Finance Committee on May 8th, 2007

[Wayne Adams, Director General, Income Tax Rulings Directorate, Policy and Planning Branch, Canada Revenue Agency]

Good morning.

Thank you, Chair.

The nickname “double-dip” is jargon for a financing structure that attempts to take advantage of the fact that one has a choice when raising capital. They can either raise capital by way of debt, where they have to pay interest, or raise it in equity by issuing shares, and there's no interest charge there but there's an expectation of the person who advanced the money to receive dividends.

In a closely related group, it provides some tax planning opportunities where one is in a position to have interest expense reflected in countries that have higher rates of tax and the interest income in countries with lower rates of tax.

In the example that we have for starters, with the alternate structure, if within a group you had one foreign company, say, named Tax Haven--and Tax Haven Company is just an expression there, it could be a company in Ireland, the Netherlands, or any other country that might have lower rates of tax--wanted to finance a factory, let's say in the United States, it could have made a $200 million loan at 10% interest. The United States company would have interest expense of $20 million, and the Tax Haven Company would have interest income of $20 million.

The double-dip is that within that same corporate entity, on the chart headed up “Double-dip Structure”, the same originating point of $20 million lends the money into Canada, and that would create an interest expense in Canada of $20 million; and if the year before it had had $20 million of taxable income, it would now have no taxable income.

[John McKay, Liberal, Scarborough—Guildwood, ON]

Just as a point of clarification, you've got the Tax Haven Company and then Tax Haven Company. Are they separate as corporations within the same corporate structure?

[Wayne Adams]

They're in the same corporate structure. They can be in different countries, and they can be different entities. I just put these together in a hurry, but thank you for clarifying that.

[John McKay, Liberal, Scarborough—Guildwood, ON]

So we could call it Tax Haven Company A and Tax Haven Company B, and A or B could be in the same country or different countries.

[Wayne Adams]

Often are in different ones, but they could be in the same country, yes.

[John McKay, Liberal, Scarborough—Guildwood, ON]

So we could go from Barbados to Ireland, or whatever, if you wanted to do it that way.

[Wayne Adams]

Yes.

[John McKay, Liberal, Scarborough—Guildwood, ON]

Okay.

[Wayne Adams]

So the Canadian company now has $200 million of cash, and it makes a share investment into its own subsidiary in a tax haven country, and that gives capital, then, to the Tax Haven Company with no expense obligation, but dividend obligation. It can lend, then, into the United States or western Europe.

In red, you'll see there are two interest expense items of $20 million. That's offset by two interest income items, but they're reported in these tax haven jurisdictions. In this case, company B would have $20 million of interest income flowing in from the U.S., and company A would have $20 million of interest income flowing in from Canada.

Essentially, on funds originating in Tax Haven Company A and ending up in a United States' company, you have the creation of a second interest expense offset by interest income. And that's how the nickname “double-dip” came about.

[John McKay, Liberal, Scarborough—Guildwood, ON]

So revenue is in the haven A company and expense is in the Canadian company.

[Wayne Adams]

Yes.

[John McKay, Liberal, Scarborough—Guildwood, ON]

Okay. Can you tell me whether this kind of structure is used by other nations and other nations' companies?

[Wayne Adams]

I checked this morning before I came over, and there are papers that refer to double-dipping in the United Kingdom, France, the United States, so almost every higher-tax jurisdiction struggles with these conduit-type opportunities.

[John McKay, Liberal, Scarborough—Guildwood, ON]

Is it fair to say that most OECD countries have this kind of structure for most of their corporate nationals?

[Wayne Adams]

Well, they're vulnerable to having that occur, because of the interest rules that say you can have a deduction for borrowed money if you make qualifying investments, and capitalizing subsidiaries or other foreign entities is—

[John McKay, Liberal, Scarborough—Guildwood, ON]

Now, Mr. Kowalski said during his testimony that they'd recovered $174 million of additional tax revenue. Presumably if you were looking at a corporate structure such as this, you could still say, well, that's not right, and apply the avoidance rules. Would avoidance rules apply to—what is it called?—the general—

[Wayne Adams]

General anti-avoidance rule.

[John McKay, Liberal, Scarborough—Guildwood, ON]

Yes.

[Wayne Adams]

We did attempt to address these types of structures and announced our position in the nineties, that we had concerns with this structure. And we did use the general anti-avoidance rule. Shortly after, the Supreme Court ruled on the Canada Trustco and Kaulius cases in 2005. The first case using the structure was heard by the tax court. It was a company called Univar. It was issued on November 3, 2005 and the Crown was unsuccessful in challenging this structure. But there are two other cases that are proceeding to the tax court, where we're hopeful that our arguments may prevail.

[The Chair, Conservative, Brian Pallister]

Mr. Crête, you have seven minutes.

[Paul Crête, Bloc, Montmagny—L'Islet—Kamouraska—Rivière-du-Loup, QC]

Thank you, Mr. Chair

According to the Office of the Auditor General, in 1990, Canadian businesses repatriated $1.2 billion from tax havens, chiefly from Barbados. Since that time, according to a study by Statistics Canada, there has been an 18% annual increase in Canada of investments in tax havens.

On the assumption that investment growth is more or less the same as profit growth, we estimate that recovered profits in 2007 amounted to some $3.8 billion.

Does this amount correspond to your estimates? If not, how much do you estimate recovered profits from tax havens to be for a current year such as this one or last year?

[Fred O'Riordan, Director General, Compliance Program Branch, Canada Revenue Agency]

If I understood the question correctly, I believe you're referring to amounts of money that were referenced in the Auditor General's report of this February on international taxation.

[Paul Crête, Bloc, Montmagny—L'Islet—Kamouraska—Rivière-du-Loup, QC]

In 1990, the Auditor General estimated that $1.2 billion was recovered from tax havens, mainly from Barbados. If we extrapolate from this, we estimate that today recovered profits would account for about $3.8 billion.

Can you confirm that this amount is correct? If not, do think it is another amount? How much is it?

[John Kowalski]

I will try to respond to that question.

We don't have estimates of tax gap per se or the amount of revenue that perhaps has not been declared by individuals. There's an argument to say there is no set methodology at this point to estimate the amount of taxes in terms of a tax gap. In 1999 the Auditor General did a study of the economy and looked at different academic research and studies over a 17-year period. They found the estimates ranged anywhere from 3% to 20% of GDP because of all the differences in assumptions and methodologies and so on.

We are aware that investment offshore has increased significantly over the years, but we would note that increased offshore investment does not mean increased tax avoidance in the same amount. As I mentioned earlier, Canada is part of a global economy, and corporations have diversified investment strategies, both domestically and internationally. We don't have a view as to where they invest--those are issues of tax policy--as long as they comply with our tax laws and report their income.

[Paul Crête, Bloc, Montmagny—L'Islet—Kamouraska—Rivière-du-Loup, QC]

You say that you do not have an estimate of the amount. For instance, we know that the Tax Treaty between Canada and Barbados contains a measure whereby businesses that benefit from favourable tax treatment must be taxed when they recover their profits. But regulation 5907 overrides this provision in the Tax Treaty between Canada and Barbados.

Actually this is done on purpose so that people do not have to pay anything. Are you telling me that the Canadian government’s Revenue Agency cannot give me an estimate of the profits recovered from Barbados and other countries without any tax being paid? You do not have an estimate of that? That means that, when you do your annual budget estimates, it does not occur to you that it might be an opportunity to get rid of the Tax Treaty between Canada and Barbados, say.