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THE HIGH COST OF LOW CORPORATE TAXES
11/11/18
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A deep dive into the financial statements of Canada’s biggest corporations shows these companies pay far less than the official corporate tax rate.
For every dollar corporations pay to the Canadian government in income tax, people pay $3.50. The proportion of the public budget funded by personal income taxes has never been greater.
At a time when Prime Minister Justin Trudeau has made tax fairness a centrepiece of his government, the Toronto Star and Corporate Knights magazine spent six months poring over tax data to determine how much income tax corporations are really paying.
We found the amount of tax most big companies pay has been dropping as a proportion of their profits for years, and not only because the corporate tax rate has been cut repeatedly. Canada’s largest corporations use complex techniques and tax loopholes to reduce their taxes significantly below the official corporate tax rate set by the government.
Our analysis of the financial filings of Canada’s 102 biggest corporations shows these companies have avoided paying $62.9 billion in income taxes over the past six years.
The 2011-2016 audited financial statements of all large Canadian corporations (those worth more than $2 billion) reveal they paid an average of 17.7 per cent tax.
During that time, the average official corporate tax rate in Canada for this group of companies was 26.6 per cent.
[see chart at link]
That 8.9 per cent gap translates into tens of billions of dollars that could have been used to pay for the schools, roads, hospitals, police and paramedics we all rely on.
The accounting manoeuvres Canadian corporations perform to reduce their tax bills are legal. But complex reporting rules make it difficult to determine if a company is actually paying its fair share of taxes.
The Star/Corporate Knights analysis looked at the amount of taxes companies paid as a per cent of profits over a six-year period to even out yearly fluctuations. Big losses and investments happen, and may reduce a corporation’s tax rates in any given year, but consistently low tax rates can indicate a pattern of avoidance.
This project is the first comprehensive attempt to combine Canadian corporations’ audited financial statements with government data to quantify the extent of corporate tax avoidance — and determine how much it costs the rest of us.
“Some income simply is not taxed,” said Peter Spiro, an economist with the Mowat Centre, a public policy think tank at the University of Toronto. “The public policy question becomes: are these tax breaks or tax exemptions justifiable?”
At a time when stocks and corporate profits are near record highs, the federal government has targeted small private corporations, expecting to recoup an estimated $250 million in tax revenue by closing loopholes.
If Ottawa instead closed all the loopholes used by large corporations, it could collect 40 times more than that.
In an average year, the 102 biggest companies in Canada pay $10.5 billion less than they would if they paid tax at the official corporate tax rate.
“That gap is undermining the integrity of the tax system,” said Jordan Brennan, an economist with UNIFOR, Canada’s largest private sector union, which represents Star employees. “Once we establish what the rates are, you have to have enforcement mechanisms to make sure (corporations) pay them.”
“If the government closed that gap they stand to gain $10 billion every year. Think about what you could do with $10 billion each year. That’s a national child care program. That’s any government’s signature program. Even if you’re fiscally conservative, you could use it to reduce the deficit. That’s not an insignificant portion of revenue,” said Brennan.
WHAT WOULD $10.5 BILLION BUY? [See link for details]
The last year that corporations paid as much income tax as people was 1952.
That year, the Canadian government was flush with money and used it to start setting up the social safety net with the establishment of the Old Age Security pension program. The private sector was also doing well, as corporate capital investments hit record levels and wages soared. The postwar boom was in full swing and the wealth was being enjoyed widely: Suburbs were exploding, schools and hospitals were built and new highways were laid down across the country.
This era of public and private prosperity — “unrivalled in our history” said then-federal finance minister D.C. Abbott — came after Canada had twice imposed an “excessive profits” tax during both world wars.
Excessive profit, or rent, is an economic term used to describe profit beyond what is needed to keep a business running.
For the first half of the 20th Century, the Star campaigned for establishing and keeping this excessive profit tax in place, repeatedly arguing: “There is, in fact, no better or juster source of tax revenue than unreasonably high profits.”
Under publisher Joseph Atkinson, the Star’s editorial board made this argument for taxing corporate profits in 1946: “A special tax should be levied upon profits in excess of a reasonable amount ... The principle of imposing a proportionately higher tax upon high incomes of individuals is recognized as just, and should be in a measure applicable to the profits of corporations when these are beyond reason.”
Today, Canada’s economy is the strongest in the G7, but municipal, provincial and federal governments have to borrow money every year, or dip into savings, to make ends meet. Inequality is at an all-time high. The rich are getting richer, the poor are getting poorer and public infrastructure — from transit to social housing — is failing and falling apart.
WHEN CORPORATE TAX AND PERSONAL TAX WERE EQUAL
While Canadian governments have trouble coming up with cash for public services, Canadian companies are rolling in dough.
Among Canadian corporations, one sector emerges as the most profitable. It’s also the sector with the companies that pay the lowest taxes: banks.
Last year, Canada’s Big Five banks — BMO, CIBC, RBC, Scotiabank and TD — occupied the top five slots on Report on Business Magazine’s Top 1000 ranking of the country’s most profitable companies. Collectively, they booked $44.1 billion in pre-tax profit. (Their just-reported 2017 profits were even higher.)
That same year, the Star/Corporate Knights analysis found those five banks avoided $5.5 billion in tax.
This was not a one-off. Over the past six years, while the Big Five have been posting record profits, the tax rate they paid has dropped.
According to Statistics Canada, pre-tax profits in the banking sector as a whole soared by 60 per cent from 2010-2015. During that period, the sector’s tax rate (taxes paid divided by pre-tax profit) has dropped by almost the same amount.
BANKS: PROFITS UP, TAXES DOWN, 2010-2015 - [see charts at link]
Banks reduce their taxes by far more than other corporations. In 2015, businesses in the rest of the economy (including the banks’ credit union cousins) paid taxes at a rate triple that of banks.
This number is skewed by the huge losses oil and gas firms suffered in 2015. If oil and gas companies are removed, the tax rate paid for non-financial companies is still 24 per cent in 2015, or 2.5 times greater than banks.
BANKS VS THE REST OF THE CANADIAN ECONOMY, 2010-2015 [See link]
Not only do banks pay a lower tax rate than other companies, Canadian banks pay at a lower rate than banks in other countries.
While all banks legitimately reduce their tax burdens through depreciation, investment losses, loan interest writeoffs and tax credits, Canadian banks use these measures to erase more tax than their global competition. We did an international comparison and found Canada’s big banks have the lowest tax rate in the G7.
This November, when the Senate was discussing closing loopholes for small corporations, Senator Scott Tannas asked Finance Minister Bill Morneau, “why wouldn’t you hunt where the ducks are … with the big banks?”
“If we could get them to pay what should be a fairly reasonable average between their U.S. operations and Canadian, we’d be billions ahead. I don’t understand why, year after year, only Bay Street has a special rate,” Tannas said.
TAX RATE PAID BY LARGE BANKS IN G7 COUNTRIES
Source: Bloomberg, cash taxes paid as percent of pre-tax profits for banks with >$2B (US) market capitalization, 2011-2016
How do the Canadian banks do it?
The Big Five earn the vast majority of their revenue in Canada and the U.S., which has a higher corporate tax rate than Canada. Yet in their financial statements to investors, the banks declare that lower tax rates in their “international operations” helped them reduce their taxes by $6.5 billion over the past six years.
While the banks don’t disclose how they lowered their tax bills through their international operations, they all have subsidiaries in tax havens.
Many of these tax haven subsidiaries have tiny offices, but account for massive profits. TD, for instance, has a subsidiary in Ireland that is valued at over $1 billion, even though TD Ireland employed only two of the bank’s more than 85,000 staff.
Canadian banks have subsidiaries in Barbados (0.25 — 2.5 per cent corporate income tax), the Cayman Islands (0 per cent), Ireland (12.5 per cent), Bahamas (0 per cent), Bermuda (0 per cent) and Luxembourg (starts at 19 per cent, but can be much lower as many multinational companies negotiate special tax deals).
All of these tax havens have something in common: they have a tax treaty or Tax Information Exchange Agreement (TIEA) with Canada. These treaties and agreements were meant to prevent the double taxation of corporate profits, but in practice they make it possible for companies to avoid paying tax altogether, recording profits where there are low or no income taxes and then repatriating this income to Canada tax-free.
Canada has admitted this is a problem, and this year joined 67 countries in an international effort to crack down on a widespread tax avoidance method called “profit shifting,” where a corporation performs internal transactions to concentrate its profits in tax havens.
“We want to make sure that large companies aren’t inappropriately having expenses in high-tax jurisdictions and taking profits in low-tax jurisdictions,” said Morneau in the Senate last month. “We want to have rules that appropriately force people to pay taxes in jurisdictions where the business activity is actually happening.”
NDP justice critic Murray Rankin suggests the government go one step further and explicitly ban corporate transactions without any “economic substance” — a move, he says, that will hamper companies’ ability to exploit offshore tax loopholes.
BIG FIVE BANKS AND TAX HAVEN SUBSIDIARIES - [See link]
The Star and Corporate Knights showed this analysis to more than two dozen financial and economic experts. Many of them explained the findings by pointing to Canadian tax rules that allow much of the banks’ investment income to go untaxed — especially if that income is recorded in an offshore tax haven.
Tax expert Spiro singles out one tax break: Dividends paid by foreign subsidiaries to their Canadian parent companies are tax free.
What qualifies for this tax exemption “is particularly generous in Canada,” Spiro said. “There is an argument to be made that there is some benefit (to the economy) from this, but the issue is whether you need quite such a generous exemption.”
According to their financial statements, over and above their tax savings from “international operations,” the Big Five saved an additional $8.6 billion in taxes from “tax-exempt income” over the past six years.
Internationally recognized tax expert Brian Arnold says Canadian tax law gives an unfair advantage to companies that invest abroad over companies that keep their money at home.
“It’s a subsidy for foreign investment by Canadian corporations,” Arnold said. “This situation is so clearly abusive that it is difficult to understand how the government can defend it with a straight face.”
Peter van Dijk, a national tax policy expert at the accounting firm PwC, pointed out that this is not a trick corporations sneak by the government.
“This was a conscious policy decision to preserve the ability of Canadian companies to compete internationally,” he said in an email.
HOW MUCH TAX DO CANADA’S BIGGEST COMPANIES PAY? 2011-16 - [See link for chart]
The Star and Corporate Knights asked international financial reporting expert Paul Rhodes to review the six years of financial disclosures made by the 10 companies with the biggest tax gaps.
While Rhodes was able to identify some broad areas where corporations were reducing their tax bills, he was unable to determine the precise techniques used due to the limited information that’s made public.
“For example, the actual operations in tax havens are not described in any way … On the face of it, you can see how much money a company is saving in tax through tax havens, but you can’t look behind that to see how and why those tax savings are coming about,” said Rhodes.
“The information disclosed may comply with the accounting rules, but it is woefully inadequate in answering these types of question,” he said after spending a week reviewing the companies’ public disclosures.
While the way we measured the tax gap has some weaknesses, Rhodes said the value in this exercise comes from the differences it identifies between companies.
“This really casts some light on the largest corporations, where some companies — the banks are singled out by an order of magnitude — appear to be avoiding large amounts of taxes.”
The tax avoidance figures and Rhodes’ analysis was provided to the 10 companies that avoided the most tax. Each corporation was asked for comment or reaction, which is summarized in the table below. While many questioned the methodology, none contested the numbers.
“Often when companies don’t like the results, they say the numbers or methodologies are wrong,” said Scott Dyreng, a visiting scholar at Oxford University and author of a widely referenced paper on global corporate tax avoidance, which used the same method as this analysis.
“There are all kinds of criticisms of this method for calculating a tax gap, but there is no other way to compute it that does not have at least an equal number of criticisms,” Dyreng said.
METHODOLOGY — HOW WE CALCULATED THE TAX GAP
We define the “corporate income tax gap” as the difference between total income taxes owed (official tax rate multiplied by pre-tax profits) and cash taxes paid from 2011 to 2016. This measurement is intentionally broad — it captures any form of tax reduction whether through tax sheltering, income shifting, tax preferences within the tax code, or rule changes. It also captures deferred tax: income that is not currently included in taxable income but may be at some later date. This is a methodology used by academics, the New York Times in a 2013 piece that looked at American companies and Canadian Business magazine in similar comparative studies.
HOW 10 COMPANIES AVOIDED $41 BILLION IN TAXES, 2011-2016 - [See link for details]
The Big Five banks referred the Star and Corporate Knights to the Canadian Bankers Association, which was provided with a summary of our analysis.
“Canada’s banking sector is proud of its commitment to responsible corporate citizenship, which includes paying its full share of taxes and contributing to the prosperity of Canadian society,” wrote CBA spokesperson Aaron Boles in a statement.
Canadian banks are considered the soundest in the world and have received accolades for the prudence that allowed them to weather the global financial crisis of 2007-2008 better than banks in the U.S. and Europe.
“When banks are profitable, they are stable,” states the CBA website, noting banks employ 285,000 people in Canada. “When banks succeed, the economy and communities prosper.”
The CBA said focusing on corporate income tax provides an incomplete picture of the banks’ total tax contribution, which should include payroll taxes, social security contributions, excise taxes, sales taxes and property taxes.
This is not how people calculate their income tax rate. If individuals included the HST they paid on everything they bought, their property taxes and the amount they pay the government for their water bills, their tax rate would balloon as well.
When comparing income taxes alone, the more than 18 million Canadian taxpayers pay 3.5 times more than all corporations, even after individuals receive their tax refunds from the government.
The CBA also pointed out that in addition to paying taxes, banks are among Canada’s top corporate donors, providing multimillion dollar support for non-profit community groups across the country.
In the past six years, total donations made by the Big Five amounted to less than one-tenth of what they avoided in tax.
BIG FIVE BANKS AVOIDED TAXES VERSUS DONATIONS, 2011-16 - [See link for chart]
The CBA has long argued any tax changes that impact bank profits could hurt average Canadians.
“As most Canadians are shareholders in Canada’s banks either directly or through the Canada Pension Plan, pensions and mutual funds, these payments benefit the vast majority of Canadians and their retirement savings,” the group wrote in a submission to the House of Commons Standing Committee in 2010.
Stockholder data collected by Bloomberg and StatsCan show that more than 80 per cent of Canadian stocks are owned (both directly and indirectly through pensions and mutual funds) by foreigners and the wealthiest households in the country.
WHO OWNS CANADIAN STOCKS - [See link for chart]
Historically, businesses have argued that raising corporate tax will hurt investment. But StatsCan numbers show that drastic cuts to the corporate income tax rate over the last 20 years have not stimulated new business investment.
Between 1997 to 2016, Canada’s corporate income tax rate was cut almost in half, from 43 per cent per cent to 26.7 per cent. But investment in machinery and equipment and in intellectual property is still below the 1997 level as a per cent of GDP.
“(Corporate tax cuts) were supposed to incentivize greater job creation and investment. This didn’t happen,” said UNIFOR economist Brennan. “And we’ve seen a massive uptick in activities that are hard to classify as productive: stashing cash on the balance sheet, share buy backs, massive increases in executive compensation and a huge increase in merger activity. That’s not what was supposed to happen.”
Peter Nicholson, former Finance Canada deputy minister, says Canada has implemented a market friendly tax rate, but failed to reap the rewards in productivity and innovation.
“I think corporate behaviour is generally driven more by opportunity and competition than by tax rates per se. … I don’t think raising or lowering taxes has a hell of a lot of influence on where companies invest,” Nicholson said.
“In Canada, the evidence is that increasingly a larger fraction of income to corporations is related to excessive profits,” said Joseph Stiglitz, a Nobel Laureate and Professor at Columbia University. “Lower tax rates encourage firms to engage in more excessive profit seeking. You have greater incentives to create more monopoly power, to lobby (the government), because you get to keep a larger fraction of the returns from the lobbying activity.”
“Some countries, including Canada, have attempted to dramatically cut taxes on the wealthy and let corporate tax avoidance prosper,” said Gabriel Zucman, an economist at Stanford University.
“The result of these ‘trickle down’ policies which started in the 1980s is now clear: income and wealth have boomed for a tiny fraction of the population, but this has not benefitted the rest of the population at all. We must learn the lessons from this big natural experiment. The main lesson is that to have broad-based growth, we need an equitable tax system, where big corporations and high-earners in the financial industry and elsewhere pay their fair share — otherwise Trumpism will prevail.”
TAXES DOWN, BUSINESS INVESTMENT FLAT, 1997-2016 - [See link]
What can be done?
Tax collectors around the world have had a tough time getting financial companies to pay more tax. Because billions can be moved around the planet at the click of a mouse, and payments can be recharacterized after the fact for tax purposes, it’s nearly impossible to shut down the loopholes they use. One potential solution is to tax cash flows instead of profits, but this would require rewriting the entire tax code.
A simpler solution that gets at the heart of the problem is a bank levy. Already implemented in the U.K. and Australia, it has the additional advantage of being difficult to wriggle out of.
With some exceptions, Australia charges a levy of 0.015 per cent every three months on banks’ riskier borrowing, “ensuring that the banking sector makes a fair contribution to the economy,” the government states on its website.
The same levy in Canada would have brought in up to $2 billion in 2016, bumping up the tax rate for the Big Five banks from 14 per cent to 18 per cent. A modified bank levy could also be applied more broadly to the financial sector. And since the financial sector accounts for more than two-thirds of the avoided taxes by all large Canadian corporations, a bank levy would go a long way toward ensuring corporations pay taxes closer to the official rate.
It’s a solution that the Mintz report, commissioned in 1996 by then-finance minister Paul Martin, recommended for Canada. The measure was to be called a “temporary increase in financial institution surtaxes” and was projected to bring in up to $300 million each year at the time.
The temporary surtax was to be phased out as taxes for the financial sector were brought into line with the rest of the economy.
“We suggest that capital and income taxes on financial institutions be adjusted over time to be comparable with those imposed on other large corporations in other industries.” stated the report, co-authored by tax expert Jack Mintz.
While many of Mintz’ suggestions were put in place, the bank levy never got off the ground.
Twenty years later, corporations — and especially banks — continue to pay less than the rest of us.
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