Good morning, Mr. Chairman and members of the committee. Thank you for inviting me back. I'm only sorry I can't be there in person.
One great thing about being down the batting order is that the key background information is all on the table and I can get straight to the meat of the matter. Of course the meat is the question of interest deductibility with respect to debt incurred for investments in foreign affiliates. Today it's framed as dealing with tax havens, but nonetheless that's the issue.
On this, I have a very few simple points. The first one is that the world has changed a lot in the past 35 years since the current framework for international taxation was put in place. The big change is in the size and the direction of investment flows. Canada has historically been very dependent on investment capital flowing in from abroad, but it's quite different now. Data released just yesterday from Statistics Canada will show you that for ten years now Canadians' foreign-directed investment abroad has exceeded foreigners' investment here. That's a big change.
At the same time, the complexity of the transactions has grown. Multinationals now more commonly steer investment through low tax jurisdictions and pursue other advanced international tax strategies. This has given rise around the world to concerns about threats to national tax revenues.
Now, Minister Flaherty perceives such a threat in Canada, and it's reasonable that he should. To see why, let's consider how Canada does things compared to our G-7 partners.
Canada generally permits dividends from foreign affiliates to be patriated, to come back to Canada tax-free or exempt, on the assumption that it's already been taxed in the foreign jurisdiction, which is often a low tax jurisdiction. Keep in mind that there is a difference between a low tax jurisdiction and a tax haven.
Now, dividends that are not exempt would generally be taxable in Canada, with a credit for tax actually paid in the foreign jurisdiction. That's the general picture in all G-7 countries. Either foreign source income is taxable, with a credit, or it comes in exempt. But what about the flip side--the big question about interest deductibility with respect to those investments and affiliates? This is where Canada probably stands out a little, with fairly loose limits, and this has led many multinationals to book debt in Canada without bringing economic activity with it--reducing their Canadian tax liability--and that is what has attracted the minister's attention.
Professor Hines made a few superb points on whether or not this is something we need to worry about. But clearly the minister is worried about it and has proposed a course of action for dealing with it. The question is what to do about it, and when I said that Canada had very loose rules with respect to interest deductibility, that is not to say other countries necessarily have very tight ones. There are lots of rules, lots of very different rules, but they generally all do have rules on interest. The difference is that none of them, none of the G-7 countries, have a simple blanket denial on interest deductibility. Whether you're looking at France, Germany, Italy, or Japan, interest deductibility is key to the ratio of debt to assets or to equity, or limited as a percentage of earnings, but there's no simple denial.
This, of course, is what has Canadian businesses worried, worried because the minister's proposal is more restrictive than what their international competitors will face. For instance, a German firm could still route investments through the Netherlands when buying assets in the United States, enabling that firm to raise capital at a lower cost than the Canadian firm bidding for the same assets. This means Canadian firms absolutely will have a tougher time expanding in global markets, will face a higher cost of capital, and will have a harder time reaching scale efficiencies, delivering good value for money in the domestic market.
But there's more. When Canadian firms invest in foreign affiliates through offshore entities, they build trade flows with other foreign jurisdictions that their alternate investments flow to. So more trade means more business in Canada. In other words, the international financial system, and the tax system that goes with it, help build the Canadian economy, not just others.
So all this is to say that the minister is right when he says that the international tax system needs a look at. There is no question that many businesses' tax structures are finely tuned to take advantage of differences between countries' tax rates and tax systems. There is no question that part of the issue for Canada is the rules on interest deductibility. What there is a question about is whether the budget proposals are the right ones, or whether better options, such as lower tax rates or better-tuned rules on interest deductibility, would be the shrewder course. I think that's what we need to be looking at.
Thank you.