Corporate tax evasion, avoidance and competition:

Transcription

1 White Paper Corporate tax evasion, avoidance and competition: Analyzing the issues and proposing solutions November 2013 taxation

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3 Table of Contents Executive Summary... 1 Introduction Concerns over tax evasion and avoidance the global context Why has corporate income tax been the issue? Why is the global corporate income tax system so complex? How does corporate income tax affect Canadians and Canadian businesses? Summary... 4 Do these concerns have merit?... 4 Fair share... 4 Tax avoidance is not tax evasion Acceptable versus unacceptable tax planning focus on the law s object and spirit....4 How should Canada approach corporate taxation? Transparency and higher-risk tax positions Next steps the role of the accounting profession and tax advisors i

4 Executive Summary Tax evasion or aggressive avoidance practices are increasingly generating headlines and sparking public outcry. The corporate sector, both in Canada and internationally, often finds itself caught in the crossfire even when a legal approach to tax planning was adopted. A number of misconceptions or confusion persist, particularly when it comes to the difference between legal tax planning and illegal tax evasion and the impact of corporate income tax on businesses and broader economies. In this paper, Chartered Professional Accountants of Canada ( CPA Canada ) aims to bring greater clarity to the discussion of tax evasion, avoidance and competition while providing concrete recommendations to address the issues. We suggest that increased transparency on the part of both taxpayers and tax authorities should be considered. Such transparency could be approached as part of a more fundamental shift toward a more cooperative and respectful relationship between the parties. We firmly believe illegal tax evasion is harmful to economies and should be prevented. However, legal tax planning by businesses should be accepted as a means of minimizing expenses, like any other business effort to reduce costs. Corporations should be expected to make legal use of low tax rates or other tax benefits that countries offer to compete for foreign investment. What can emerge are grey areas where the tax planning is technically legal but a revenue authority views the action as going against the spirit of the law. In such situations, the tax courts and policy makers should be relied on to resolve questions and provide certainty for businesses and the revenue authority going forward. The Organisation for Economic Co-operation and Development (OECD) is working on the G20 s behalf to develop global solutions to stop tax evasion, increase tax transparency and information sharing, and modernize international tax laws. It is essential that Canada and its taxpayers are part of the process to ensure that our competitive position is maintained and the effects of recommended solutions are addressed from a Canadian perspective. CPA Canada further submits that there are unilateral steps Canada should take now to improve the operation of its tax system. These steps include: 1. Keeping corporate income tax rates low 2. Tightening the focus of specific anti-avoidance rules 3. Rethinking the corporate income/consumption tax mix 4. Using tax policy to help Canadian businesses compete 5. Pursuing more international Tax Information Exchange Agreements. Finally, we believe the government should consult Canadian businesses and tax advisors on the potential benefits that greater tax transparency may offer. Such transparency could come as part of a broader move toward enhanced relationships among taxpayers, tax auditors and tax advisors based on more transparency, cooperation and trust. Given the significant role that Canadian professional accountants play in advising and assisting companies to comply with their tax obligations in Canada and abroad, CPA Canada and the profession are uniquely positioned to foster the development of such an enhanced relationship. Introduction In recent months, there has been an escalating outcry globally and in Canada over domestic and international tax evasion. As well, there is a growing perception among the media, certain non-government organizations (NGOs) and ordinary citizens that many corporations engage in aggressive or unacceptable tax planning activities. Governments throughout the world are weighing various strategies to respond to these concerns. This topic is extremely complex, and the debate has been muddied by a number of factors, including: A lack of understanding of the nature of corporate income tax and its effect on business and the economy, globally and in Canada 1

5 Misconceptions about the meaning of tax evasion, which have led to confusion in distinguishing between tax evasion, which is illegal, and tax planning, which is legal Confusion over the distinction between acceptable and unacceptable tax planning The notion that companies should pay some fair share of tax. As a result of these factors, many corporations are under fire for their legal tax planning activities. While this paper focuses on corporations, similar concerns have been raised for high net worth individuals. In this paper, CPA Canada aims to bring its perspective to the debate on international corporate tax evasion and avoidance. We also provide the federal government with concrete recommendations to protect Canada s tax base and ensure the corporate tax system works as effectively as possible. In particular, we believe an enhanced relationship based on more transparency, cooperation and trust among taxpayers, tax auditors and tax advisors is needed to improve the functioning of Canada s self-assessment system. Given the significant role that Canadian professional accountants play in advising and assisting Canadian companies to comply with their tax obligations in Canada and abroad, they are uniquely positioned to facilitate the development of such an enhanced relationship. Concerns over tax evasion and avoidance the global context The recent Communiques 1 of the G8 and G20 leaders following their Lough Erne, Moscow and St. Petersburg Summits show the serious intent of the international community to tackle both tax evasion and what governments view as unacceptable tax planning. The OECD s newly released Action Plan on Base Erosion and Profit Shifting 2 ( Action Plan ) identifies 15 specific actions for a coordinated international approach. These concerns have arisen for a number of reasons. Most governments have incurred historically high budget deficits and debt levels in order to restore their economies following the 2008 financial crisis. Individuals in a number of countries have seen taxpayer dollars used to rescue large, financial institutions whose actions, along with lax regulations and government oversight, are seen to have contributed to the crisis. Deepening these concerns are highly publicized examples of large multinational companies earning significant profits but using legal tax planning to avoid paying what is viewed as their fair share of tax. These factors have spurred widespread calls for change, especially to the international corporate income tax system. Why has corporate income tax been the issue? Corporate income tax is the tax levied on corporate profits by national jurisdictions. The amount of tax that a company pays generally varies in step with its profits. As the recent economic downturn showed, corporate income tax is one of the most volatile revenue sources for governments. Taxing income is one of many alternatives that governments can use to raise revenue. Taxes on consumption, for example, offer more stable revenue streams and generally allow less scope for tax avoidance. For companies, income and other taxes are a cost of doing business. Like any other cost, companies typically aim to reduce their domestic tax costs. Among other things, reducing their tax cost helps companies create jobs by investing in more business activities and distributing more of their profits to shareholders. Companies that operate globally seek to reduce their taxes on an international basis as well. This is not surprising. As with individuals, no corporation should be expected to pay more tax than is legally required. Why is the global corporate income tax system so complex? The Canadian corporate tax system is complex, especially for companies that operate globally as they also must comply with the tax laws of all jurisdictions in which they operate. 1. G8 Leaders Communiqué and G8 Lough Erne Declaration, 2013 Lough Erne Summit, July 8, 2013; Communiqué: G20 Meeting of Finance Ministers and Central Bank Governors, 2013 Moscow Summit, July 20, 2013; Tax Annex to the St. Petersburg G20 Leaders Declaration, 2013 St. Petersburg Summit, September 5-6, Action Plan on Base Erosion and Profit Shifting, OECD, July 19,

6 Different national legislative frameworks and approaches to corporate income taxation have created a complex global tax system with a number of tax asymmetries and anomalies. Tax asymmetries and anomalies sometimes subject companies to double taxation; in other circumstances, companies can exploit these differences to reduce their tax liabilities. As governments have sought to address these asymmetries over time, corporate tax systems in Canada and other countries have grown ever more complex. Further, with globalization and new technology, increasing mobility of capital, integrated supply chains, and corporate valuations increasingly attributable to intangibles, shifting profits globally has become easier. When announcing its Action Plan, the OECD noted, National tax laws have not kept pace with the globalization of corporations and the digital economy, leaving gaps that can be exploited by multi-national corporations to artificially reduce their taxes. 3 Similarly, the Advisory Panel on Canada s System of International Taxation recommended several years ago that aspects of Canada s international tax rules be updated. 4 Adding to this complexity is the use of tax policy as a competitive tool both to attract foreign investment and to ensure domestic companies are competitive abroad. Many jurisdictions, including Canada and the United Kingdom, are lowering tax rates or providing special tax incentives to encourage business to invest in their country. For example, the United Kingdom recently introduced a special low-tax patent box regime to encourage companies to develop and retain intellectual property for commercialization in the U.K. Many Canadian and other companies have taken advantage of tax incentives offered by governments and can be expected to continue to do so in the future. There is nothing fundamentally wrong with corporations arranging their global business affairs to take advantage of a particular country s tax incentives or its lower corporate tax rate. Companies that take advantage of tax incentives should not be considered to be tax evaders or abusers of the tax system. How does corporate income tax affect Canadians and Canadian businesses? Economic studies have shown that, in effect, corporate taxes are not borne by the corporation. Real people bear the burden. In fact, these studies show that the burden of corporate taxation in Canada is borne almost entirely by employees of corporations through lower wages. 5 Studies also indicate that corporate taxes undermine productivity and growth and that recent federal and provincial corporate tax cuts are paying off in higher investment and more jobs for Canada. In their annual global tax competitiveness report for 2012, well-known economists Jack Mintz and Duanjie Chen say: Canada has been remarkably successful in building a more competitive corporate tax system, principally by lowering tax rates and broadening the tax base. Canada s marginal effective tax rate is now the lowest, and hence the most tax-competitive among the G-7, the 20th most tax-competitive in the 34-member OECD, and 57th among the 90 countries surveyed in this paper. The result has been greater investment and improved economic growth despite recessionary pressures. 6 In terms of actual forecasts, a previous report by the authors predicted that taking the federal corporate rate to 15 per cent would add $30.6 billion to the country s capital stock and generate 100,000 jobs Closing tax gaps OECD launches Action Plan on Base Erosion and Profit Shifting, OECD media release, July 19, Enhancing Canada s International Tax Advantage, Final Report, Advisory Panel on Canada s System of International Taxation, December 2008, e.g., at p Federal and Provincial Business Tax Reforms: A Growth Agenda with Competitive Rates and Neutral Treatment of Business Activities, Duanjie Chen, Jack Mintz, School of Public Policy, University of Calgary, SPP Research Papers, Volume 4, Issue 1, January Annual Global Tax Competitiveness Ranking: A Canadian Good News Story, Duanjie Chen, Jack Mintz, School of Public Policy, University of Calgary, SPP Research Papers, Volume 5, Issue 28, February See note 5. 3

7 Summary In short, the corporate tax system is complex. It has potential to undermine productivity and growth and it is one of the most volatile revenue sources for governments. Given these issues, one could question the merits of continuing with the current corporate tax system. However, at this time, fundamental change to the system is likely impractical. Hence, the concerns being raised by the media, NGOs, ordinary citizens and governments about the current corporate system need to be addressed. Do these concerns have merit? It should be no surprise that corporations plan and arrange their business affairs to legally minimize their taxes provided such minimization is consistent with their overall business strategy. Nevertheless, corporations are being called on to pay their fair share. Confusing the issue further are the often-blurred distinctions between legal tax avoidance and illegal tax evasion and between acceptable and unacceptable tax planning. Better understanding and consensus about the meaning of these terms are essential to determine what actions need to be taken. Fair share The fair share concept implies that even where a company structures its affairs to minimize its income tax liability in accordance with the law, it should still pay some larger amount its fair share. The term is difficult, if not impossible, to define and thus is not helpful in debating the issue in the public forum. 8 Corporations should pay what they legally owe, and they should be expected to plan their affairs to legally minimize their tax liability, as they would with any other business cost. The question as to whether corporations should pay some sort of fair share of tax is most appropriately a policy debate that is the responsibility of governments to resolve. The debate should not be directed at specific corporations if they are working within current laws. Further, the notion of fair share should not be used exclusively to refer to the amount of income tax that a corporation incurs. Many corporations incur other taxes such as property taxes, customs duties, sales and other consumption taxes on business inputs, and employment taxes. These taxes, together with the income tax they pay, better reflect a corporation s total tax contribution. Tax avoidance is not tax evasion Tax evasion is illegal. Illegally avoiding tax by disregarding the law, by not reporting taxable income, or by hiding funds offshore is a scourge that should be prevented through vigorous enforcement of domestic tax laws. Legally avoiding tax or tax planning is not tax evasion. Recently, the term aggressive tax avoidance has entered the debate. This term is difficult to define. In Canada, tax planning is considered to be either acceptable or unacceptable, and so we think that framing the debate in these terms would facilitate more meaningful discussion. Acceptable versus unacceptable tax planning focus on the law s object and spirit In this light, the discussion should shift toward whether legally effective tax planning is within the object and spirit of the taxing statute and thus acceptable, or if it is contrary to the law s object and spirit and thus unacceptable. Given the complexity of corporate tax laws and business transactions and structures, situations can develop where a corporation believes its tax planning is acceptable only to find that the tax authorities believe it is unacceptable. The Canadian Income Tax Act s general anti-avoidance rule (GAAR), which was introduced in 1988, is intended to provide the Canada Revenue Agency with a tool to combat tax planning that is contrary to the object and spirit of Canada s tax laws. When a corporation and the tax authorities have different views, then it is for the courts to decide whether a transaction is within the object and spirit of the tax legislation or whether the GAAR applies and the 8. The concept of minimum taxes has been used in certain circumstances in Canada and elsewhere. We do not believe this approach is appropriate, especially in light of the complexity it would add to Canada s over-complicated corporate tax system. 4

8 planning is unacceptable. This can be a long, uncertain and costly process, and companies need to be mindful of the reputational and financial risks, as well as the financial statement disclosure obligations, of being on the wrong side of the eventual outcome. How should Canada approach corporate taxation? Internationally, the G20 nations are calling on countries to cooperate to develop global solutions, update tax laws, increase transparency and information sharing, curb international tax evasion, and level the playing field between countries. The OECD s Action Plan is an ambitious undertaking that will provide the G20 nations with important background, analysis and recommendations on the way to effectively achieving their objectives. Canada and Canadian taxpayers need to actively participate in the OECD s work to ensure that Canada s competitive position and practical business constraints are considered as solutions and recommendations are debated and developed. 9 The final recommendations arising from the Action Plan may have significant consequences for the future of tax planning. That being said, CPA Canada believes there are some concrete steps that Canada could and should take unilaterally now. Our recommendations are as follows. 1. Keep corporate tax rates low. The federal government s policy of reducing corporate tax rates is the right approach. This policy should be continued, together with steps to broaden the tax base. 2. Tighten the focus of specific anti-avoidance rules. Canada s tax system contains anti-avoidance rules that apply, in some cases, more broadly than required. In order to further clarify the distinction between acceptable and unacceptable tax planning, these rules need to be better targeted to simplify compliance and administration. 3. Rethink the corporate income/consumption tax mix. Given the volatility of corporate income tax, its economic impacts and the ability of corporations to plan their affairs to reduce their liability, governments need to assess their reliance on corporate income taxes versus consumption taxes. Consumption taxes have been found to be a more efficient and effective means of collecting taxes Use tax policy to help Canadian businesses compete. Canada should continue to seek ways to make the corporate tax system globally competitive. The federal government also should monitor the way other countries, and in particular our major trading partners, respond to the OECD Action Plan s recommendations for establishing a level playing field globally. However, Canada should not be an early adopter of a number of the OECD recommendations as doing so could put Canadian companies at a competitive disadvantage. 5. Pursue more international Tax Information Exchange Agreements. Canada should continue pursuing agreements with other countries to permit or ease the exchange of tax information. The transparency provided by these agreements makes them key tools for detecting and preventing tax evasion, and also for potentially identifying unacceptable transactions. In the final analysis, when companies engage in legal tax planning that the government finds inappropriate and no specific or general anti-avoidance rule is found to apply, the government has in the past and presumably will continue to use its prerogative to change the law and shut the plan down. In addition, the government also should strive to provide further clarity on the object and spirit of the legislation. 9. In a recent C-Suite Survey of Canadian executives, 67 per cent of respondents reported that they somewhat or strongly support the OECD Action Plan. In addition, more than one-third reported that they or their boards have taken steps to address the issue of whether their company is paying their fair share of tax. See Companies must adapt to public desire for tax transparency, The Globe and Mail, October 6, The survey was conducted by Gandalf Group, sponsored by KPMG, and published by Report on Business and BNN. 10. Why economists love consumption taxes, The Globe and Mail, October 12,

9 Transparency and higher-risk tax positions One OECD Action Plan recommendation is to require taxpayers to disclose their aggressive tax planning arrangements. 11 The federal and Quebec governments already have laws in place requiring the disclosure of certain tax plans, with penalties for non-compliance, to help tax authorities identify transactions that may not be acceptable. Should additional transparency for particular higher-risk tax positions be pursued in Canada? Helping to frame the debate on this question are the following points: The Advisory Panel on Canada s System of International Taxation recommended enhanced dialogue among taxpayers, tax advisors and the Canada Revenue Agency to promote the mutual responsibility and cooperation required to uphold Canada s self-assessment system. 12 The Business and Industry Advisory Committee to the OECD s draft statement of tax principles says, transparency, open dialogue and co-operation between the tax authorities and business contribute to greater compliance and a better functioning tax system. 13 The U.S. tax authority may impose under-reporting penalties where there is no substantial authority for a position taken on a tax return, unless the position has been adequately disclosed and there is a reasonable basis for the filing position. 14 Given the complexity of tax laws, it is unlikely that the line between acceptable and unacceptable tax planning will ever be clear. Perhaps U.S. Supreme Court Justice Louis Brandeis summarized the benefits of openness and transparency best 100 years ago when he said, Sunlight is the best disinfectant. 15 Given this context, increased transparency on the part of both taxpayers and tax authorities should be considered. Such transparency should be approached as part of a more fundamental shift toward an enhanced relationship between the parties based on mutual cooperation and respect, with appropriate checks and balances. Moving to an enhanced relationship between taxpayers and the government would likely require change on both sides. For taxpayers, this could involve some form of greater transparency in the reporting of higher-risk tax positions. For tax authorities, this could involve a change in legislation or administrative practice to ensure greater oversight and consistency in the issuance of assessments. After all, what is good for the taxpayers in a self-assessment system should be good for the tax authorities as well. Before any action is taken in Canada, tax authorities, businesses and tax advisors would need to take part in a consultative process to develop a consensus on whether any increased transparency should be required and, if so, the way it would be implemented. Next steps the role of the accounting profession and tax advisors Given the complexity of the system, taxpayers need specialized knowledge to help them self-assess their tax obligations. Every day, professional accountants help taxpayers understand and comply with tax laws. Professional accountants assist taxpayers in navigating the audit, assessment and appeals process. They also work closely with all levels of government on tax policy and tax administrative matters. In short, the engagement of professional accountants in the tax system is critical to making it work effectively. In these capacities, CPA Canada and its members are well positioned to help taxpayers and the government work toward an enhanced, more open relationship based on mutual responsibility and cooperation, thereby improving the operation of our tax system. We look forward to advancing the debate over the future of Canada s corporate income tax system and helping to develop workable solutions for the benefit of all Canadians and Canadian businesses. 11. See note 2, at p See note 4, at p Statement of Tax Principles, Business and Industry Advisory Committee to the OECD (BIAC), draft/not dated. 14. United States Treasury regulations (d) and (b)(3). 15. Louis D. Brandeis, Other People s Money and How the Bankers Use It, 92 (1914). 6

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