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Auto makers began lobbying for a change in the program after it was introduced in 2008, arguing it was one factor that made Canada uncompetitive in the battle against Mexico and the U.S. for new investments.Jeff Kowalsky/Bloomberg

The federal government has quietly signalled to the auto industry that it is changing one of the key terms of the Automotive Innovation Fund (AIF), which offers financial assistance to vehicle manufacturers and parts makers to invest in existing Canadian plants or open new facilities.

The federal program, introduced in 2008 by the Conservative government of Stephen Harper, offers repayable loans – treated by Canada Revenue Agency as revenue and thus partly subject to tax – to auto makers and parts companies. The Ontario government and many other jurisdictions seeking to land auto investment offer tax-free grants.

Ottawa will change the program so that it offers grants instead of loans, multiple industry sources said.

Auto makers began lobbying for a change in the program almost immediately after it was introduced, pointing out it was one of a series of factors that made Canada uncompetitive in the battle against Mexico and the U.S. South for new investments.

Some auto makers that invested in their Canadian operations after the program was introduced refused federal assistance, including Honda Motor Co. Ltd. and Fiat Chrysler Automobiles NV.

"In the highly competitive area for automotive investment, a package that contains an expectation of eventual repayment and which is taxed as income in the year it is received is not very persuasive," the Canadian Automotive Partnership Council, an advisory board that includes industry, union and government representatives, said in a 2013 report on the state of the industry in Canada.

The move by the federal government comes amid negotiations between General Motors Co. and Unifor, the union that represents the company's hourly paid workers in Canada, that centre on the future of an assembly plant and about 2,400 jobs in Oshawa, Ont.

General Motors of Canada Co. president Stephen Carlisle has said the federal program should offer grants instead of loans and it is one factor among several – including the outcome of bargaining with Unifor – that will determine whether Oshawa will be competitive enough to win new investment.

The Liberal government of Justin Trudeau has extended the AIF through the end of 2020-21.

Philip Proulx, a spokesman for Navdeep Bains, Minister of Innovation, Science and Economic Development, would not confirm or deny that the program has been modified to meet the wishes of auto makers.

Ottawa has been discussing the program with the industry and other levels of government, Mr. Proulx said.

"The government will continue to work with these partners to raise the profile of Canada's strong capabilities and better influence investment location decisions."

The offer of federal loans instead of grants was a strong factor in Jaguar Land Rover rejecting Canada as a site for a new assembly plant last year, a source familiar with that auto maker's decision said.

In their documents that assess various alternatives, auto makers "don't have a column that says 'loan.' The column says 'grant,'" the source said.

Changing the program is "a big deal," said Greig Mordue, an associate professor at McMaster University in Hamilton and a former Toyota Motor Manufacturing Canada Inc. official.

"The way the AIF has been structured has made the work for those involved in automotive investment attraction – policy makers, internal champions, anyone – very, very awkward," Dr. Mordue said.

"That this government has given every indication they are prepared to fix this is very good news."