Allan Lanthier is a former chair of the Canadian Tax Foundation, and a retired partner of Ernst & Young.
Are large Canadian corporations bilking us out of billions of tax dollars every year, as commentators sometimes suggest? And if so, how do they get away with it? Two recent decisions of the Tax Court of Canada offer some answers, and a rare glimpse into the secretive world of corporate tax avoidance.
The first decision involves Bank of Montreal. In 2005, Harris Bank – BMO’s wholly owned U.S. subsidiary – required cash, and third parties were willing to lend the funds. You might have thought that Harris would simply borrow the cash from the third parties. You would have been wrong.
Instead, BMO established a complex finance vehicle referred to in tax circles as a “tower structure." The structure typically involves three entities – a U.S. limited partnership, and a corporation in each of Nova Scotia and Delaware. The structure plays on different tax rules that exist in Canada versus the United States, with the result that interest expense on third-party debt is deducted twice – once in Canada and a second time in the United States. The entities have little substance and no employees. They exist on paper, on nameplates and in legal offices, solely to facilitate double-deductions for interest expense.
BMO established a tower structure in 2005. Cash of US$1.4-billion was borrowed from third parties, and transferred through the structure to Harris. Harris deducted the related interest expense in the United States, and BMO also claimed deductions in Canada – against income that had nothing whatever to do with the Harris operations. BMO unwound the structure in 2010, and the third-party debt was repaid. In aggregate for the years 2005 to 2010, BMO in Canada, and Harris in the United States, each deducted interest expense of about US$275-million.
Not surprisingly, these transactions and double-dip deductions drew the attention of the Canada Revenue Agency. However, the CRA did not challenge the interest deductions claimed by BMO. It only challenged a foreign-exchange loss that arose when the structure was unwound.
As a result of U.S.-Canada foreign-exchange fluctuations, BMO had incurred a significant capital loss on the unwind. Relying on the general anti-avoidance rule (GAAR), the CRA denied substantially all of the loss. The court found in favour of BMO and allowed the loss, stating in part that “it is important to note that the GAAR reassessment did not challenge the use of the tower structure itself."
The end result? Using a double-dip structure, BMO deducted interest expense of US$275-million without a whimper from the Canadian tax authorities. And to add insult to injury, the court allowed the capital loss that was in dispute.
Double-dips are only the tip of the iceberg. There are many other tax strategies that allow the transfer of deductible expenses to Canada and of Canadian profits offshore, often involving group companies established in tax havens. Cameco Corp. – a second recent decision – provides an example of one such strategy.
Cameco, headquartered in Saskatoon, is one of the world’s largest producers of uranium. In the late 1990s, Cameco developed a transfer pricing scheme to shift profits out of Canada – a strategy that ultimately included subsidiaries in Barbados, Ireland, Luxembourg and Switzerland.
Further to a number of intragroup and third-party agreements for the purchase and sale of uranium, Cameco’s Swiss subsidiary earned substantial profits – $8.4-billion for the years 2003 to 2017. There were only two employees in Switzerland: Most of the required business and management support was provided by Cameco. Cameco also provided financing to its Swiss subsidiary, and guaranteed its performance under the third-party agreements for the purchase of uranium.
The CRA issued assessments for the years 2003 to 2012, and is expected to issue similar assessments for the remaining years to 2017. The Canadian tax on the disputed amounts totals $2.5-billion for all years, before interest and penalties. The CRA’s position is that, under either the concept of sham or Canadian transfer pricing rules, all of the Swiss profits are taxable in Canada.
The first three years in dispute went to trial and, in a massive 293-page decision issued last month, the court found unequivocally in favour of Cameco: It ordered the CRA to reverse the assessments in their entirety. The court stated in part that the Swiss subsidiary was exposed to price risk associated with its ownership of uranium and that, under transfer pricing rules, it was entitled to compensation for that risk. The facts that the subsidiary did not have the financial resources to support the risk, and that it relied on its parent company Cameco for that purpose, did not change the court’s conclusion.
So, do large Canadian corporations avoid billions of dollars of taxes each year? You bet they do. And other taxpayers – you and I – have to ante up the shortfall. Canadian tax rules are in desperate need of repair. If the federal Department of Finance is not up to the task, the government should appoint a fair-minded and non-partisan group of tax experts to do the work.