The Big Heist

Canada continues to let billions leave the country tax free
July 1, 2015

On April 12, 2013, the late Jim Flaherty, then Canada’s finance minister, made an unpublicized trip to Bermuda, one of corporate Canada’s tax havens of choice, to offer his government’s support and reassurance in a time of uncertainty. G8 countries, led by the United Kingdom, France and Germany, were discussing how to co-ordinate national efforts to close tax loopholes and discourage capital flight into offshore tax shelters of the kind offered by the tiny Caribbean nation. Though Flaherty had included a tax cheat snitch line in that year’s budget, many observers questioned Canada’s commitment to the G8 project. 

Then, as now, they have good reason to doubt. Reports out this spring show the tax evasion problem is not going away, with up to $199 billion in corporate assets sitting in offshore accounts, out of reach of Canadian tax collectors. Meanwhile the government is cutting resources from the only department with the power to claw some of that money back, depriving itself of a stable revenue source for new infrastructure, public services and reducing income inequality. There is nothing illegal about this situation, but it is clearly not desirable, and with the right political will it is almost certainly fixable. 

Canada’s Caribbean connections

Alain Deneault mentions Flaherty’s Bermuda trip in his book Canada, A New Tax Haven: How the Country that Shaped Caribbean Tax Havens is Becoming One Itself, out in English this May. The University of Quebec in Montreal (UQAM) professor emphasizes how, by 2012, the banks of the British overseas territory had become a repository for Canadian financial assets totalling about $12 billion. This was more than a case of Canadian banks, which established themselves in the Caribbean in the early 20th century, exploiting a half-century-old loophole. (The tax haven phenomenon exploded after the Second World War with the flow of excess Marshall Plan–era Eurodollars from the U.K. into the banks of the British Caribbean.) As Deneault describes in his book, Canadian lawyers and policy makers figured prominently here in the establishment of the institutional frameworks for low-tax or tax-free environments. 

So when Bermuda signed a tax information exchange agreement with Canada in 2011, you could argue it continued a long and profitable (for some) pattern of bilateral co-operation. The treaty allows Canadians to register their money in the island’s local banks and then have it transferred back to Canada as tax-free dividends. Of course, we can’t be too hard on just one country or even one region. Deneault estimates there are close to 80 tax havens in the world including Switzerland, Ireland, Luxembourg and beyond. Typically, these countries impose little or no tax on corporate and sometimes personal deposits. Their financial institutions offer security, privacy and secrecy for those seeking to stash their money where prying eyes and government tax collectors cannot reach. The United States, European Union and several other Organization for Economic Co-operation and Development nations are grappling with the contagion of tax avoidance by global companies, with its potential to hurt government finances. But, as Deneault discovered in researching his book, Canada is marching to a different beat. 

“Officially, Canada shows solidarity with other western countries about tackling tax avoidance. I have informants in other countries, people whom I talk to when I travel, and they say that Canada, in the meeting rooms, is also always fighting against any kind of proposal that would make it difficult for corporations to use tax havens,” he says in a recent interview. Deneault highlights how Canada, as a major player at the World Bank and International Monetary Fund, provides representation for smaller nations in the English-speaking Caribbean (The Bahamas and Barbados) and Ireland that do not have seats at either of these bodies, and which, incidentally, happen to be major havens.

“Canada is trying to look like its creatures (tax havens) to have the same strategies to attract capital,” says Deneault. “You will find that in Alberta with respect to oil, you will find that in Ontario with respect to the mining industry.” (See the Index on page 12.) Real tax reform, he maintains, begins with examining how Canada has morphed into a tax haven itself, with exceptionally low corporate tax policies at the federal and provincial levels, and a number of legal loopholes that allow corporations and wealthy investors to avoid paying their fair contribution to Canada’s social wealth. 

Learning to love the tax haven

What looks like a historical trend of Canadian government support for tax havens under successive Liberal and Conservative governments has actually taken on a sharper ideological focus in the Harper years, according to Dennis Howlett, executive director of Canadians for Tax Fairness. “This government is not that interested in increasing government’s capacity to do anything about anything. They are not interested in raising more revenue,” he says. 

More pertinent to the tax haven discussion, the government also doesn’t appear too worried about where the money is leaking out of public revenues. Howlett points to the 2013 complaints of Kevin Page, then parliamentary budget officer, about difficulties getting data from the Canada Revenue Agency for his analysis on tax avoidance. Not to be deterred, the tough nuts at Canadians for Tax Fairness pursued their own investigation based on data from Statistics Canada and investment information from Canadian corporations. What they found created quite a stir this spring.

According to the group’s research, as much as $199 billion in Canadian corporate assets is sitting in offshore jurisdictions, most of them countries with little discernable economic activity beyond a fully functional banking sector. That includes $71 billion in Barbados and $36 billion in the Cayman Islands. As Denault explains, Barbados has a population of fewer than 300,000, but the former British colony is the third largest holder of offshore Canadian money after the U.S. and the U.K. Keep in mind these figures represent Canadian corporate money abroad and do not include funds of individual Canadians that may also be sitting in tax havens, which is more difficult to determine. 

CRA spokesperson Jelica Zdero says the agency is “committed to protecting Canada’s revenue base and takes offshore non-compliance very seriously,” adding “[t]ax evasion and aggressive tax avoidance can lead to significant taxes, interest and penalties.” She says the CRA has implemented new anti–tax avoidance measures and is working with Canada’s treaty partners “to gather data, intelligence and knowledge from these sources to address offshore non-compliance.” 

Howlett counters that the federal government has cut about 3,000 positions from the CRA, many of them tax auditors from the very sections meant to investigate complex tax avoidance accounting schemes. He applauds the promise in the 2015 federal budget to invest $83.5 million over the next five years in the CRA’s campaign to root out international tax evasion and aggressive tax avoidance. But Howlett also notes the CRA’s budget was reduced by more than half a billion dollars in 2012–13. “It is good that [Finance Minister Joe] Oliver has put money back into the CRA. But this doesn’t replace damage done over the past several years.” 

 Catch me if you can

One of the biggest challenges facing tax reformers is the secrecy surrounding tax havens and the difficulty in tracing capital flight from so-called high-tax jurisdictions. An international network of tax lawyers, chartered accountants, bankers and tax haven governments works diligently to think of complex financial mechanisms for tax avoidance and how to keep them legal. Margaret Hodge, a sitting U.K. Labour MP, described it once as a system of “industrial avoidance.” 

Meanwhile, thanks to leaks by whistleblowers in Europe, some of whom face charges for their efforts, the public is learning interesting details about tax evaders and avoiders. One of the biggest stories broke late last year and continued to create headlines into the spring. It involves the Swiss branch of the U.K.’s largest bank, HBSC, which was apparently supplying celebrities, politicians, rock stars, drug dealers and a few Canadian billionaires with secret bank accounts. Tax authorities in France, the U.S., Belgium, India and several other countries are pursuing the prosecution of citizens identified as benefitting from HBSC’s services. Here in Canada, according to CBC reports, a CRA voluntary disclosure program resulted in 264 Canadians caught up in the scandal simply confessing their failure to report earned income with little consequence. The policy recovered about $63 million in unpaid taxes for the Canadian and Quebec governments. 

“Second chances don’t often happen in life,” states the CRA website. “But if you have ever made a tax mistake or left out details about income on your tax return, the [CRA] is offering you a second chance. The Voluntary Disclosures Program (VDP) gives you the opportunity to come forward, make things right, and have peace of mind.”

The other highly publicized leak came out of Luxemburg around the same time, implicating the grand duchy as a conduit tax haven for about 500 firms including Amazon, Fed-Ex, Ikea, H.J. Heinz, the Walt Disney Company, Koch Industries and one lesser-known Canadian crown agency, the Public Sector Pension Investment Board. PSP Investments, as it is also called, reportedly avoided paying significant foreign taxes on hundreds of millions of federal civil servant pension dollars invested in German real estate through a complex system of shell companies in Europe. The Canadian federal agency was unapologetic, telling reporters it “fully complies with all laws, rules and regulations,” and acts “in the best interests of the pension plans for which we manage assets.” 

Opposition parties were skeptical, with Murray Rankin, the NDP critic on tax issues, calling the revelations deeply troubling. “Here we are talking at the OECD really tough about how we're going after multinationals for tax avoidance… Even if the government didn't know, it is consistent with a pattern where we appear to be backing off,” he told reporters. 

Statistics Canada figures showed that Canadian citizens and corporations had parked $30.2 billion in Luxemburg by 2013. There was a strong incentive to do so: the leaks suggested that despite a statutory tax rate of 29% the government routinely approved tax rulings as low as 1.1% on overseas profits. As Howlett points out, more recent StatsCan data shows the publicity surrounding the “Lux Leaks,” as they were dubbed, has resulted in more than $5 billion of that money being withdrawn by Canadians last year. 

We can thank large chartered accounting firms like PricewaterhouseCoopers (PwC) for setting up the elaborate tax avoiding schemes revealed in Luxemburg, says Francine McKenna, a Chicago-based journalist, blogger and a certified public accountant with an extensive background in the industry. She explains how typically these firms will devise a tax avoidance scheme that takes into account their client company’s business model (e.g., where it has customers, earns revenue, buys raw materials and employs people). Internal accounting is then structured so the firm’s divisions in high-tax countries are set up to lose money. At the same time “a shell” division is established in a low-tax jurisdiction like Luxemburg or Ireland where more of the corporate revenue resides and is subject to a lower tax. 

“The companies do not think this stuff up. They go to their [tax] advisors and say, ‘I have a business problem, what do you think?’” explains McKenna. The chartered accountant develops a financial template, including a determination of the ideal tax haven in which to park a client’s money. The situation is different whether it is a corporation or individual seeking the advice. 

“An individual has much more freedom to live here or there, to avoid taxes,” says McKenna. “They might be burdened by where their income comes from, but they want to pay less tax. Corporations have rigid set of reporting requirements and are working with complicated reporting requirements in the countries they are doing business.” 

The world moves on, Canada stands still

The OECD is attempting to get around this problem of hidden offshore money. The organization envisions a set-up where tax authorities in one member country can easily access corporate financial information from any other, including tax payments and deferred income. 

“It would make it more difficult for corporations to hide a true picture of what their profits are,” says Howlett. He explains that under the current OECD proposal only tax authorities and perhaps law enforcement (those fighting things like money laundering and terrorist financing) would be able to access this information, but it’s an important precedent. “We are hoping we could get it to be made public, down the road,” he says. 

Deneault applauds the OECD efforts, but he’s concerned the plan is primarily aimed at illegal tax evasion where the individual or company fails to disclose earned revenue. There is nothing to tackle the problem of offshore tax havens and the legal frameworks supporting them in countries like Canada. “If it is legal, it can be a problem,” he says. “It is not enough to exchange [tax] information.” Incidentally, that point is also made by a defender of tax havens, Toronto tax lawyer Richard Tremblay. 

“I can tell you that I have been in practice for almost 40 years and I have never dealt with a public Canadian company or even a private one that hid their money,” he tells me. “Everyone that I have dealt with has used the rules in the way they were intended… Basically, if you conduct active business offshore, under the Canadian system, you can bring those profits home as exempt surplus dividends.” 

The problem is partly, then, one of questionable court decisions and partly about overcoming this challenge by finding the political will to act.

The federal government passed tax legislation in 1988 that, among other things, restricted Canadian companies and individuals from claiming tax benefits in artificial transactions that have no economic substance. However, the Supreme Court of Canada threw out this provision in 2005 in the highly publicized Canada Trustco Mortgage case. Ottawa tax litigator Robert McMechan explains it in a nutshell: “It involved the complex acquisition on paper by Canada Trustco of a set of tractor trailers. While not having the title to the trailers anymore, the original owner still kept them on its property. In return, Canada Trustco benefited from a $33 million capital cost allowance deduction.”

What made this case unusual, explained Globe and Mail business journalist Beppi Crosariol in a 2005 article, is that payments were not made by one party to another on an instalment basis. Instead, the tractor trailer company, U.S.-based Transamerica Leasing Inc., prepaid the lease “in a lump sum through a circuitous route that included an intermediary company registered in the United Kingdom.” Federal lawyers then “pounced,” wrote Crosariol, by arguing in court that “Canada Trustco, by getting its money back right away, had not acquired title to the trailers and was avoiding the risk associated with leaseback arrangements.”

Nonetheless, the Supreme Court ruled that Canada Trustco’s tax deduction did not contravene any federal tax law. A spokesperson for Toronto-Dominion Bank, Canada Trustco’s parent company, was fulsome in his praise for the judges’ actions, telling the Globe, “I think it's reassuring to both regular taxpayers and the government, because I think it indicates that the government can't do whatever it wants [even though] there are definite limits on taxpayers."

To mitigate what he describes as “the wrong turn” by the courts, Victoria, B.C. MP Rankin introduced a private members’ bill in Parliament that would have eliminated a loophole in the federal tax regulations that facilitates what he calls “sham” business transactions—those designed purely for tax avoidance purposes and which result in the loss of billions of dollars in unpaid tax revenue. This was about a year ago, and though the bill would have simply brought Canada up to par with the tougher approach to tax cheats taken by the U.S., it failed to receive government support.

“Murray Rankin’s bill is right on,” says McMechan, a former general counsel in the tax litigation section of the Department of Justice who also spent two years at the CRA as a senior rulings officer, because it places the emphasis on “complicated corporate transactions where money goes around a circle and nothing of real economic substance occurs.” 

According to the MP, there is a social and moral imperative in going after tax havens rather than turning Canada into one.

“This lost money could be used to build a better medical system, to tackle environmental degradation and to make Canada a fairer country by reducing the growing inequality among Canadians,” he says. “It also is unfair for small businesses that must compete against large enterprises that are able to take advantage of aggressive tax planning and tax havens to arrange their affairs to pay very little tax in Canada as compared to struggling Canadian enterprises.”