Finance Committee on June 7th, 2007

[Massimo Pacetti, Liberal, Saint-Léonard—Saint-Michel, QC]

Thank you.

Just quickly, Mr. Brown, given your background of being an accountant in a big firm, what are the tax structures being used right now--and I'm not going to say the word “avoid”--to plan around paying high Canadian corporate taxes? Is there a specific vehicle that's being used, or is there a specific foreign entity or a foreign country through which we're putting our investments?

[Dr. Robert Brown]

There is a wide variety of techniques, as a matter of fact, some of the more complicated structures devised by the mind of man. A lot of them concern international financial centres, as my colleague has mentioned, and there are ways of essentially moving income out of Canada without actually moving the operations.

You do that by putting a lot of debt, in simple terms, on what's going on in Canada. So you've got lots of interest expense. And the interest income may flow into an international financial centre where it's subject to very low rates of tax, if any tax at all.

Another way, of course, is the double-dip, where you can borrow money in Canada, get a deduction, and invest it in the shares of an offshore company. And then that offshore company itself lends it to another affiliate, which gets another deduction. And therefore you get two deductions per 1¢ of interest expense.

There are complex mechanisms between Canada and the United States involving partnerships whereby, in effect, you can exploit the fact that an enterprise is treated one way in Canada for tax purposes and another way in the United States and get away with very little tax. And there are more and more ways beyond that.

As I said, the tax system is a high-maintenance activity. You have to keep at it all the time, because taxpayers will keep on thinking of ever more elaborate and sophisticated ways to beat the system, and you've got to be able to react.

[The Chair, Conservative, Brian Pallister]

Thank you very much, sir.

Mr. St-Cyr, you have five minutes.

[Thierry St-Cyr, Bloc, Jeanne-Le Ber, QC]

Thank you, Mr. Chair, and my thanks to our two witnesses, Mr. Brown and Mr. Larin.

Mr. Larin, I should tell you that the committee members all have simultaneous interpretation. You do not have to worry if you want to continue in French.

[Prof. Gilles Larin]

I'll reply in English, as it will be easier for everybody.

[Thierry St-Cyr, Bloc, Jeanne-Le Ber, QC]

Fine, but it would be easier for me if you answered my questions in French.

[Prof. Gilles Larin]

Whatever you want. Tell me what you want, French or English?

[Thierry St-Cyr, Bloc, Jeanne-Le Ber, QC]

In the committee, we have discussed double dipping structures and the use of tax havens to claim interest costs twice or to reduce the tax payable. The committee has also briefly discussed tower structures, which are hybrid entities used in Canada and the United States to the same end.

How do companies use these hybrid entities to reduce the tax payable in Canada and the United States? Could you explain to me in French how the mechanism works?

[Gilles Larin]

I understand the question perfectly, but I think that your best answer would come from Mr. Brown rather than from me.

[Thierry St-Cyr, Bloc, Jeanne-Le Ber, QC]

Fine.

Did you understand the question, Mr. Brown?

[Dr. Robert Brown]

Yes, you're talking about the tower structures of the limited liability partnerships. It's a little hard to describe them simply, because they're not simple.

You take an entity that looks like a corporation, but it doesn't necessarily have limited liability to the shareholders. Now, the point is that such an entity would be treated as a partnership under U.S. rules, meaning that it doesn't pay tax at all; the income flows through to the shareholders and gets taxed in their hands. If you have a bunch of Canadians as the shareholders, and the corporation is operating in the U.S., then it's the Canadians who pay U.S. tax. But the point is, for Canada, it's treated as a corporation, and if there's no actual distribution from the corporation, then Canada treats the entity as not having distributed any income to Canada; therefore, there's no Canadian tax. Now there is some U.S. tax, but it's usually at low rates on a deemed distribution to shareholders, and there may be no immediate Canadian tax at all. Now, in fact the structures are more complicated than that, and they consist very frequently of not just one, but two or three layers of this type of enterprise in order to get the desired result.

The heart of it is that you can get an enterprise that's treated as a partnership under U.S. law and a corporation under Canadian law.

[Thierry St-Cyr, Bloc, Jeanne-Le Ber, QC]

So you can avoid tax without going to a tax haven, because, in those cases, we are talking about the United States, which generally has comparable and relatively high rates of taxation. How can we...

[Dr. Robert Brown]

That's right. Because of differences in the law, you can get tax-exempt operations and opportunities for tax avoidance, even in dealing with a large country with a complex system.

The point, as I mentioned, is that every country has their own rules, and these rules are different. That's why you need a tax treaty to reconcile the rules. Unfortunately, our present tax treaty with the United States does not reconcile the treatment of these partnership/corporations.

[The Chair, Conservative, Brian Pallister]

Thank you, Monsieur St-Cyr.

We continue with Mr. Del Mastro now. Five minutes, sir.

[Dean Del Mastro, Conservative, Peterborough, ON]

Thank you, Mr. Chair.

Mr. Brown, you touched on a couple of things that I think are really critical to the success of this particular study. You talked specifically about debt dumping and double-dipping. Quite frankly, I think Canada can't look at itself in isolation, certainly as a trading nation, and move forward on these things unilaterally. Having said that, we spoke to the CRA, and they did indicate that these are very significant concerns.

Would you make a recommendation to the committee as to what is our best method, moving forward, on dealing with both debt dumping and double-dipping, as to how we could, one, work as a nation, and secondly, perhaps work with our G8 and our G8+5 partners on this to ensure tax fairness?

[Dr. Robert Brown]

In broad outline, what should be done on the disadvantages whereby foreign companies move interest selections into their Canadian subsidiaries? We need effective, thin capitalization rules that would limit the amount of debt that a Canadian corporation, which is owned by foreigners, could borrow in Canada and deduct the interest. Many other countries have such rules. We have them ourselves, but they are not very effective, and we need to beef them up and say that you have to have a ratio of equity to debt of no more than x in order to avoid just having you dump debt into Canada.

On the double-dip, I think it's appropriate to consider disallowing the interest expense in Canada if, in effect, another deduction for that interest is being taken somewhere else--taken abroad. I think the net result would be that Canadian companies would tend to move just a little more of their borrowing offshore. If you're going to invest in the United States, you try to borrow in the United States. And provided we don't go overboard on this, that's a positive move, because it means there are fewer deductions against the Canadian tax base.

[Dean Del Mastro, Conservative, Peterborough, ON]

Thank you.

There is a second thing that I've spoken about a number of times. You spoke about the incentive to circumvent the rules. As long as you have tax rates, there are going to be people working awfully hard to figure out how not to pay taxes, especially in corporate Canada. But in the corporate world in general, there are people who are literally employed to come up with methods to avoid tax. In general--and I'm certain you're going to agree with this--lower rates and a broadly fairer system would significantly reduce the incentive for corporations to avoid tax, and individuals as well.

[Dr. Robert Brown]

Yes, I think that's right. It reduces the incentive. It doesn't eliminate it, but it reduces it. When we have relatively high tax rates, we're immediately identified as a good place to dump deductions and to shift borrowing too, because the tax rate is so high you get a big tax saving.

[Gilles Larin]

It is essential to be able to flag deductions that are not warranted, as Mr. Brown has just explained, in the case of double dipping. But this is not the only aspect that should occupy our attention. The problem is much bigger than Quebec. Tax avoidance happens all over Canada because of the different tax planning mechanisms. The Supreme Court of Canada tried to find a way of preventing abuse in its second decision in the Trustco case about two years ago.

[The Chair, Conservative, Brian Pallister]

Merci, monseiur.

I recognize we have a delay. I'll keep talking until you stop, Monsieur Larin.

We should continue with Judy Wasylycia-Leis, sir.

Five minutes, madam.

[Judy Wasylycia-Leis, NDP, Winnipeg North, MB]

Thank you, Mr. Chairperson.

Thank you, Mr. Brown et Monsieur Larin.

I would like to come at this from a different point of view. I think what our study should be about at this committee is the question of tax fairness and whether or not corporations are paying their fair share. I think based on the statistics, we have a clear problem of corporations managing to find more and more tax loopholes, tax avoidance schemes to offshore tax havens, to avoid paying Canadians or the Canadian government a rightful share of revenue.

We've seen revenue from corporate income tax drop as a significant percentage of total revenue from 15% to 11% in the last number of years. At the same time, we've seen that Canada's average corporate tax rate is much better than the United States. We have a KPMG study showing that Canada is the cheapest G7 country in which to do business. We have studies showing this huge rise in corporate profits and we have obviously a record now of Liberal and Conservative governments who have cut corporate taxes, have made life easier for corporations, have allowed them to do more tax avoidance, but have provided little benefit for our economy, for example. We've seen no commensurate increase in investment in this country, no increase in jobs, no trickle-down effect.

My question to Mr. Brown is, on what basis can you say that Canada is so hard done by in terms of the corporate sector when internationally speaking we fare very well and give corporations a very easy ride; and secondly, why are we not seeing any benefits when we do cut taxes and we do make life easier?

[Dr. Robert Brown]

That's a big question.

First of all, I think the view is well supported by studies done by Professor Mintz at the University of Toronto and others that Canadian tax burdens on corporate activity are relatively high by world standards. Now, that's all the taxes that corporations pay, not just income taxes. For example, one of the most significant disadvantages that Canadian corporations face is the fact that in Ontario and a number of other provinces they have to pay provincial sales tax on their business inputs. This puts them at a material disadvantage to taxpayers in Quebec and in Europe who have a value-added system that doesn't have this drawback.

It's a complex question. It's the total tax burden, not just one.

Our tax breaks are relatively good if you compare only the tax rates with the United States. But our tax rates are high compared to those that apply in Europe, which is a very active and growing part of the world. The U.S. has features to their tax system, including a substantial number of loopholes, that also make it very attractive to investors.

The big issue here is that you have to say that, as the Carter report pointed out 35 years ago, corporations don't pay tax, they pass it on to other people. When you impose a tax on people, the burden of the tax falls on somebody who has to take money out of their pocket and cut back on their consumption of goods and services in order to pay the tax. When you impose a tax on corporations, they either have to reduce their payments to their workers or their payments to their suppliers or increase their prices or reduce their return to investors.

Incidentally, in a global economy it's not very easy to get investors to take a lower return when they have lots of other places to go.

But the main point is that corporations just pass taxes on, and that's the heart of it.

[Judy Wasylycia-Leis, NDP, Winnipeg North, MB]

Thank you very much. Obviously we may have to agree to disagree on some of these issues. I hear what you're saying; however, I also realize that the average Canadian is feeling the burden growing on his or her shoulders in terms of taxation and paying for government revenue, but corporations generally are seeing a diminished role.

Could I have one more question?

[The Chair, Conservative, Brian Pallister]

No, madam. Thank you very much.

Mr. McCallum, you have four minutes.

[John McCallum, Liberal, Markham—Unionville, ON]

Merci. Thank you, Mr. Chair.

Welcome to our two witnesses.

I would like to make two comments and ask each of you your position on these two points.

The first is that we had five expert witnesses some weeks ago, and the question arose as to whether the principal abuse that should be addressed in the area of interest deductibility had to do with debt dumping. And all five said that the key thing was debt dumping. That was the real source of abuse where significant additional funds for the government could be found, and double-dipping was much less important.

This is my second and related question. We've heard from a number of witnesses that if companies were limited to a single dip--a single deduction, as it were--they would choose to take that deduction in Canada, by and large. So the net effect of the policy would be to increase the tax revenue of foreign countries at the expense of Canadian companies.

I'm not quite sure if that's right, because the U.S., I think, has a slightly higher corporate tax rate than Canada, but I'd like, if I may, to have both of you give an opinion on both of those issues.