In 1999, Montreal apparel company Gildan Activewear established a subsidiary in Barbados to handle all of its international sales and marketing. Most of its foreign employees and manufacturing facilities were already located in the Caribbean, and Gildan’s founder and then CEO Greg Chamandy explained in a press release that the small island nation was attractive because of its high literacy rate and excellent telecommunications system. He then divulged a more important reason: “a good working tax treaty.”
“Good” understates the case. Canada’s treaty with Barbados, which dates back to 1980, essentially allows Canadian multinationals to bring their profit back home and pay no tax. Historically, treaties are signed with countries that have a similar tax system to ours and are meant to avoid double taxation. But Barbados hardly taxes income at all—the rate varies between 1% and 2.5%. In this case, the treaty is really more of an economic development tool, helping Canadian companies grow internationally by easing their tax burdens.
The Canadian government has since expanded this policy through an initiative that has received little attention. While the feds made an effort to curb corporate tax breaks a few years ago, they actually ended up making it easier for multinationals to pay less tax by doing business in offshore jurisdictions. “People think we are more aggressive with tax havens,” says Brigitte Alepin, an independent tax specialist at boutique firm Agora Fiscalité in Quebec. “But tax havens are really more open than ever for multinationals.”
Successive federal governments have lowered corporate taxes in a bid to boost the economy. Between 1980 and 2012, the share of federal revenue derived from corporate tax revenue fell to 13.6% from 15.2%. Canada has taken an even more generous approach with multinationals in recent years. In 2009 Canada started signing tax information exchange agreements (TIEAs) with offshore jurisdictions. It’s part of an international effort led by the Organization for Economic Co-operation and Development o curb tax evasion and secrecy. In practice, TIEAs allow the Canada Revenue Agency to crack down on citizens hiding money offshore by requesting information from foreign tax authorities. But the government also extended what’s known as “exempt surplus” provisions to countries that sign TIEAs, which now include Bermuda, the Cayman Islands and the Isle of Man. This means that a Canadian company with a subsidiary in Bermuda, for example, can bring back foreign profit tax-free in the form of a dividend—provided the subsidiary is carrying out active business, such as sales or manufacturing, and is not merely a P.O. box. This is the same arrangement that makes Barbados attractive for Canadian firms.
But Bermuda, unlike Barbados, imposes zero tax. In the end, the foreign profit of a Canadian corporation might not be taxed anywhere. Allison Christians, the Stikeman Chair in Tax Law at McGill University, says there is a “perversity” to the arrangement. “This really only works if the subsidiary is subject to tax in a foreign jurisdiction. If they’re not, why would you give an exemption? Now you’re giving a subsidy,” she says. “My concern is that every time you do this, you hollow out the tax base a little more.” When Canada signed a TIEA with Bermuda, even law firm Cassels Brock was puzzled. “This tax policy initiative seems to be at odds with Canadian international tax policy objectives to discourage taxpayers from deferring Canadian tax by the use of tax havens,” it wrote in a briefing.
More such deals are on the way, too. An agreement with the British Virgin Islands comes into force soon, and Canada is in negotiations with eight more jurisdictions including the Cook Islands and Gibraltar. Cayman Islands, a no-tax jurisdiction, is courting Canadian companies. In 2012, the country established the Cayman Enterprise City, a special economic zone to allow companies to quickly and cheaply form physical subsidiaries. A CEC backgrounder notes the zone should be of particular interest to Canadian companies because of the TIEA that went into effect in 2011. The CEC’s proponents anticipate some Canadian firms will move subsidiaries away from Barbados so as not to pay that country’s 1%–2.5% tax.
So what’s the logic behind Canada’s approach? Back in 2007, the Conservatives wanted to get rid of rules that allowed corporations to engage in what’s called double-dipping. Canadian companies could deduct interest payments on a loan to a foreign subsidiary, and then potentially bring profit from that same subsidiary home without paying Canadian tax. In the 2007 budget, the government called the situation a “problem” and said it amounted to Canadian taxpayers “indirectly subsidizing” multinationals. The government proposed eliminating the rules around interest deductibility that made this possible. As a kind of consolation to corporations, it extended the exempt surplus benefits to TIEA countries.
Still, the outcry was swift as businesses complained that throwing out the interest deductibility rules would cripple their ability to compete internationally. The government capitulated. A humbled Jim Flaherty backtracked and announced the creation of an advisory panel to examine Canada’s international taxation system. Arthur Cockfield, a professor of tax law at Queen’s University, was retained by the panel to research a number of issues, including interest deductibility and double-dipping. “This advisory panel was really set up, I believe, to bring back double dips,” he says. “It was filled with industry people.” The panel recommended maintaining the interest deductibility provisions. The government followed that advice, and also left the extension of exempt surplus to TIEA countries in place. Cockfield, in his report, wrote of the implications of this approach: “The gate would be left more open, and Canadian corporate taxpayers can pick and choose the most favourable tax haven.” The upshot is that the government first attempted to eliminate an important corporate tax break, changed its mind, and then bestowed businesses with another tax break.
Canada’s approach to taxation has benefited multinationals such as Gildan. The company’s expansion to Barbados helped it contend with the likes of Fruit of the Loom in a brutally competitive industry. Gildan employs 200 people in Barbados, with about the same number staffing its headquarters in Montreal. Last year, the Barbadian subsidiary generated nearly 70% of Gildan’s net sales. The company earned more than $1.5 billion before tax over the past 10 years and paid just 5.5% of that in cash taxes. Over the same period, Gildan has reduced its footprint at home. Between 2003 and 2007, it shut down a sewing plant, two yarn-spinning facilities and two textile facilities in Canada. Gildan no longer has manufacturing operations here.
Ultimately, Canada may have little choice in deciding how it taxes its companies. Other developed countries grant their multinationals all kinds of breaks, and provide exemptions with respect to foreign profit. Canada could be unfairly penalizing its corporations if it bucked the trend. In the recent budget, the government said it’s also looking at ways to prevent corporations from abusing treaties and claiming tax benefits they’re not actually entitled to. For many tax policy experts, however, the vexing issue is that taxpayers who have resources and are mobile will end up paying less. “This trend just pretends it doesn’t cost anything to have a society that makes this kind of multinational business possible, and it does cost something,” Christians says. “You’re just pushing the costs of the state onto workers and the consumer.” Concerns about corporate taxes often flare up when a country has a fiscal crisis. Witness the furor in the U.K. over the aggressive tax planning strategies of Starbucks, Google and Amazon. Even U.K. Treasury officials proposed blackballing such companies from bidding on government contracts.
At Canadian Business, we were curious about the tax-planning strategies of our domestic firms and decided to take a look. We identified companies that paid little income tax relative to their profits over the past decade, and selected several for further investigation. The results show that Canadian companies take full advantage of the tax opportunities afforded to them, and aren’t afraid to battle it out in court over their interpretation of the rules.