Tax Code Fiscalamity
Last December, the Senate Finance Committee recommended that the government withdraw its proposed small- business changes and undertake a comprehensive review of Canada’s tax system. While most of the small- business proposals have now been abandoned, the government seems opposed to a broader review of the tax regime. Perhaps our tax rules are already absolutely terrific. Let’s look at three examples and see.
Emma is retired, and owns a substantial investment portfolio. Emma receives dividends from Canadian public companies and under Canada’s concept of “tax integration” — and its complex rules for dividend gross- ups and credits — she receives a credit for the tax of about 27 per cent that the corporations have already paid. Tax integration comes at an annual federal tax cost of $5 billion.
There i s one problem: Very few Canadian public corporations pay tax at anywhere near the stated rate of 27 per cent. They benefit from a host of incentives and tax breaks, such as accelerated deductions, credits for all types of investments and activities, and exemption for dividends from foreign subsidiaries. One recent study suggests that Canadian corporate taxes are, on average, 10 percentage points below the stated rate of 27 per cent. And of course some corporations pay no tax at all. Still, Emma receives a full credit of 27 per cent, whether or not any corporate tax has been paid.
Michael is our second example. Michael is a successful entrepreneur. He has profited from his business activities in Canada, and wants to give back to the community. A local university has been urging him to contribute $ 500,000 to help fund a study on economic mobility. While Michael believes that this is a great initiative, $ 500,000 is a lot of money. But the university says it has a plan: It involves something called “flowthrough shares.”
Canadian resource companies in cursubstantial amounts of exploration and development expenses — expenses that some companies are not able to deduct because of insufficient income. If an individual invests in flow- through shares, then the investor — not the resource company — deducts the expenses. If Michael invests in flow-through shares, he will benefit from a tax deduction equal to the full amount of his investment. The university says that a promoter will attend to everything.
Michael acquires the shares, and immediately donates them to the university. On the same day, the university sells the shares for cash to a third party arranged by the promoter. Michael receives both a deduction for the resource expenses, and a credit for the charitable donation, reducing the after- tax cost of his donation to about 10 cents on the dollar. This means that the donation of $ 500,000 only costs Michael $ 50,000, while other Canadian taxpayers — you and I — pick up the rest of the tab. And here is the baffling part. The tax authorities have issued a number of rulings blessing this scheme.
The third example is PubCo, a Canadian public company with extensive inter- national operations. PubCo’s foreign operations are carried on by wholly owned subsidiary companies, most of which carry on business in high- tax countries. The foreign subsidiaries are paying a lot of tax. Or at least they were, until an accounting firm proposed a new structure.
PubCo forms a subsidiary ( HavenCo) in a tax haven. HavenCo has one part- time employee to attend to the flow of money and prepara- tion of corporate documents. Using a number of techniques — including finance and royalty charges — most of the foreign operating profits are diverted from the high- taxed subsidiaries to HavenCo.
HavenCo pays no tax on its income and, under Canadian rules, there is also no Canadian tax, either when HavenCo earns the income or when PubCo receives dividends from HavenCo. And PubCo’s shareholders ( investors like Emma) even receive a 27- per- cent credit when PubCo pays dividends to them. The Department of Finance is on to this, right? Er, not so much.
Canada is participating in the OECD plan to address global tax avoidance by multinational corporations — the base erosion and profit shifting ( BEPS) initiative. BEPS has 15 action plans, one of which includes measures to limit the use of conduit companies in tax-haven jurisdictions. The OECD began its work in 2013, and its action plan was released in final form and endorsed by G20 leaders two years later. But it is now 2018, and Canada has still taken no action to limit the use of tax havens.
In short, Canada’s tax code is a fiscalamity, and in need of major repair. The last comprehensive review of our tax system was carried out in the 1960s, and layer upon layer of ad hoc changes have been added since that time. It is time for the government to appoint a panel of non- partisan experts to complete a thorough review, and recommend changes aimed at competitiveness and attracting business investment.
A DONATION OF $500,000 ONLY COSTS MICHAEL $50,000, WHILE CANADIAN TAXPAYERS PICK UP THE REST.