Most readers of the June 17, 2016 edition of the Toronto Star could not have failed to notice the headline of a prominently featured article:
“Tax loopholes cost Canada billions in lost revenue”
This was followed by the following subheading:
“Canada used agreements meant to crack-down on tax evasion to open-up tax loopholes”
What a scandal! Just the kind of thing over which the writers at the Star salivate! And, certainly in keeping with its generally leftist, wealth-resenting orientation, although not as savory a feast for them as the “Panama Papers”. Not surprising, the Star partnered with the CBC on the story, which has a similar orientation when it comes to the issue of Canadian taxpayers exercising their right to legally avoid paying taxes.
The underlying message of the articles is that Canada’s bungling, and possibly corrupt, bureaucrats at the Ministry of Finance, in league with the Harper Government, have done it again! They entered into “Tax Information Exchange Agreements” (“TIEAs”) with various offshore jurisdictions in an attempt to combat tax evasion, and it turns out that the TIEAs are generally useless, and, to boot, this has allowed Canadian corporation to avoid paying billions in taxes. And, the rich keep getting richer and the poor keep getting poorer!
However, before I go further, let me explain the significance of TIEAs in this context for those who do not deal with Canadian-based international tax planning, and are not familiar with rules in the Income Tax Act (“the Act”) regarding “foreign affiliates”.
In a nutshell, if a Canadian corporation (“Canco”) has a foreign subsidiary (“Forco”), special rules in the Act[1] have the effect of allowing the earnings of Forco to be repatriated to Canco tax-free as dividends, as long as those earnings were included in Forco’s “exempt surplus” relative to Canco.
Up until recent changes to the Act and Regulations, the earnings of Forco would generally only be included in “exempt surplus” if Forco was resident in, and carrying on an active business in, a jurisdiction with which Canada had a full-fledged tax-treaty.
However, changes that were first proposed as part of the 2007 Federal Budget had the effect of extending “exempt surplus” treatment to Forcos established and operating in other jurisdictions as long as they entered into a TIEA with Canada[2]. This was intended to be a “carrot” aimed at encouraging tax haven jurisdictions to co-operate with Canada in its efforts to combat international tax evasion. There was also a “stick”: if a jurisdiction was invited by Canada to enter into a TIEA, and it did not, within a specified time, Canada would punish Cancos with Forcos operating in those evil locales: it would require Canco to pay tax on Forcos earnings even if not repatriated to Canada.
In due course, starting in 2011, many TIEAs came into force, including ones with Netherlands Antilles, Bermuda, Bahamas, British Virgin Islands, Jersey, Grand Cayman, and even Panama! Presently, there are 23 in force and more on the way.
Now, I don’t consider myself to be an expert on TIEAs in terms of their stated purpose of information exchange to combat tax evasion. It may well be that the comments in the Star article are quite valid when it comes to criticizing the effectiveness of these agreements. However, when it comes to that, as Rhett Butler said in Gone With the Wind, “Frankly, my dear, I don’t give a damn”. That is only an issue if entering into those TIEAs have really cost Canada anything of significance. As indicated below, I am far from convinced that it has.
In particular, I certainly don’t buy the notion that there has been a loss of “billions” in taxes for the Canadian government because of the expansion of the “exempt surplus” concept to include TIEA jurisdictions. In fact, I don’t even think it has been millions, if anything at all.
Canadian corporations did not suddenly invent offshore planning when the TIEA-related changes to the foreign affiliate rules were introduced. They, and their advisors, like me, have been doing this kind of thing long before there were any TIEAs.
To accept the idea that there were “billions” in taxes lost by Canada would be to assume that, were it not for the changes, the income channeled through TIEA tax havens would have otherwise been subject to tax in Canada. But, common sense alone tells me that this is not the case. Rather, I believe that the income in question would have been channeled, instead, to tax-haven jurisdictions with which Canada maintains tax treaties. Canadian tax would have been avoided in any event. My guess is the Barbados government has lost more in tax revenues, as a result of the TIEA havens increased presence in the marketplace, than has Canada[3].
However, my thoughts on this are not just based on common sense. They are also based on my first-hand experience. Below is the essence of the type of dialogues I have had in recent years with Canadian clients interested in offshore corporate tax planning:
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ME: Sounds like this is certainly worth investigating and I think there would be enough bucks involved to make it worthwhile.
CLIENT: So should we set something up through a Barbados IBC? That seems to be what everyone does.
ME: Barbados is good, but there are other options now. We can use another country that has a TIEA with Canada, like Cayman, and pay ZERO in taxes, rather than (up to) 2.5%, and also probably reduce the administrative costs.
CLIENT: Great! Let’s look into it!
Readers will note that, with or without the TIEA, the same amount of Canadian tax would be avoided.
I cannot think of any situation that I have encountered where the option of using a Forco based in a TIEA jurisdiction was the deciding factor for a Canadian corporation looking to do offshore tax planning.
So, how does the Star get its “billions” in taxes avoided by TIEAs? They show that there have been billions in additional assets accumulated in those places by Canadian corporations since the first TIEA came into effect in 2011.
The Star equates that increase in dollars left offshore with Canadian taxes that have been avoided by the use of TIEAs. However, nowhere does the article even acknowledge the possibility this is just the natural result of repositioning offshore activities to TIEA jurisdictions from other tax havens. That is, I suggest that those amounts would have been shifted offshore, even without the TIEAs, but into other (likely tax treaty) jurisdictions. That is, again, with or without the TIEAs, there would have been offshore planning that would have avoided all of those “billions” in Canadian taxes in any event.
The Star article focuses on two leading Canadian corporations that have used offshore corporate tax planning to reduce their global tax liabilities: Gildan, an apparel manufacturer, and Valeant Pharmaceuticals, a company that has been frequently in the news of late. It is not apparent to me how its comments regarding these companies in any way bolster the thesis of the article. In the case of the former, the article mentions that many years ago it has shifted much of its operations to Barbados to reduce taxes. However, if anything, that example only serves to undermine the thesis of the article, since it shows that, even without the TIEA havens, offshore corporate tax planning has always been alive or well in Canada. In the case of Valeant Pharmaceuticals, which inherited the well-known Barbados structure of its Canadian predecessor Biovail, the article mentions that it has numerous subsidiaries in various offshore jurisdictions, including those which have TIEA with Canada. However, nowhere is there any indication that the changes that started in 2011 in any significant way had a bearing on its offshore structure, or that its income offshore was increased as a result of those changes.
If there is any real tax cost to the Canadian fisc as a result in the TIEAs, it would be on forgone taxes in connection with dividends from Forcos in those jurisdictions. Nowhere does any of the data in the Star article focus on that at all. I suggest that this would be extremely difficult to quantify. My gut feeling is that this amount would be relatively small. Large Canadian corporations with Forcos based all over the world have always been very adept at avoiding repatriating “taxable surplus” of Forcos[4], and there is no reason to think that they would not have continued to be. Furthermore, the Star itself stated as part of its analysis that “despite the tax-free privileges the TIEAs provide, the money isn’t coming back”. So where is the tax cost to Canada?
[1] Particularly paragraph 113(1)(a)
[2] By expanding the definition of “Designated treaty country” in Regulation 5907(11) to include such countries.
[3] Both directly, as a result of the loss of 1%-2.5% on profits that would otherwise been taxed there, as well as indirectly in connection with taxes on fees that would have been earned by service providers based there.
[4] Except to the extent that it could be offset by underlying foreign taxes under paragraph 113(1)(b)
ABOUT THE AUTHOR OF THIS ARTICLE
Michael I. Atlas, CPA,CA,CPA(ILL),TEP
Michael Atlas is one of the most prominent international tax experts in Canada. He advises accounting and law firms all across Canada, as well as select private clients (corporate and personal) worldwide. He can be reached by phone (416.860.9175) or email (matlas@TaxCA.com).
