Chapter 4
The public sector

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4.1 The public sector
4.2 The public sector universe
4.3 The public sector classification decision process

4.1 The public sector

The public sector is the domain of statistical observation that measures the economic activity of governments in Canada. It encompasses all entities classified to the government sector and all publicly controlled government business enterprises.

The government sector is composed of all governments as well as the non-profit entities created by public administrations to deliver services for the benefit of society. Adhering to the Canadian System of National Accounts (CSNA) sectoring system, the government sector is partitioned into sub-sectors, components and sub-components in order to group different types of government activity. Sub-sectors distinguish units by the government of control. Within the sub-sectors, the components group units by type of activity. In the government sector, these components are general government, non-autonomous pension plans, universities and colleges, school boards, and health and social service institutions. Sub-components isolate the constituents of the components to provide groupings for the lowest level of measurement. Examples of these categories are ministries, municipalities, universities, hospitals and residential care facilities.

Government business enterprises are part of the public sector domain because they are controlled by governments. However, they operate in the market place, often in competition with privately owned organizations. Since they are profit-oriented entities, they must be included in the sectors that reflect their primary economic activity. Therefore, government business enterprises are classified to either the non-financial corporations sector or the financial corporations sector depending on the nature of their activities. Within the CSNA, they are identified as publicly controlled non-financial or financial corporations according to the naming conventions of the Canadian System of National Accounts .However, in the public sector, they are collectively recognized as government business enterprises with either non-financial or financial characteristics.

4.2 The public sector universe

A classification process is necessary in order to determine whether or not an entity belongs in the public sector universe. This process involves analysing and documenting the legal and operating structures, financial performance and activities of the entity in question. There are three criteria used to assess an entity for potential inclusion in the public sector universe:

• Is the entity an institutional unit?
• Is the entity controlled by a government?
• Is the entity a non-market or market producer of goods and services?

4.2.1 The institutional unit

The institutional unit is an economic entity that is capable, in its own right, of owning assets, incurring liabilities and engaging in economic activities and transactions with other entities. It is the basic unit of statistical measurement in the public sector universe. The institutional unit's characteristics may be further described as follows:

• It is entitled to own goods or assets in its own right and is therefore able to exchange the ownership of goods or assets in transactions with other entities.

• It is able to make economic decisions and engage in economic activities for which it can be held directly responsible and accountable by law.

• It is able to incur liabilities on its own behalf, to accept other obligations or future commitments and to enter into contracts.

• It either maintains a complete set of accounts, including a balance sheet of assets and liabilities or it would be possible and meaningful, from both an economic and legal point of view, to compile a complete set of accounts if required.

An entity may be comprised of a single unit or multiple units that form a consolidated unit. For example, a government consolidates the transactions of its ministries to disclose its activities as a single entity. This consolidation represents one institutional unit.

There are sub-institutional units or sub-units that are included in the public sector universe for information purposes. They do not conform to institutional unit criteria. However, they are consolidated in an entity's financial transactions. It is useful to account for these sub-units in order to understand all the elements that constitute an entity. Examples of sub-units are government departmental programs as well as special operating funds and accounts. Sub-institutional units take the same sector classification as their parent institutional unit's sector classification.

4.2.2 Government Control

Control is the potential to affect the strategic decisions of an organization either through the board of directors or directly, where an entity operates without a board. Such strategic decisions include the acquisition or disposal of assets, the appointment of the chief executive officer, the allocation of resources or the diversification of activities. The degree of this influence falls into three categories: direct government control, effective government control and indirect government control.

4.2.2.1. Direct government control

• Direct government control of an organization implies that there exists actual or potential majority voting ownership by a government.

• An organization is directly controlled by a government if more than 50% of the voting equity is held directly, other than by way of security only, by and for the benefit of that government.

• Where there exist irrevocable options or the right to acquire shares, or convertible debt or equity, exercisable at the discretion of a government, then the calculation of the voting equity of the government is generally made as if the option had been exercised.

4.2.2.2 Effective government control

• The government holds significant voting equity in an organization when
  • the holding is the largest block of voting equity
  • the holding exceeds 33.3% of the voting equity
  • the block is larger than the combined percentage of the next two largest blocks.
    
    

• There exists a method or a variety of methods that yield effective control. For example, there could be significant voting ownership of the organization; technological agreements; supply controls or contracts; management contracts; interlocking directorships; debt; or convertible debt or equity.

• The organization declares that it is effectively controlled by a government.

• In rare instances, these factors will be insufficient to determine effective control. In these circumstances, the inclusion criteria may be based on related information such as historical precedent.

4.2.2.3 Indirect government control

• An organization is indirectly controlled by a government if that government directly or effectively controls a government organization that in turn directly or effectively controls that organization.

These control indicators are based on the classification concepts used by the Industrial Organization and Finance Division of Statistics Canada for all organizations conducting business in Canada. See Appendix C for more information about corporate control.

4.2.2.4 Other indicators typical of government control

The direct, effective and indirect control criteria are applied to all institutional units to determine control. Reports obtained from an organization may not provide the information that is necessary to prove the control conditions. To compensate for this situation, these control types are enhanced by the addition of criteria that are characteristic of units controlled by governments. Public sector control indicators are specifically designed to establish government control. The following criteria are used in this determination process:

• The entity was created by government legislation.

• The entity was created under existing laws of incorporation.

• The government determines the general policy or program of the entity.

• The government appoints members to the board of directors.

• The government controls the entity through a legally binding agreement.

• In the event of liquidation or dissolution, the entity's assets revert back to a government.

4.2.2.5 Lieutenant Governor in Council or Ministerial control

Governments generally impose strict rules of accountability upon the entities that they control. This adjunct of control is determined by examining the accountability requirements stated in an entity's enabling legislation. These regulations stipulate the procedures that an entity must follow to accomplish their mandate, conduct business, and report to their sponsoring government regarding the spending of public funds.

The following conditions indicate public control through a government's legal representatives, the Lieutenant Governor in Council or the Minister of a government ministry or department:

• The Lieutenant Governor in Council or a Minister holds control.

• The entity's budget must be approved by the government.

• The entity must submit an annual, audited report to a government.

• The entity's financial accounts are subject to examination by an Auditor General.

• The government finances the entity's current operations, in total or large part.

• The government finances the entity's investments, in total or large part.

• The government approves or guarantees loans contracted by the entity.

• The government controls fees charged by the entity.

• The government openly allows itself to be exposed to the financial risks and rewards associated with a venture.

4.2.2.6 The determination of government control

The determination of government control is a decision based on an evaluation of all relevant indicators. For some organizations, a single indicator could be sufficient to establish government control. However, the majority of organizations require multiple indicators which collectively indicate control. The determination process considers all contributing factors which provide the evidentiary support for the decision. Subsequently, the same logic is applied to similar entities to ensure consistent classification treatments.

4.2.2.7 The source of control

In the Canadian System of National Accounts (CSNA), the source of the institutional unit's control must be identified. There are three categories:

• public control
• national private control
• foreign control.

Institutional units controlled by Canadian governments are classified as publicly controlled, whereas those controlled by Canadian private sector entities are classified into the national private control category. For institutional units controlled by entities residing outside Canada, the foreign controlled classification is applied.

4.2.3 Public sector indicators for non-market producers

A non-market producer is an institutional unit that provides goods and/or services for public benefit free of charge or at prices that are not economically significant. (See Appendix D for information about economically significant prices.) The organization may operate on a cost recovery basis or charge user fees but, in general, it does not compete in the open market for a profit and their operations are mainly financed by public funds. All institutional units that are government controlled non-market producers are classified to the government sector. The following indicators are used in this determination process:

• The entity performs a regulatory function.

• The entity is exempt from income tax.

• The entity is a trust wherein the government has access to the assets.

• The entity provides goods and/or services only to a government.

• The entity delivers a government service such as administering government programs or implementing government policies that provide a collective or individual benefit.

• The public has no free choice to acquire or reject the good or service.

• The entity charges prices that are not economically significant.

• The entity gets its primary income from non-market activities.

• Government transfers or grants cover any deficit generated by the entity.

• The entity's employees negotiate collective agreements with a government.

4.2.4 Public sector indicators for market producers

Most market producers are profit-oriented organizations. They are institutional units that provide goods and/or services in the open market at prices that are economically significant. The majority of these organizations are financially self-sufficient and generally do not rely on public funds to support their operations. Since they usually compete with other providers of similar goods and services, the public has free choice in their market selection. All institutional units that are government controlled market producers are classified as public non-financial or financial corporations in either the non-financial corporations sector or the financial corporations sector. The following indicators are used in this determination process:

• The entity has the financial and operational authority to carry on a business.

• The entity competes in the marketplace.

• The public has free choice to acquire or reject the good or service.

• The entity charges prices that are economically significant.

• The entity gets its primary income from market activity.

• The entity can borrow autonomously.

• The entity remits profits and/or dividends to a government.

• The entity's employees do not negotiate collective agreements with a government.

4.2.5 Statistical treatments

The majority of entities in the public sector universe are classified according to the standard inclusion criteria and indicators. Some entities require special solutions to resolve their unique characteristics within larger conceptual frameworks. These classification treatments are necessary in the following circumstances: 

• where institutional units in a specific activity group meet the inclusion criteria for a sector that is different than the rest of the group's economic sector classification. Usually, institutional units of the same type are classified to the same economic sector

• where economic ownership rather than legal ownership is the determining factor

• where an institutional unit meets the inclusion criteria for a particular economic sector, but must be classified to another sector in order to meet an analytical need.

4.2.5.1 Treatment to resolve sectoral disparity within a group of institutional units

For statistical purposes, it is important to have all institutional units that behave in a similar manner grouped within the same sector. Depending on how a government has constructed their organizations, the classification of these entities may produce qualification in different sectors, thus compromising sectoral measurement.

To resolve these situations, treatments were devised to ensure that same type activity would always be classified into the economic sector that best typified the general characteristics, regardless of each unit's actual non-market or market behaviour. As an example, the majority of governments organized their public housing authorities as non-market producers while the minority established them as market producers. To resolve this disparity, a classification decision was taken to treat all public housing authorities as non-market producers of the government sector.

4.2.5.2 Treatment where economic ownership rather than legal ownership is the determining factor

Governments create entities that are empowered to finance, develop and manage assets according to specific purposes.

For some entities, their obligations give rise to relationships involving assets under management; the transfer of assets or liabilities to create off-balance sheet arrangements that produce special purpose organizations such as variable interest entities; the acquisition of assets through long term purchase plans, usually in lessor-lessee contracts; and public-private partnerships.

These transactions generate temporary or indefinite economic ownerships. In such circumstances, the ultimate beneficiary of the assets determines the sector classification. The following situations are typical of these conditions:

• Public sector pension fund managers who provide services on behalf of beneficiaries. In this instance, the pension fund is controlled and operated by a government but the pensioners are the ultimate economic owners and beneficiaries of the assets. Thus, the government's responsibilities for the pension liabilities are recorded in the Government Sector and the corresponding pension assets are recorded in the Households Sector of the Canadian System of National Accounts (CSNA).
  
  
• Variable interest entities where a public sector entity is the primary beneficiary of a variable interest entity's financial results. An entity is considered a variable interest entity if it does not have enough equity to finance its own activities, nor do its equity investors have sufficient equity at risk to finance the entity. A public sector entity may have created a variable interest entity or conducted business with an entity that meets the conditions of a variable interest entity.
  
  Although public sector entities do not control variable interest entities, they are the ultimate beneficiaries if they are exposed to the majority of potential losses, or will receive the majority of potential returns. This relationship constitutes an economic ownership where a public sector entity does not legally own or directly control a variable interest entity, but does derive economic benefit from the prospective risks and rewards of its financial activity.
  
  Accounting practices have been broadened to stipulate the consolidation of variable interest entities in a primary beneficiary's financial statements. Thus, public sector entities that have variable interest entity economic relationships, are consolidating variable interest entity financial transactions in their financial statements.
  
  The Canadian System of National Accounts (CSNA) agrees, in principle, with the concept of economic ownership but also whenever possible tries to classify institutional units such that they do not straddle institutional sectors. If a variable interest entity is consolidated into another entity that is in the same sector, then there is no issue. But, if the consolidation crosses an institutional sector, efforts will be made to preserve the separate units.
  
  At present, it appears that this new accounting treatment is having little impact but the treatment of these entities will be reviewed more extensively during the project to introduce changes based on the revision to the System of National Accounts 2008 (SNA 2008).
  
  
• Lessor and lessee relationships where the lessor legally owns the asset, but the lessee, as economic owner, assumes the majority of the financial risks and rewards until the asset either becomes their permanent property or is returned to the lessor.
  
  Government entities enter into these types of contractual relationships usually to acquire assets over a period of time. As the lessee, they are entitled to economic ownership of the asset throughout the contract period. When the contract conditions and lease payments have been completed, the government entity assumes legal title to the asset.
  
  During the lease period, the assets under economic ownership are classified in the public sector, as if the government entities were the legal owner. At the end of the lease period should the assets become the legal property of a government entity, there is no change in classification. The asset remains classified in the public sector.  An example of this type of relationship could involve the acquisition of buildings, equipment, vehicles, vessels or aircraft.
  
  
• Public-private partnerships are another instance of assets that are acquired by government entities through a financing method similar to lessor-lessee relationships. The same treatment is applied. An example of this type of relationship could involve the development of major infrastructure projects such roads, bridges, transit, water and sewer installations or other public facilities. (See Appendix B for information about public-private partnerships.)

4.2.5.3 Treatment to meet an analytical need

Economies organize some specialized functions differently but it is useful to have them presented in a consistent fashion to allow for analytical consistence. For example, the Foreign Exchange Account of the Government of Canada has characteristics that would normally classify it in the government sector. However, since this activity is often undertaken by the central bank, it is classified with the Bank of Canada as part of the federally controlled monetary authority in the financial corporations sector.

4.2.6 The resistance rule

Over time, an organization's objectives may evolve in different directions. For example, a goal of financial self-sufficiency may not be realized or amendments to enabling legislation could change its mandate. Annual scrutiny of financial transactions ensures consistent classification treatments. If there are changes, then the classification decision will be reviewed and the organization reassessed.

Classification revisions that cause a public sector institutional unit to change from one economic sector to another are only performed when there is a major shift in the entity's main source of revenue evidenced over a period of years or, there is a modification in the entity's enabling legislation causing a change in mandate and funding. 

The purpose of this on-going review process ensures that the organization is accurately classified over the course of time and avoids re-classifications that could cause distortions to statistical time series. This quality assurance measure is referred to as the resistance rule.

4.3 The public sector classification decision process

There are four phases involved in the public sector classification decision process.

The initial phase involves researching and gathering information about the organization under review. Publicly available documents are normally the basis for the classification assessment. For example, an organization's status, powers and operational requirements are stated in its enabling legislation. Operational and financial performances are published in the organization's annual reports.

The second phase entails applying and documenting the public sector inclusion criteria to the information contained in the entity's enabling legislation, annual report and audited financial statements.

In phase three, all public sector inclusion criteria are evaluated to determine the organization's institutional unit status, control and sector of economic activity. A rationale is then prepared to summarize the conclusions and state the final classification decision.

In the final phase, the entity is assigned classification coding to identify its primary activity within various classification systems. The major classification systems are the

• Canadian System of National Accounts (CSNA) – Classification of Institutional Units by Sector
• North American Industrial Classification System (NAICS).

The public sector entity classification decision constitutes the official record that summarizes all pertinent information related to the classification of an entity. See Appendix E for an example of a public sector entity classification decision.