Corporate tax stories involving major multinationals like Apple, Google and Starbucks made international headlines last year. But there’s been comparatively little examination of what Canadian corporations pay. This year Canadian Business decided to tell some of those stories. Our objective was simple: We sought to identify companies paying relatively little tax, and explore the reasons why. We devised a methodology for doing so. To understand the strengths and shortcomings of our approach—at least from our own perspective—read on.
Our starting point was data compiled by Bloomberg, which reflects what publicly listed companies disclose in their financial statements. We’d rather pull numbers directly from corporate tax returns but alas, they’re not publicly available. We pulled key information about taxes paid by member companies of the TSX Composite Index, of which there are currently 241.
We could have chosen a variety of tax figures for our rankings. Companies disclose an amount paid in income taxes on their income statement, for instance. This number is manifestly misleading, however. For one thing, it includes a concept called “deferred tax.” In essence, that’s tax the company expects to pay down the road. Really it’s an abstraction, because there’s no assurance these “deferred” taxes will ever be paid. The Fair Tax Campaign, a British civil society organization that promotes corporate tax transparency, observes: “one of the major objectives of tax avoidance activity is to defer the time when tax is paid. If we included the deferred tax charge in our calculations we’d immediately ignore the consequences of a major part of all tax planning activity.” We concur. But the Fair Tax Campaign’s solution—relying on what companies report as their “current” tax—also has problems. Once again it’s governed by accounting rules, not tax rules.
Our solution was to consult another number: cash taxes paid. As the term suggests, it’s the amount of taxes paid in cash each year. It’s usually found in the footnotes to financial statements, or as a supplementary disclosure on the cash flow statement. We think it’s the best available measure.
As a general rule, companies pay tax on profits earned. We divide a company’s cash taxes paid by its pre-tax income for the period in question to arrive at an effective tax rate. Companies publish their own effective tax ratios, but their numbers are almost invariably higher than those arrived at when you look at cash taxes paid.
We excluded companies that suffered any net losses over the period. That’s because the ratios provided by such companies under our methodology seemed nonsensical. “Whenever you have losses it’s hard to say something meaningful,” Alex Edwards, an assistant professor of accounting at the University of Toronto’s Rotman School of Management, told us. “Because you might say, Company X didn’t pay any taxes. Well, they didn’t make any money. There’s probably not much of a story.” We also eliminated companies that were incorporated as income trusts or REITs at any point during the period studied. Trusts pay little or no tax, and it didn’t seem fair or useful to compare them to corporations that didn’t enjoy the same tax benefits.
We collected our data from the last 10 published audited annual financial statements from these companies. Our reasons for doing so were several. First, a company’s tax situation can change considerably year-to-year: it might suffer a whopping tax bill one year only to get a big refund the next. Also, we wanted to capture an extended business cycle, including not only years of strong expansion but also recession.
We asked academics and tax experts about our methodology. Most identified shortcomings, but were supportive nonetheless. “I think that your methodology, as you described it, is sound,” said Ken Klassen, a University of Waterloo professor who also serves as director of the Deloitte Centre for Tax Education and Research. “And certainly something that’s fairly widely used within the academic research that explores similar questions. So I think you’re on fairly solid ground.”
Our approach isn’t perfect. To begin with, our decision to use publicly available financial statements has implications. In the UK, for instance, it’s foreign-based multinationals like Google and Starbucks that are taking the most heat for alleged tax avoidance strategies. Such companies are generally not listed on the TSX and, as such, will be ignored in this package even though their Canadian presence may be significant. For the moment, we have no method of discovering the taxes such companies pay here.
As mentioned above, financial statements are produced by companies for the benefit of shareholders, and are prepared in accordance to sets of accounting rules (i.e. International Financial Reporting Standards, or IFRS, in Canada, and Generally Accepted Accounting Principles, or GAAP, in the U.S.) These rules differ greatly from those used to calculate corporate income taxes owing. “The tax numbers in corporate filings are mostly fiction,” Alison Christians, a law professor at McGill University who specializes in tax matters, told us. “And when it comes to tech companies, they’re almost wholly fiction. And so, the point is that you can’t actually know what they pay.” She’s right. But again, public financial statements are the best we’ve got.
Our decision to select a decade-long period also limits the number of companies we’ll study. “The disadvantage when you do that is that there are not a lot of companies that are around that long,” Edwards told us.
Some might argue our approach fails to capture the entirety of benefits companies provide to society. For example, the Railway Association of Canada claims its members paid nearly $1 billion in taxes in 2011. That calculation includes payroll taxes such as CPP payments and unemployment insurance, which are actually paid by workers. The Association explained that it includes those in its calculation because it wants to show the industry’s economic contribution. When criticized for paying little tax, companies often respond by emphasizing how many jobs they’ve created.
Corporate tax is an enormously complex subject. We do not suggest otherwise. Nevertheless, we believe and hope this exercise sheds valuable light on what companies pay here, and why.