Finance Committee on May 17th, 2007

[The Chair, Conservative, Brian Pallister]

Good morning, committee members. Welcome back.

Hello to our witnesses today. Good morning. It's nice to see you again. Thank you for being here.

We will continue with our briefings on tax havens and tax avoidance with

the Office of the Auditor General of Canada. Welcome.

I understand you have some introductory comments. We welcome them. Please proceed.

[Sheila Fraser, Auditor General of Canada, Office of the Auditor General of Canada]

Thank you, Mr. Chair.

We thank you for this opportunity to speak with the committee about our work related to tax havens and international tax avoidance.

I'm accompanied today by John Rossetti, the assistant auditor general responsible for audits of the Canada Revenue Agency; Vicky Plant, principal; and Brenda Siegel, director, both responsible for performance audits of the Canada Revenue Agency.

I would like to begin by briefly outlining some points from our recent audits that are relevant to the issues you are studying. This work has helped us identify a number of factors that contribute to the success of the Canada Revenue Agency in identifying and addressing non-compliance and tax avoidance.

These factors include effective risk assessment techniques; robust information sources to facilitate risk assessment and the targeting of audit effort; experienced and well-trained auditors; qualified specialists to address complex areas like transfer pricing; information sharing with other national tax administrators; and a legislative environment that facilitates the administration of complex tax legislation and responds in a timely way to identified cases of abuse and unintended consequences.

In February 2007, we tabled a status report that followed up on our 2001 and 2002 audits of non-resident taxation and taxation of international transactions of Canadian residents. Overall, we found the agency's progress in addressing our recommendations to be satisfactory.

We found that the agency had undertaken some good initiatives in developing risk assessment techniques and tools for planning audits of international tax issues. However, we also recommended that the agency seek access to broader information sources about taxpayer activities where it can demonstrate that this would assist it in identifying emerging risks and improve its compliance efforts.

We also found that the agency had not developed any new initiatives to deal with the low-level of international tax audit expertise which continues in some of the tax services offices with the highest risk files. A lack of expertise could result in an inconsistent approach to and coverage of international audits across the country, as well as in a loss of tax.

It is important to mention that the agency is not solely responsible for maintaining international tax compliance in Canada. For example, the tax litigation services at Justice Canada are responsible for litigating tax cases, including abusive tax avoidance schemes. Finance Canada is responsible for initiating changes to the tax legislation and negotiating Canada's tax treaties that protect Canada's right to tax international transactions. All three organizations must work together if the tax base is to be protected.

We have reported on various tax plans that have come to our attention over the years. For example, in 2007 we reported on progress made by the agency in reassessing 72 trusts with capital gains of over $600 million. These trusts had been created to avoid Canadian tax by using the treaty with Barbados. They came to our attention in 2001, along with several other schemes developed to exploit the Canada-Barbados treaty.

A number of times in the past we expressed concerns about certain tax arrangements for foreign affiliates. We observed transactions where foreign-owned Canadian corporations incurred debt in Canada to finance investments in third countries. We also observed a transaction where a foreign affiliate of a foreign-owned Canadian corporation was used to move $500 million in capital gains from Canada to Barbados tax free.

It is important to note that my office did not call for the broad elimination of interest deductibility. Rather, we identified the issue as a potential threat to the tax base, and we recommended in 2002 that Finance Canada obtain and analyze current information to reassess the tax revenue impact and the rationale for allowing foreign-owned Canadian corporations to deduct interest on borrowed funds related directly or indirectly to investment in foreign affiliates and for allowing tax-privileged entities in treaty countries to bring income into Canada tax free.

The concerns we raised remain relevant today and clearly are of interest to the committee. We think the announcement by the Minister of Finance to create an advisory panel of tax experts to undertake further study and consultations is a positive step that addresses our long-standing recommendations. We hope that this will result in a clear determination of what legislative amendments may be needed to protect the integrity of Canada's tax base.

That concludes my opening statement, Mr. Chairman. We would be pleased to answer the committee's questions. Thank you.

[The Chair, Conservative, Brian Pallister]

Thank you very much for your presentation.

We'll begin with questions from Mr. Pacetti.

Seven minutes, please.

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

Thank you, Mr. Chairman.

Thank you, Ms. Fraser, for appearing. It's always a good occasion when you come here. It's always about good things, and we want to continue on that path.

We're having a little trouble with the committee. From what we're hearing from witnesses, the issue is very complex in terms of whether we should have agreements with countries that are supposedly tax havens and whether it's good for Canada in terms of investment, maintaining capital here, and repatriating some of the capital that sometimes goes overseas and is coming back here.

Do you have an opinion on that?

[Sheila Fraser]

Much of that is a policy issue and would have to deal obviously with tax legislation.

What we have been concerned about is the protection of the tax base in Canada, and Revenue Canada's work to ensure that this is maintained, that they have a proper risk assessment, that they undertake the necessary activities to identify where abuse may be occurring, and that they have the proper resources to do that. That's largely where our work has been focused recently.

In the past, we noted a number of areas where plans or schemes were being developed that would seem to go against the objectives of some of these treaties and agreements and would have the effect of reducing or undermining the Canadian tax base.

What we were recommending, and have been recommending for many years, is that there should be a very good study done of this. It needs to be quite a broad study because the issues are so interrelated, interest deductibility and tax havens, and all the rest, and it needs to clearly identify what are the major risks and how should they be addressed, likely through legislation.

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

The purpose of these meetings is to study and look at the different options we might have in terms of recommending to the finance minister or the department. That's why I'm asking your opinion. If we didn't have a treaty with a country like Barbados, would the money go somewhere else, and then we'd lose all the money being repatriated back? At this point, it looks like if a Canadian multinational set up to have some of its revenue going through Barbados and eventually coming back to Canada, it is coming back to Canada. That's one argument.

Do we maintain these relationships?

[Sheila Fraser]

I think the obvious answer to that is that taxpayers, be they corporate or individuals, are going to try to find ways to reduce tax. If it's not Barbados, it could be somewhere else, quite honestly.

I think what's important is that the government has to assess what schemes are being put in place. We noted in the last audit we did that they have now gone after a number of trusts—

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

Sorry to interrupt you, but we're limited for time.

We seem to have trouble really understanding what these schemes are. We had lawyers here, we had accountants, and they say it's normal procedure. We had CRA here, and they're telling us that unless we see the whole corporate structure, it's very hard to audit...unless we can actually have cooperation from the company being audited and we're able to see the whole corporate structure.

Where do we start? The lawyers are not willing to tell us what all their schemes are about. The accountants don't want to tell us either. I guess that's where they make their money. The CRA is having a hard time auditing the whole corporate structure unless there are tax treaties with the countries in which these multinationals have corporations.

Where do we start? How do we look at that whole risk analysis?

[Sheila Fraser]

I guess from the CRA point of view, we've talked about two things. We've talked about their ability to get the information, and that they have to have the agreements in place to be able to access that information. The second issue that I think is a very important issue for CRA is that they need to have the expertise; they need to have the people who are going to be able to understand what these transactions are. We noted in our most recent audit that they were having great difficulty, especially in the greater Toronto area, getting that expertise in their offices. So if you don't have the expertise, they can't understand what the transactions are or even begin to imagine what the transactions could be.

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

On the same train of thought, the other question I have for you is this. In your experience, are there legitimate business reasons to have multinationals in countries that are considered tax havens? I understand the part about income tax--companies don't want to pay income tax, just as individuals don't want to pay income tax--but is there another reason other than that? Is there a business reason?

[Sheila Fraser]

There could potentially be a business reason, but when you look at the investment, we had some numbers, and I think it went from $600 million to close to $3 billion in Barbados within five to ten years. I would be surprised if that was all for investment in Barbados.

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

On another subject, the tax treaty and the agreement we have with Barbados--and I think the Bloc is going to speak on this. I'd like to talk more about the numbers whereby a company from Barbados will be able to clean up its retained earnings or pay a low tax and have all this tax-free distribution. They repatriate it to Canada, and then the Canadian multinationals pay dividends to Canadian taxpayers, so Canadian taxpayers will then get revenue in the form of dividends, but they will also get a dividend tax credit that is supposed to be based on the corporate tax the multinational would have paid.

The Finance officials don't seem to have any figures as to how much that's costing Canadian taxpayers. Would that calculation be anywhere, from your understanding, whether it be from CRA or from the Department of Finance?

[Sheila Fraser]

I don't think information on the dividends Canadians would receive...there might be some information on the foreign investment, because a declaration has to be made to Revenue Canada and there's a database, and we use that database to get some information, but to have the amount that would flow through to Canadian individuals in the form of dividends, I don't think they would be able to give you that.

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

You wouldn't....

[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. Chairman.

Thank you, madam, for your presence here today.

When we undertook this study, a Bloc initiative, we found no progress had been made with respect to the accessibility of information. On point 10 of your statement, referring to recommendation 11.114 which you made in 2002, you said the following:

...that Finance Canada obtain and analyze current information to reassess the tax revenue impact and the rationale for allowing:

And you refer to tax treaties signed between Canada and other countries. I am thinking more specifically of the tax treaty between Canada and Barbados.

Have you received a response from the minister on this point since 2002? This committee has been unable to obtain information which might have provided you with a response to your request.

[Sheila Fraser]

No, we have not received a response.

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

Is that one of your concerns when it comes to the strength of the tax base? We have noted the increasing significance of globalization when it comes to international tax issues. Has the time come for an investigation into the international tax issues that affect Canada?

[Sheila Fraser]

Indeed, if we want to protect the tax base, it is important to have a good understanding of the threats and transactions occurring. We shouldn't be doing this on a case-by-case basis, but rather we should have a global outlook, because things are so interconnected.

I'd like to remind the committee that in 1997 a very significant report, the Mintz report, issued recommendations which were very seriously considered by everyone. As far as we know, there has been no follow-up to it. We believe that it would be good to have a study carried out, but we cannot forget about the one that was already done. Perhaps it could be updated and we could include the most recent events, but a comprehensive study was already done in the past.

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

The Minister of Finance has announced the striking of a committee for that five-year period. My reading of the committee transcripts did not give the impression that a comprehensive overview would be carried out. The minister stated that he hoped the committee would identify the legislative amendments which could be required to protect the integrity of Canada's tax base.

You would like this committee to have the mandate to undertake a study of international tax issues in general. Is that correct?

[Sheila Fraser]

We are not aware of exactly what the committee's mandate would be or of the scope of the work it will be carrying out, but we believe that if a study is to be carried out, it may as well be as wide-ranging as possible.

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

Could you give us a few examples of what you are concerned about? You've already given some, but I would like you to expand a bit.

[Sheila Fraser]

Yes, or I could defer to my colleague. We noted, during the most recent audit, in 2007, that the Canada Revenue Agency had identified 72 trusts that had managed to avoid taxation on $600 million worth of capital gains in Canada. There were other transactions prior to that. I will call on Ms. Plant to give you more details.

[Madam Vicki Plant, Principal Director, Office of the Auditor General of Canada]

I will find you an example.

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

In the meantime, could you tell me whether any of these cases were related to tax treaties, Ms. Fraser?