companies are financially fit to support their own overseas initiatives. After weathering the financial downturn, these cash-rich companies aren’t letting economic uncertainty postpone their growth agendas anymore. The real challenge remains attracting and retaining talent — that’s where the elimination of the credit is going to pack the biggest punch for companies nationwide.

With aging demographics and more and more companies pursuing projects in developing nations, it’s no surprise that skills shortage placed second in EY’s most recent annual Business risks facing mining and metals report. Strong commodity prices and confidence in long-term sector fundamentals coupled with a renewed appetite for growth have reinvigorated the mining and metals sector. Companies are quickly developing new projects and ramping up the production of existing ones. But an impending global skills shortage threatens to slow growth and increase costs across the board. Now pair this challenge with the elimination of the OETC, and we could see a much more significant impact on the ability of Canadian mining and metals companies to address the already difficult task of attracting Canadian skilled workers to remote regions.

During the phase-out period over the next four years, the 80% factor applied to an individual’s qualifying overseas employment income will be reduced to 60% for the 2013 taxation year, 40% for the 2014 taxation year, 20% for the 2015 taxation year and nil for 2016 and subsequent taxation years.

Similarly, the $80,000 limit on qualifying overseas employment income will be reduced to $60,000 for the 2013 taxation year, $40,000 for the 2014 taxation year, $20,000 for the 2015 taxation year and nil for 2016 and subsequent taxation years.

On the upside, under proposed transitional rules, the phase-out rules will not apply to qualifying foreign employment income earned by an employee in connection with a project or activity that the employer committed in writing before 29 March 2012. That means the OETC will continue to be available at the 80% factor, and on up to $80,000 of qualifying income, for the 2013–15 taxation years for these projects. However, any new projects after 29 March 2012 will be subject to the phase-out.

Once the phase-out is complete, companies’ cost of doing business in foreign jurisdictions is likely to rise as employers may be left with no choice but to offer higher salaries or compensation packages to attract qualified individuals to difficult-to-fill overseas positions. So how can companies compensate for this loss?

Companies affected by the phase-out of the OETC should review their compensation programs and policies and make appropriate revisions. By performing cost-modelling, companies can also estimate the financial impact of the OETC phase-out to both their eligible employees and potentially themselves. It is presumed that these companies will be looking for alternative ways to deliver the value of the lost OETC benefits in order to retain their skilled employees.

Most important — don’t waste any time. Companies that are affected by the elimination of this tax credit should start reviewing their compensation programs and policies and make appropriate revisions today. Getting a head start is the very best way to prepare.

Bruce Sprague is a partner in EY’s Tax Services practice. Jonathan Leebosh is a senior associate in Ernst &Young's allied business immigration practice, Egan LLP. They are based in Vancouver.