Finance Committee on Feb. 17th, 2011

[The Chair, Conservative, James Rajotte]

I call this meeting to order, the 59th meeting of the Standing Committee on Finance. Pursuant to Standing Order 108(2), we are continuing our study of tax evasion and offshore bank accounts.

We're very pleased to have two guests with us here this morning. First of all, we have Mr. Lawrence S. Rosen, Accountability Research Corporation. Thank you for being with us here, Mr. Rosen. And we have Mr. Arthur Cockfield, associate professor, Faculty of Law at Queen's University.

Gentlemen, you will each have up to 10 minutes for an opening statement, and then we'll have questions from all the members.

Mr. Rosen, we'll begin with you when you're ready.

[Lawrence S. Rosen, Accountability Research Corporation, As an Individual]

I won't take 10 minutes.

The main point that I've noticed in testifying before standing committees is that usually I'm off topic, because some of what I'm doing, of course, overlaps into other areas, and I keep getting the comment back, “You're not sort of in our compartment right now.” Again, at the risk of being off topic, there are a couple of points I want to make.

First, I have a handout. It's translated, and on the second or third page I start to list all of the reasons why there can be these offshore bank accounts. Given that we've done quite a few of the major sorts of securities scams—I guess that's a polite word—and quite a few of the failures of the major Canadian companies, we of course run into the offshore bank accounts all the time.

I just don't want to somehow leave the impression that people just take money offshore and leave it in an account in Switzerland, or whatever it happens to be, and earn pitiful interest rates. In the cases we've had over the years, for the most part somebody works some sort of securities problem. For example, they sell short; they do all sorts of other trades. There are restrictions on securities, but they ignore that and sell them anyway.

So the money then gets sent to a particular location, and within hours it gets flipped out of there into other locations. On that particular basis, trying to track these things is not at all easy. Mostly we've had to bring in other specialists with the problem. So this is not a situation where you just look at it and say somebody has something in a bank account. Where did it come from, to me, is the problem.

If you look at just the CRA attacking “particular accounts”, they could be gone days or even hours later. And this is not going to stop, because the root causes of most of these are, for example, people getting ready for a divorce and they send offshore. But the ones that trouble me immensely are the ones that arise from securities situations where trades that are barely legal, if at all, then end up offshore and the money gets transferred.

So if you look at this logically, eventually that money has to end up in territories where someone is going to get a decent return on investment. When you look at it that way, these plans are set up long in advance. I'm going to send it into A, then to B, then to C, then to D, and then finally it's going to be placed somewhere else.

Quite often you're going to find that lawyers' trust accounts are used to launder the money. Quite often you're going to find that these plans were put together by professionals, and as long as they are left exempt, that's not going to solve any problems.

We have, at this point, a major problem in Canada that is not being addressed at all, which has to do with where we're going to have these offshore accounts, etc., in a few years. This is a subject called international financial reporting standards. This was brought into Canada with virtually no debate. This affects the provinces as well as the federal government, and this is such a totally different concept we've had in my lifetime of how one counts income.

Many of these offshore accounts and so on are the result of Ponzi schemes, where you represent to people that you are giving them a return on investment, but all you're really doing is giving them back their own money. So if that's the basis for what is happening, then we have to look at how you minimize these Ponzi schemes, because that's where you cut off the money going offshore.

So these international financial reporting standards...it's not being monitored in Canada. It's being pushed by the audit community. It is based on European ethics and standards. We are sending out information to our clients about all of the frauds that can be worked through this IFRS. I have given up, quite frankly, but I've tried, along with my son, to alert most of the cabinet ministers and so on across Canada that this is a problem.

So what is the problem? The problem is, how did IFRS get brought into Canada with virtually no debate? Despite what's been said, it's been misrepresented as principles based and everything else. So we left control in self-regulating organizations for mutual funds, for investment dealers, auditors, and so forth, and there is the problem that then leads to the offshore.

There's no doubt in my mind. If you check my track record, we called the Nortel failure years in advance. We called the business income trusts years in advance. We had involvement with the asset-backed commercial paper to point out that the accounting and reporting didn't work. For leveraged ETFs, the same thing. If you look at Loewen Group, Cott, and so on, we called these in advance, so we're not stupid people. On that basis, somebody should be paying attention, and we've tried to do it through Finance, repeatedly, to say that this is a major problem.

So just trying to sum up where I am, I'm saying that many of the real serious problems start long before the bank account is set up offshore. If that is not looked at, in conjunction with whoever has to look at it, then you're picking the low-hanging fruit, so to speak, instead of dealing with the most serious problems.

Thank you.

[The Chair, Conservative, James Rajotte]

Thank you for your presentation, Mr. Rosen.

We'll go to Mr. Cockfield.

Mr. Cockfield, I just want to make you aware...you did give me your presentation, but we have had it translated for all the members. So they already have your presentation in both French and English, just for your information.

[Arthur Cockfield, Associate Professor, Faculty of Law, Queen's University, As an Individual]

Thank you.

And thank you also for this invitation to provide comment on this important issue. I'll also make very brief opening remarks. I'll touch on three areas. I'll discuss what is international tax evasion, try to gauge the extent of the problem for Canadians, and then discuss possible reform initiatives.

Of course, this is quite a complex and tricky area of tax law. Tax evasion generally requires a purposeful non-disclosure of income. This is to be contrasted with tax avoidance, which really involves attempts to engage in tax planning while complying with all relevant Canadian and foreign tax laws.

I just thought I'd note up front that our Income Tax Act encourages international tax planning, encourages the use of offshore tax havens for devices like double-dip financing, where you place a financing affiliate in your tax haven.

So my comments will only focus on tax evasion and not avoidance.

What is encouraging the enhanced international tax evasion? Tax academics have focused on two particular factors: globalization and technology change. Of course, globalization is shrinking the world, bringing us closer together, encouraging a greater provision of cross-border financial services, but also, importantly, there is the technology change. We have this information technology revolution. It's making it cheaper and easier to shift funds offshore. It's leading to the development of certain financial products, like offshore credit cards. These became more prevalent around 15 years ago. If a Canadian shifts his or her moneys offshore, she can now have a Bank of Nova Scotia branch in Barbados and have a credit card issued to that bank. The credit card is used to make purchases here in Canada, but there's no paper trail because all of the invoices get sent directly to Barbados.

In terms of gauging the extent of the problem, nobody really has their head around what sorts of revenue losses we're looking at. I'm not aware of any empirical studies that try to measure this problem. That would in any event be problematic due to the fact that this is illegal and secret. These offshore havens have bank secrecy laws that make it a criminal offence to divulge financial personal information to any third parties.

For comparison purposes, a U.S. Senate permanent subcommittee, back in 2006, estimated that U.S. residents are evading between $40 billion and $70 billion each year as a result of tax evasion. So they spent a lot of time half a decade ago looking at this problem, but they also acknowledge that this estimate is quite tentative.

How much is really in these havens, not just from Canadians but from folks all around the world? Again we don't know. Estimates range from $5 trillion to $38 trillion. The latter figure is from a Boston consulting report.

I think there is some good news, and that is that when tax academics measure tax compliance and they prepare these comparative international surveys, the surveys show that the vast majority of Canadians are honest. Our tax compliance rates are among the highest in the world.

But—and I think this is in part why this committee's work is so important—there are a lot of stories, anecdotes, that suggest international tax evasion is on the rise. Page 2 highlights some of these things. I won't get into them in any detail, but our Auditor General, Sheila Fraser, in 2001 and 2002, in those reports highlighted really aggressive international tax planning, not evasion. Nevertheless it brought some attention to the issue, and subsequently there were more resources devoted to fighting the problem, resources given to the CRA and elsewhere.

Then the other stories, which I think you've heard from other witnesses, about the Liechtenstein bank, the UBS Swiss Bank, and most recently the HSBC Swiss bank, all suggest that certain Canadians are engaged in this illegal international tax evasion. We've seen a rise in audits and moneys recovered from these audits. A previous witness here from the CRA indicated that in 2009 alone, $1 billion was recovered from international activities. It wasn't clear whether that's attributable to evasion. In fact I think for the most part it's audits of aggressive international tax avoidance.

So we suspect that the problem is on the rise, and what can we do about it? Well, again, page 2 of the memo sets out a number of possible reform initiatives. I've listed them in order of what I consider to be the cheapest, most realistic options to the more difficult options. I won't touch on all of them. I'm happy to answer any questions.

The first issue is that Canada needs to ratify the Council of Europe and OECD Convention on Mutual Administrative Assistance in Tax Matters agreement. We signed it in 2004. I've been told in the past by people at Finance that legislation has been introduced on several occasions to ratify this agreement, but for reasons that of course have nothing to do with this particular agreement, that legislation wasn't passed. In any event, the agreement is not in force in Canada, and it ought to be ratified.

Another possible reform effort could involve a public education campaign that would emphasize the criminal sanctions. Possibly, we need enhanced audits and even greater resources to the CRA. The Auditor General wrote about this in her 2007 report, but then she appeared later on that year before this committee, the standing committee, and indicated that the progress was satisfactory. So there is a view that maybe there are sufficient resources. But since 2007, again, we've heard all of these stories that suggest the problem may be greater than we previously realized.

I would advocate reforming the voluntary disclosure program. I think it's generally working, but it could be tweaked. The one recommendation I'll mention up front is to have a temporary reduction in the interest penalties, and this could be done by removing a subsection in the Income Tax Act, subsection 220(3.1), I think, that indicates there can be no interest relief beyond a 10-year period. But when I talked to lawyers in Toronto and elsewhere, their clients have had these accounts, some of them at least, since, say, the 1980s and they're not getting any interest relief. So the penalty, in their view, is so large that they're not coming forward and entering into the program. Again, the purpose of the program is to rehabilitate these tax cheats, and I think there could be certain steps to reform the program.

TIEAs are one thing that has been on the policy horizon in Canada since the 2007 budget, tax information exchange agreements. It's an open question whether they'll actually work. We've been signing them. The OECD currently is in the review stage of looking at them. Many tax scholars who have written in this area suspect that they won't work, there won't be meaningful cooperation by the tax haven countries. Perhaps we ought to offer incentives to certain countries to engage in this meaningful cooperation.

The bottom of page 2: the problem could be fixed, although it may require a level of global cooperation that's currently unrealistic. In a 2001 article that I wrote—it came out in the Minnesota Law Review—I set out a potential regime using the Internet to share taxpayer information, a secure extranet among all participating tax authorities. If we got all of the fairly wealthy countries, the OECD countries, to agree to it, then if they had absolute information sharing, we could impose a withholding tax on any payments outside of these participant countries. I'm not sure, again, whether that is politically feasible.

Then, finally I thought I would highlight taxpayer privacy. I'm a tax researcher, but I've also been a member of the Queen's Surveillance Study Centre since 2001. We conducted in 2005 an international survey of 7,000 respondents in eight different countries, and the Canadian respondents indicated that they were quite worried about their privacy; in particular, they're worried about foreign governments and foreign businesses misusing or mishandling their personal information.

So this is the tricky part: we want to be aggressive and go after the tax cheats, but the other side of the equation is we need to do it in such a way that it continues to preserve their taxpayer rights, including privacy.

Elsewhere, I've suggested that a multilateral taxpayer bill of rights might actually encourage heightened information sharing among different nations, because sometimes the Canadian authorities, other tax authorities elsewhere, are reluctant to share information because they don't know how that information is going to be treated. They don't know whether that information is going to be treated in the same way that would be required by their domestic law. But if we all got together and agreed on the threshold of legal protection for taxpayer rights, it actually, in my view at least, would enhance information sharing and would help to fight international tax evasion.

Thank you.

[The Chair, Conservative, James Rajotte]

Thank you very much for your presentation.

We'll begin members' questions with Mr. Szabo, for seven minutes.

[Paul Szabo, Liberal, Mississauga South, ON]

Thank you, gentlemen.

There's no question that there are many elements to the problem, and the committee understands that there's no simple solution. But there is probably a preferred direction in terms of dealing with it. Some things are very long term.

Let's deal with Mr. Cockfield's suggestion of basically having a multilateral treaty among countries who are concerned about this, and let's all get together and come up with these strategies. I want to ask both of you whether or not a complex arrangement like that is even possible, given how difficult it is even to enter simple trade agreements with countries and how long that takes. I'm concerned about using that approach of let's get everybody together. That may very well just gobble up time. Should we, in lieu, establish a Canadian approach to the elements of a Canadian problem?

[Arthur Cockfield]

I agree that a multilateral treaty would be particularly problematic, and I think, in the first instance, Canada should try its own approach. We've been doing a pretty good job. We may be able to improve it. There are certain unilateral measures that we can take. Again, I've listed them on page 2.

With respect to this multilateral treaty, you're correct in pointing out the difficulties. In fact, the Convention on Mutual Administrative Assistance--the one I'm trying to get Canada to sign.... There are only, currently, 16 signatories. I think Germany and Canada have yet to ratify the agreement. It's only enforced for 14 people, and it's been a number of years since that convention was first created.

International taxes is particularly an interesting area to study from a public international law perspective, because in all other areas we've seen over the last half century the rise of multilateral agreements, world trade organization agreements, but now we only have bilateral agreements in Canada and elsewhere to preserve tax sovereignty.

[Paul Szabo, Liberal, Mississauga South, ON]

Mr. Rosen, do you have any thoughts?

[Lawrence S. Rosen]

I'm coming from the bias that for years and years we've been doing these major director-officer-auditor-corporate failures. We also do some of the matrimonial, and so on. But when I look at the dollars that I have personally seen over the years go offshore, the vast majority is as a result of some sort of securities trickery.

If Canada wants to go it alone, then it has to do something about the securities picture in Canada. This is not a national securities regulator issue. This is more a prosecutor-type issue. It's clamping down on the trading and on the people who are getting the tax advice to do certain things.

The one that annoys me the most is when there's a prohibition on trading shares--it's a private placement or a corporate buyout. In these situations, you can't trade those shares for six months or a year, or whatever it happens to be. Yet these people are able to sell to these intermediaries and get the cash upfront, which ends up offshore.

If we can't get serious about better securities prosecution and investigation, I think we're missing most of the big money.

[Paul Szabo, Liberal, Mississauga South, ON]

That's an excellent point.

In terms of the approaches, the United States decided they were going to have a good, big look at this, and they did a lot of work on it. Canada hasn't. That tells me something, and it concerns me.

When we look at approaches to problems just in a generic sense--there's the carrot and the stick and combinations thereof--one of the suggestions in the papers is about, effectively, some sort of an amnesty approach, where people are encouraged to clean up their stuff, come out even more than the voluntary disclosure program, but for a limited time. It probably would then have to be followed up with more severe penalties for those who decided not to come out.

Do you have any evidence or information about how an approach of a temporary amnesty and possible changing of the penalties under legislation might have a success rate worth looking at?

[Lawrence S. Rosen]

My feeling is that you'd clean up some of the act's past sins, so to speak. But I don't see that this helps at all as long as you can keep on working Ponzi frauds and things of that nature. Yes, amnesty is okay. Bring in the low-hanging fruit. But I've never really liked that concept, because it doesn't solve the major problem.

[Paul Szabo, Liberal, Mississauga South, ON]

Do you have some comment? My time is up.

[Arthur Cockfield]

I would support a temporary amnesty on just the interest penalties, not the back payment of taxes.

There is a view by lawyers—and I haven't seen a study on this—that the interest penalty is supposed to help us get at the present value of the tax debt. If people haven't been paying taxes for several decades, the interest penalty will bring it up to the present. But because the interest is applied on an accrued basis, then the tax debt or the ultimate penalty far exceeds both the original tax debt and any kind of return the person may have earned on this investment.

There is a view that this would help clean up a number of dishonest secret accounts. I'm basing this on discussions with international tax lawyers working out of Toronto, whose clients are not entering into the voluntary disclosure program because first they ask, “Will I get caught”? and then they ask, “How much is this going to cost me?”

If you compare our program with the American one, in some respects the American program is more lenient. Maybe they've seen a great uptick in people stepping forward with voluntary disclosures.

[The Chair, Conservative, James Rajotte]

Monsieur Paillé.

[Daniel Paillé, Bloc, Hochelaga, QC]

Thank you, Mr. Chair. Thank you, gentlemen, for being here with us.

Since I was myself a university professor at the École des hautes études commerciales, HEC Montreal, I can confirm that university professors habitually go off on tangents. However, this was not the case with you and you have defined the issue very well.

First, I must say I agree with you. Indeed, we cannot determine the income tax-related shortfall because if we knew that, we would know where to go and get the money. That's obvious. Tax evasion is like a prisoner's evasion. When a prisoner has gotten away and you know where he is, you can go and get him. It is the same thing in this case.

As you both mentioned but in different ways, the problem concerns very large businesses. SMEs are not trying to set up fiscal evasion mechanisms. They might try and do a little tax avoidance to pay as little tax as possible since the objective of private companies' chief financial officers is not only to maximize profits, but to pay as little income tax as possible. So we are talking about big business acting this way, and not ordinary individuals.

So it is not every Tom, Dick and Harry, as certain political parties say. Nor does this concern the average taxpayer; but the very wealthy and large taxpayer attempts tax evasion. So the impact is quite considerable.

I would like to attempt to make a link between your two presentations. Mr. Cockfield, one can see on the second page of your brief that there has been an increase in the number of audits, but one also senses that there has been an increase in tax evasion. More and more, we get that impression.

Mr. Rosen, one sees on page 5 of your brief that we are losing ground because of the IFRS, the International Financial Reporting Standards, and the blind use of generally misunderstood accounting standards that no one understands, even in a business that has good accounting practices. These accounting practices are like large clouds within which only the corporation's accountant or a tax specialist can navigate. So we are looking at a sort of de facto deregulation.

Mr. Cockfield or Mr. Rosen, is that not one of the reasons that explains the “open bar” in Canada?

[Arthur Cockfield]

I apologize for not being able to reply to you in French.

This is my hometown, and I studied in the French immersion system here, but

the technical language is too difficult for me.

I think I understood most of what you said. You were asking me about the level of tax evasion. We don't know what the problem is, but we see an increase in the audits and the amounts recovered. That doesn't necessarily mean that in fact the problem is greater. We're devoting more resources to the problem, and we're recovering more revenues, and that might be simply as a result of the more effective approach by the CRA.

I'm not sure if I got the rest of your question. I apologize.

[Daniel Paillé, Bloc, Hochelaga, QC]

Okay. Maybe Mr. Rosen could comment.

[Lawrence S. Rosen]

I'm not too sure I got your final point either.

[Daniel Paillé, Bloc, Hochelaga, QC]

On page 5, you are denouncing the change in these standards, saying that we are going back 50 years in time and opening the door to several fraudulent machinations. Is that why in Canada there is more tax fraud?

[Lawrence S. Rosen]

No. Just to come back to the point, this IFRS came into Canada just January 1 of this year, so we haven't even seen the first-quarter results.

[Daniel Paillé, Bloc, Hochelaga, QC]

So, things will get worse.

[Lawrence S. Rosen]

Absolutely they have to get worse, because we have thrown away closures we've made over the years. I've probably done a dozen of the big financial failures in Canada involving financial institutions, and one of the tricks they use there is to not collect the cash but to keep on increasing the assets of the loan company and increasing their profits.

[Daniel Paillé, Bloc, Hochelaga, QC]

Indeed.

[Lawrence S. Rosen]

And this has gone through the Alberta bank failures, to Castor Holdings in Montreal, to Confederation Trust. I've done all of these things. So on that particular basis, this IFRS has abolished all the prohibitions.

[Daniel Paillé, Bloc, Hochelaga, QC]

I have a lot of reservations as to the voluntary disclosure program that is used in Canada. This puts me in mind of the voluntary opting-in of provinces in other areas. Isn't there a problematic permissiveness in the fact of not having any sanctions? You said earlier that the real value of cumulative interest would be so enormous that people won't want to disclose anything.

Is there a lack of leadership on the part of tax authorities in Canada, plain and simple?