- News Release 2007-041 - 

Archived - Notes on the Initiative

Last October, we took an historic step to improve the fairness of our tax system through the introduction of our Tax Fairness Plan. We levelled the playing field between corporations and income trusts, bringing Canada in line with other jurisdictions around the world.

In Budget 2007, we are taking tax fairness a step further with our Anti-Tax-Haven Initiative.

As many of you know, this issue has been around for some time.

Concerns were expressed by the Auditor General, the 1997 Mintz Committee on Business Taxation, the House of Commons Public Accounts Committee in the 1990's and the House of Commons Finance Committee in 2006.

The Auditor General, in 1992 and 2002, recommended that the government review its rules and policies on the matter.

The 1997 Committee on Business Taxation recommended in its 1998 report that interest expenses of Canadian taxpayers paid on debt incurred to invest in foreign affiliates be disallowed.

We are following through on this advice.

Our proposed Anti-Tax-Haven Initiative is composed of four specific parts:

• Firstly, preventing the use of double dipping and other tax avoidance schemes such as the "tower" structure, which I will talk about in a minute;
• Secondly, we are providing corporate Canada with a transition period of almost five years to comply with these rules. This means that implementation will take place only after our planned corporate tax reductions are fully in place, allowing us to make our strong competitive economy even stronger;
• Thirdly, any tax revenues generated through the Anti-Tax-Haven Initiative will be used to further reduce business taxes in Canada; and
• Finally, we will continue to look for ways to bring fairness to Canada's tax system. In the near future, we will be appointing an advisory panel of experts to look for ways to further improve the fairness and competitiveness of Canada's international tax system.

Let me explain the kinds of tax planning I am talking about.

On this next slide, you will see a simplified illustration of a "single dip."

For example, a Canadian company, referred to here as Canco, has borrowed money from a bank to invest in a foreign affiliate and claims the interest as an expense against taxes.

The single dip provides a significant benefit to Canadian businesses investing abroad because the interest is deductible even though the related income from the investment is generally exempt from tax in Canada.

This treatment gives Canadian businesses a competitive edge when combined with other elements of Canada's tax system, such as competitive tax rates.

The "double dip," seen here, is where we need to draw the line. It simply goes too far.

For example, Canco takes the borrowed funds noted above and makes an equity injection into Havenco, a company in a low-tax jurisdiction. Havenco then lends the funds to Canco's affiliate in a third foreign jurisdiction, Opco, and Opco claims a second interest expense on those funds.

A "double dip" is a structure to finance investments abroad that, in short, allows two tax deductions for only one investment in a foreign affiliate.

Again, what we are talking about here is: one investment, some transfers of funds and two deductions.

Is this fair?

Is it fair for corporations to get two deductions to avoid paying tax?

Is it fair to ask hard-working Canadians to subsidize multinational corporations?

Is it fair to maintain a tax loophole that benefits some, but not others?

This is not what we call tax fairness in Canada.

This is inherently unfair.

This next slide gives you an idea of the lengths some are willing to go to avoid paying tax. This is the "tower" structure I mentioned earlier.

The details are quite complex, but essentially this achieves the same result as the double dip transaction because Canada treats the U.S. partnership as a partnership and the interest paid by the partnership as an expense deductible by the Canadian partners, whereas the U.S. treats the U.S. partnership as a corporation and allows the interest paid by it to be deducted against U.S. investments.

There is a real investment at the bottom of the chain, but only one. The different characterizations of the transactions mean that the corporate group has managed to deduct the cost of financing that investment twice, once in the U.S. and a second time in Canada.

Again, this is inherently unfair.

Now some believe that by preventing the use of tax havens and other tax avoidance measures, we will be putting Canada at a disadvantage, that we will lessen the international competitiveness of our multinationals because the practice is allowed in other jurisdictions.

I do not agree.

International competitiveness depends not on a particular isolated aspect of a country's business environment, but on the economy as a whole. This is equally true of tax competitiveness, which depends on many factors including marginal effective tax rates, statutory tax rates, taxation of foreign-source income, and interest deductibility.

Canada compares well to other countries. Some limit double dipping-for example, the U.K. has taken important steps against certain forms of double dip transactions in recent years; some impose higher tax rates, like the U.S. and Japan; some tax repatriated foreign earnings-again the U.K. is in this category; and some restrict interest deductibility, such as Australia. Importantly, overall, Canada's tax system is competitive.

In fact, if we were to compare our tax system to the U.S. tax system, Canada's is more favourable in many important respects: the U.S. has higher tax rates; the U.S. taxes foreign earnings when repatriated; and the U.S. has been aggressive in shutting down tax avoidance, including, but not limited to, certain double dip structures.

Some people believe that our Anti-Tax-Haven Initiative will contribute to the so-called "hollowing out" of corporate Canada. Several reports issued lately suggest this is not the case.

The Institute for Competitiveness & Prosperity has looked at hollowing out and says in its latest report:

"We now have 72-or more than twice as many global leaders as in 1985. In fact, we are growing globally competitive Canadian firms at a rate that wildly exceeds the rate of foreign acquisition. Net, we simply are not being hollowed out. We are thickening up."

Statistics Canada reports that there was a greater increase in Canadian investment abroad relative to foreign investment here. At the end of last year, Canadians' foreign corporate holdings were worth $74 billion more than foreign corporate holdings here, up from $52 billion more a year earlier.

In its fourth-quarter 2006 report, the Crosbie investment banking firm said "Canadian companies continued to exhibit a strong appetite for foreign companies, making 456 purchases valued at $70 billion, nearly quadruple the number of foreign acquisitions of domestic companies."

A KPMG report released last week says there have been more Canadian acquisitions of foreign firms than foreign acquisitions of Canadian firms over each of the past two years.

There is a considerable body of evidence pointing to the fact that Canada is a strong competitor in the vastly expanding global economy. Nevertheless, the Minister of Industry, Maxime Bernier, will soon be launching a competitiveness panel that will be studying a variety of areas, including "hollowing out." I look forward to reviewing their findings

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We are also ensuring tax fairness will not compromise our competitive advantage in the world. The fact is that we have moved quickly to improve our competitive environment by lowering corporate taxes substantially.

• We are reducing the general corporate income tax rate to 20.5 per cent in 2008 as part of our commitment to reduce this tax to 18.5 per cent by 2011;
• We are eliminating the corporate surtax in 2008;
• We increased the threshold for small business income eligible for the reduced federal tax rate from $300,000 to $400,000 as of 2007;
• We are reducing the 12-per-cent rate for eligible small business income to 11.5 per cent in 2008 and 11 per cent in 2009;

• We eliminated the federal capital tax in 2006;
• We are providing incentives for the provinces to eliminate their capital taxes-in their most recent budgets, Quebec, Ontario and Manitoba have taken action to reduce their capital taxes;
• We are better aligning capital cost allowance rates with the useful life of assets; and
• We have reached an agreement in principle on the Canada-U.S. Tax Treaty that includes the elimination of withholding taxes on interest and the extension of treaty benefits to limited liability companies in Canada.

Through our two budgets and our Tax Fairness Plan, we have also provided significant, positive tax relief for individuals, families, students and seniors-almost $38 billion over three fiscal years. For example:

• We reduced the GST from 7 to 6 per cent;
• We introduced a Canada Employment Credit to help offset the cost of working;
• We are providing a new $2,000 child tax credit for each child under 18;
• We are introducing a Working Income Tax Benefit to help low-income Canadians over the welfare wall; and
• We introduced income splitting for pensioners and seniors.

We are beginning to realize the benefits of our actions. As noted in this graph, when fully implemented, our changes will move Canada from the third highest tax rate on new business investment in the G7 to the third lowest by 2011.

Quite an accomplishment in just over a year, but we won't be satisfied until Canada's effective tax rate on new business investment is the lowest in the G7.

By maintaining our determination and focus we will reach our goal, but not at the expense of tax fairness.

We are proceeding with our Anti-Tax-Haven Initiative because it is the right thing to do, but we must ensure we get it right. As I said previously, the principle is sound and will be adopted. Implementation is something our tax experts are open to discuss.

The changes to the Income Tax Act required to give effect to the Anti-Tax-Haven Initiative will be complex and highly technical. To ensure a comprehensive consideration of the factors involved and a smooth implementation, a Technical Roundtable of tax experts, chaired by the Department of Finance, will be created to provide input in the development of the enabling legislation.

- News Release 2007-041 -