Morneau misses the target
Finance Minister Bill Morneau appeared before the Senate Finance Committee last week to defend the private corporation tax proposals — those that survived the government’s concessions in mid-October. Given the minister’s statements to the committee, business owners will be looking for the exits. Meanwhile, the release of the Paradise Papers suggests that his officials may have chosen the wrong target to begin with.
The minister said three things to the Senate Finance Committee regarding passive investments, one of the proposals that survived. One, the government intends to enact the measure. Two, his officials have not yet tried to estimate its impact on government revenues. And three, the government has not undertaken any type of economic impact analysis. The government’s apparent indifference and incompetence regarding a tax proposal of such significance is astonishing.
Morneau told the committee that he does not know the cost to Canadian business, because “the design has not yet been completed.” However, in an apparent suggestion that the annual cost — once phased in — will be significant, the minister asked committee members to “suspend disbelief ” on the revenue number for a few months.
Taxes reduce economic growth and job creation. However, governments require revenue — for social programs, for essential services including health care, and to service their national debt. The challenge is therefore to impose taxes in a manner and at rates that inflict the least possible economic damage. The passive investment proposal — and its confiscatory tax rates on some of Canada’s largest and most profitable private corporations — is not up to that challenge.
And so are billions of dollars of business investment about to flee the country, as many have warned? The answer is no. Canadian law includes an “exit tax.” Under this regime, any individual or corporation that becomes a non-resident has a deemed fair market value disposition of most assets, and owes immediate Canadian tax on accrued gains (individuals can elect to defer the payment of tax, by providing acceptable security to the tax authorities). As a result, many Canadian taxpayers are fiscally trapped in this country. So what to do?
First, many taxpayers will have their CCPCs make future business investments outside Canada — in foreign subsidiaries owned by the CCPC. The loss of Canadian government revenue will be significant. There will be no Canadian corporate tax, either when the business income is earned or when the CCPC receives dividends from its subsidiary. The only Canadian tax will be personal tax when the CCPC pays dividends to its owner, perhaps many years in the future.
To add insult to injury, if third- party financing is required for the new investment, the CCPC should borrow the funds, and deduct the interest expense against its own business income. The CCPC would then route the cash from the borrowed funds to its foreign subsidiary using a so-called “doubledip” structure, eroding not only Canadian tax, but foreign tax as well.
On the other hand, if the CCPC has passive invest- ments, these could be transferred to a foreign subsidiary. The combined personal-corporate tax on passive income earned by a foreign subsidiary of a CCPC can be reduced from a rate of about 73 per cent under the proposed rules, to as little as 54.5 per cent: Canada’s share would be less than 30 per cent.
But the biggest danger lies in the next generation of Canadian entrepreneurs and job creators. They face exorbitant tax rates in Canada, and a federal government that seems both antibusiness and unpredictable. Many in this next wave may choose the path of least resistance, and get out now while they can.
At the recent finance committee meeting, Senator Scott Tannas suggested that international tax planning by certain Canadian banks is eroding government revenues by billions of dollars annually. Tannas asked Morneau why he wouldn’t “hunt where the ducks are,” instead of attacking small business and private corporations. In light of the subsequent release of the Paradise Papers, and a renewed focus on aggressive tax avoidance by corporate giants such as Apple and Nike, the question seems prescient.
It is true that Canada is part of the OECD- G20 attempt to address tax avoidance by multinational corporations — the base erosion and profit shifting ( BEPS) initiative. For example, Canada has enacted country-by-country reporting, designed to give revenue authorities a better picture of the operations and structures of large multinational groups. However, there is no evidence that BEPS has made any dent in Canadian corporate tax avoidance.
Canada’s 15 most profitable public companies had after-tax earnings of close to $ 60 billion in 2015. Finance should abandon the passive investment proposal, and turn its attention to international tax avoidance by large Canadian business — both public and private corporations. That is where the ducks are.