Public conversations about taxation have long been dominated by conservative demands for tax cuts for those much cited icons—job-creating businesses and hard-working families. Less attention has been paid to the issue of who pays more tax to fund tax cuts for others. This is changing in many countries. Economic insecurity, inequality and pressure on government budgets create a receptive environment for scandals about wealthy individuals hiding money in offshore tax havens and profitable multinational companies such as Apple avoiding taxes in many countries in which they operate. Alain Deneault has been deeply involved in the Canadian backlash against international tax evasion and avoidance, and the publication in English of Canada: A New Tax Haven — How the Country That Shaped Caribbean Tax Havens Is Becoming One Itself aims to aid the campaign by social justice advocates to pressure Ottawa to take the issue more seriously.
The book is grounded in a spirited defence of taxation’s role in funding the state and its programs, including social programs but also the economic policies and legal system that benefit corporations and wealthy individuals. This is in sharp contrast to most of the specialist tax literature, which revels in complexity, technicality and legal issues, obscuring the crucial political and social issues at stake. In fact Canada: A New Tax Haven occasionally suffers from the opposite problem, as technical details with important political and social implications get lost in the course of criticizing government policy and corporate behaviour. Still, this is a valuable contribution to a debate that merits serious attention.
It is useful at this point to define some key terms. Tax evasion is intentionally concealing or misrepresenting activities to escape taxes. In contrast, tax avoidance means using legal mechanisms to reduce taxes owing. Aggressive tax avoidance is using tax provisions to reduce taxes in ways not intended by the legislation. It is difficult to draw precise boundaries between acceptable and aggressive tax avoidance, and between aggressive tax avoidance and tax evasion.
Deneault argues that the language of tax avoidance helps legitimize questionable moves to reduce taxes, and that we should focus on the real consequences rather than get bogged down in definitional and legal issues. He claims that Ottawa’s approach is to “fight tax fraud by legalizing it. The government simultaneously condemns the fraudulent use of tax havens and encourages their legal use by corporations and the very rich.” This is viewed as part of a much larger problem: “the framework of capitalist globalization makes it possible for powerful people to bypass the constitutional principles that are the foundation of states, and Canada in this sense is actively pursuing its own destruction.”
These are strong claims. Let’s begin with the assertion in the title. Most analysts, including Deneault, agree the two key features that define a tax haven are: a) low or no taxes on income, especially income from business and investment; and b) secrecy rules that enable individuals and businesses to hide assets and income from other governments. Low taxes and secrecy are usually also accompanied by lax regulation. Businesses establish shell operations with little substantive activity in tax havens, and use a variety of techniques to shift income and profits to those shell operations to avoid paying taxes in the countries in which the income actually was earned. Classic examples include tiny offshore islands such as the Caymans and Barbados, as well as land-locked Luxembourg and Switzerland. Tax havens began to emerge as soon as governments started taxing personal and corporate income, although their number and impact have grown enormously in the era of globalization. Importantly, if perhaps surprisingly, the emergence of offshore tax havens was long tolerated and sometimes even encouraged by powerful western countries because the existence of these jurisdictions eased the global expansion of business across national boundaries. This paradox has been examined by Ronen Palan, Richard Murphy and Christian Chavagneux in their landmark 2010 study Tax Havens: How Globalization Really Works.
Deneault argues that Canada played a key role in the development of Caribbean tax havens such as the Bahamas, Barbados and the Cayman Islands, at one point describing them as “Canada’s creatures.” This is an overstatement; while Canadian banks, individuals and businesses played a role, the historical literature shows the United Kingdom’s government and the City of London were much more important. Lengthy chapters in Canada: A New Tax Haven focus on the development of various Caribbean tax havens and include lots of entertaining stories about criminals laundering money and about the misdeeds of various Canadian investors, but most are only loosely relevant. To support the claim that Canada had a role in creating the Caribbean havens distinct from the roles of private individuals with connections to Canada, more attention needs to be paid to describing and analyzing what the Canadian government did or did not do to support the emergence of these havens. For example, it would be helpful to explain the events and reasoning behind the 1980 decision to sign a tax treaty with Barbados that allowed Canadian companies to repatriate untaxed profits from Barbados to Canada exempt from Canadian tax.
Regardless of how they came to be, there is no doubt the Caribbean tax havens enable large-scale tax avoidance by multinational corporations. This leads to the book’s central claim: “instead of fighting tax havens, Canada is bringing its own regime into compliance with the pattern established by its formidable rivals.” Hence the book’s subtitle: “How the country that shaped Caribbean tax havens is becoming one itself.”
But is Canada itself becoming a tax haven? Ottawa does tax Canadian-owned companies lightly on profits earned abroad. In theory, Canadian-owned companies are taxed on their worldwide income, in contrast to countries that tax nationally owned companies only on the income earned in the home country. But in practice, as Deneault documents, Canadian multinationals take advantage of a variety of policies to avoid Canadian tax on their international earnings. Most important, the earnings of affiliates in countries that have tax treaties with Canada are exempted from Canadian taxation, on the assumption that the income was already taxed abroad. However, Canada has tax treaties with a number of tax havens such as Barbados that do not tax the income in question. Canadian companies therefore channel a large share of their international operations through tax havens. Unfortunately, Deneault provides few recent examples of specific Canadian companies’ tax-avoidance accounting, no doubt in part because of the secrecy that surrounds corporate taxation, but aggregate statistics are illuminating. Citing a study by Jean-Pierre Vidal, Deneault notes that the share of Canadian foreign investment going to Barbados rose from 0.7 percent in 1987 to 7.7 percent in 2006. The share going to Barbados and other tax havens has continued to increase; according to Statistics Canada, in 2014 the stock of Canadian foreign direct investment in Barbados totalled $71 billion. This amounts to $249,000 for each of the 280,000 Barbadians, and is enough to rank this tiny tax haven second only to the United States among recipients of Canadian foreign direct investment. The UK has slipped to third, with the Cayman Islands and Luxembourg—both tax havens—filling out the top five. Rapid growth in the Caribbean operations of Canadian banks also testifies to the increasing role of tax havens in Canadian companies’ overseas operations, and (not incidentally) helped the banks dramatically increase the share of tax-exempt income in their total earnings. Tax avoidance is the reason for the concentration of outward investment in tax havens.
The Conservative government made the problem of tax-exempt earnings from tax havens worse in 2009, when it extended the exemption to income repatriated from countries that did not have a tax treaty but were willing to sign a tax information exchange agreement with Canada. Current TIEAs do little to reduce tax avoidance and evasion because information is provided only when the requesting country has detailed information on the suspected tax fraud—the kind of information often unavailable because of secrecy rules in the tax havens—and because many havens do not collect or have the administrative capacity to provide relevant information. Deneault is rightly outraged: “tax havens couldn’t line up fast enough to enjoy the benefits of a Canadian-style agreement, including the certainty of attracting money seeking to escape the taxman.” He accuses the government of duplicity, “stimulating offshore activity while pretending to fight tax havens.” However, he only briefly notes the move in the G20 and the Organisation for Economic Co-operation and Development since 2013 to exchange information automatically rather than only on request. This promises to make tax information exchange much more effective. In 2014 Ottawa committed to introduce automatic exchange of information starting in 2018—consistent with the recommendation in Canada: A New Tax Haven that Ottawa adopt something like the Foreign Account Tax Compliance Act in the United States. (Canada’s new policy is based on the OECD standard, which was inspired by FACTA.) Questions remain about the implementation of the new standard, but the impact on tax evasion likely will be substantial.
The automatic exchange of information will have less impact on tax avoidance, the key problem for corporate taxation. It is well documented, by Deneault and others, that Ottawa tolerates some degree of tax avoidance by multinational businesses. The reason was made explicit in the Finance Department’s response to the auditor general’s 1992 criticism of the non-taxation of foreign affiliate earnings: “international norms limit the range of options available to the Canadian government and, in this context, the government’s policy has generally been to favour competitiveness concerns over those of revenue generation.” In effect, other taxpayers subsidize the overseas expansion of Canadian multinationals and the investments of foreign multinationals in Canada, though we have no estimates of the size of these subsidies. In this and other policy areas, competitiveness seems to be an all-purpose excuse for pro-business policies.
Canada also lowers the tax burden on Canadian-owned multinationals by allowing loopholes in so-called anti-avoidance rules intended to prevent companies from shifting profits to foreign tax havens. The most important are rules about transfer prices, the foreign accrual property income rules and rules to limit income stripping by means of interest payments on loans from tax-haven affiliates to Canadian operations. Deneault identifies important flaws in these rules and concludes they are ineffective. Anti-avoidance measures introduced to block aggressive tax avoidance usually carve out a range of activities that are acceptable—consistent with the book’s claim that Ottawa fights tax fraud by legalizing it. Anti-avoidance measures also, in the words of Canadian tax experts Brian J. Arnold and James R. Wilson, “often provide taxpayers with a road map to avoid the application of the specific rules.” Deneault shows how the problem is made worse by the willingness of the courts to permit aggressive tax planning as long as the taxpayer can show any possible business purpose for transactions designed mainly to avoid taxes. For example, in 2012 the Supreme Court legitimized a common aggressive tax avoidance strategy by siding with pharmaceutical company Glaxo against the Canada Revenue Agency. The CRA had claimed that Glaxo’s Canadian subsidiary paid far too high a price for a drug it imported from a Swiss affiliate, thereby reducing its Canadian tax bill by $51 million.
Canada: A New Tax Haven, like the author’s earlier co-authored Imperial Canada Inc., pays particular attention to mining companies, arguing that Ottawa and Ontario have made a concerted effort to establish Toronto as the global centre of mining investment using tax incentives and secrecy rules that shelter companies from accountability for exploitative labour and environmental practices in developing countries. However, aside from the already-discussed exemption of overseas corporate earnings from Canadian tax, most of the discussion of mining focuses on domestic tax incentives or non-tax supports Canada provides for mining companies at home and abroad, and therefore adds little to the title argument. This points to a weakness of the book; there is a tendency for the core argument to get lost in details of corporate misbehaviour of many kinds, matched by insufficient clarity on the specific tax measures in need of reform.
Deneault also points to cuts in corporate tax rates as evidence of Canada’s becoming a tax haven. The federal rate is now below that of the United States and many other OECD countries, which Ottawa touts as an incentive for investment. This, plus relaxed enforcement of anti-avoidance measures, should undermine frequent business calls for lower taxes: “there is absolutely no need to try and make the Canadian jurisdiction competitive; it already is.” Still, the combined federal and average provincial rate is comparable with that of many other OECD countries and notably higher than in tax havens such as Ireland and Switzerland. The overall burden of corporate taxes in Canada is right at the OECD average (2.9 percent of gross domestic product). In 2013–14, Ottawa took in $36.6 billion in corporate income tax revenues, far less than the $130.8 billion in personal income tax revenues but substantially more than from the goods and services tax ($31.0 billion).
It is true that $36.6 billion is a lot of money, and it is hard for this observer to reconcile that amount with the book’s depiction of Canada as an emerging tax haven. One answer to the puzzle is that the CRA’s anti-avoidance measures are not wholly ineffective. By focusing almost exclusively on the part of the glass that is half empty (i.e., on opportunities for tax avoidance by Canadian-owned multinationals), Canada: A New Tax Haven misses reasons why corporate tax revenues remain substantial. Even though outnumbered by the armies of accountants and lawyers employed by multinational corporations, tax auditors do limit opportunities for income shifting and tax avoidance, and the courts do rule against some avoidance schemes. The rules are occasionally revised to block tax planning techniques that exceed what Ottawa is prepared to accept, although Deneault points out that in some cases rules are changed to make legal what was previously not permitted. A recent example of the former is the 2015 budget proposal to limit companies’ ability to avoid taxes on income shifted to so-called captive insurance companies in tax havens. Multinational companies establish these companies in order to pay them for insuring Canadian risks, with the profits earned from that insurance going to the tax-haven affiliate. The foreign accrual property income rules are supposed to ensure Canadian companies pay tax on the profits of the captive insurance company, but tax specialists found ways around those rules and in recent years the CRA has been continually playing catch-up in response.
What does all this mean for the book’s central argument? While multinational companies have lots of scope to avoid Canadian corporate taxes, the country is not becoming a tax haven—yet. If not taxing the overseas earnings of nationally owned companies makes a country a tax haven, most countries are tax havens and the term becomes meaningless. Canadian- and foreign-owned companies together pay a substantial amount of income tax, even if one believes they should pay more. Deneault also provides little evidence that Canada fulfills the traditional role of a tax haven—a location in which to establish a shell company and shift foreign-earned profits to it in order to avoid foreign taxes—although the situation of some mining companies comes close.
This does not mean the problems identified in Canada: A New Tax Haven are insignificant—to the contrary, the book highlights some critical issues. Ottawa has made a great deal of tax avoidance legal for businesses and wealthy individuals, thereby lessening the burden on those best able to pay. In contrast, individuals earning wages and salaries have no choice about how their income is taxed and cannot structure their earnings to minimize taxes. Furthermore, the complexity and secrecy that surrounds international corporate taxation mean those taxpayers who compensate for the lost corporate tax revenues—mainly wage- and salary-earners—are not aware of how they are subsidizing the expansion of multinational businesses. The situation is exacerbated by the growth of a sophisticated legal and accounting sector devoted to helping multinational firms avoid taxes. The sector also is the most influential lobby on international tax issues, for example supplying many of the experts drafted by government to advise on policy.
Another important contribution Canada: A New Tax Haven makes is to highlight the Canadian government’s refusal to gather and publish information about international tax avoidance and evasion, in contrast to the attention it pays to small-scale domestic tax fraud. The government refuses to estimate the revenues lost to international tax avoidance and evasion, unlike many other countries including the United States and the United Kingdom. In various reports the auditor general of Canada estimates losses in the hundreds of millions of dollars. The Department of Finance rejects those estimates but has not provided its own. Information like this is critical for democratic accountability. It is not realistic to expect the public to have well-articulated views on the technical details of foreign accrual property income or transfer-price regulation, but the public should be able to assess the overall impact of government policies. The recent Offshore Leaks, Luxembourg Leaks, and Swiss Leaks data releases by the International Consortium of Investigative Journalists show that publicity can generate pressure on governments to do more about tax avoidance and evasion.
Opportunities for international tax avoidance are made worse by another recent trend in Canadian tax policy. In the past, light taxation of corporate profits was sometimes justified with the argument that the profits would eventually be taxed in the hands of shareholders. But Canada has also dramatically reduced the taxation of investment earnings at the level of individuals, by reducing capital gains taxes, taxing dividends at a reduced rate and introducing generous tax-free savings accounts. Corporate profits now are lightly taxed at both the corporate and individual levels. The fact that most investment earnings and the associated tax breaks go to the wealthiest Canadians makes the problem worse.
Can anything be done to limit international corporate tax avoidance and promote tax fairness? The concluding chapter of Canada: A New Tax Haven lists a variety of technical solutions identified by other analysts, and expresses the hope that growing citizen awareness led by social advocacy groups means “the people will learn to re-establish institutions in their own likeness.” This seems unlikely if the book’s description of the political power of economic elites is accurate. But Deneault is correct to highlight the need for greater pressure from citizens, which will require continued efforts to lift the shroud of secrecy that surrounds corporate taxation in Canada. These efforts should include pressuring the government to provide estimates of the tax gap as discussed earlier. Also crucial are efforts to reveal the international tax-avoidance strategies used by specific companies—Canadian and foreign owned—and the impact on their tax bills in Canada. The international Tax Justice Network has called for country-by-country reporting of the activities and tax payments by multinational companies. This could have a powerful impact by enabling citizens to assess whether those companies are paying a fair share of taxes.
There are also measures Canada could take to tax multinational firms more effectively. These include a modest increase in the corporate tax rate, especially since recent cuts have not generated the promised increase in business investment. Anti-avoidance measures could be strengthened. The OECD has developed detailed guidelines for taxing multinational corporations, and is currently preparing specific recommendations for combatting so-called base erosion and profit shifting. The OECD’s traditional approach is partly responsible for the problem of aggressive tax planning; it requires multinational corporations to artificially divide their integrated global operations into separate national accounts, and companies take advantage of this to locate profits in low-tax jurisdictions and costs in high-tax jurisdictions. It is not feasible for a single country such as Canada to pursue a radically different approach. Nevertheless, stricter enforcement of OECD guidelines could improve tax fairness. The guidelines are complex, which puts a huge administrative burden on governments wanting to defend tax revenues against the armies of tax experts employed by multinational firms and the tax service industry. Stricter enforcement would require hiring more tax auditors, but the resulting rise in tax revenues means the increase would be self-financing. The 2015 budget proposes steps in this direction, with an increase in audits of large, complex businesses—domestic and international—expected to net almost $200 million annually.
Canada should also strongly support an ambitious conclusion to the OECD’s BEPS project, which Deneault suggests Ottawa has so far been reluctant to do. The BEPS project does not fundamentally change the flawed traditional OECD approach to taxing multinationals, but it initially promised to address the key mechanisms of international corporate tax avoidance created by that approach. BEPS now faces intense opposition from multinational businesses, the international tax planning industry and American political leaders concerned it will help foreign governments tax U.S. multinationals more heavily. Without strong political support from other member-country governments the BEPS project could suffer the same fate as the failed Harmful Tax Competition project launched by the OECD in the late 1990s.
Incremental and diplomatic measures like these would not meet the more far-reaching demands outlined in Canada: A New Tax Haven, but could make the tax system less inequitable. The efforts of groups such as Canadians for Tax Fairness and the global Tax Justice Network show it is difficult to generate public understanding and concern about a policy area as dry as corporate taxation, and it is also difficult to mobilize a social movement around incremental and diplomatic measures such as those just described. While not the definitive analysis of the problem, Canada: A New Tax Haven should help inspire concern and possibly even greater pressure from the Canadian public.