Documents leak turns up heat on Canadian tax loopholes

Paradise Papers spur criticism of Canadians’ use of offshore tax havens

The leak of the so-called Paradise Papers has stoked criticism of Canada’s tax regime | ProStockStudio/Shutterstock

For veteran tax lawyer Joel Nitikman, the latest leak of millions of documents dubbed the Paradise Papers, said to reveal yet more connections between secretive offshore tax havens and the wealthy people they attract, raised a simple question: Who cares?

“The fact that you’ve set up an offshore account doesn’t tell me one thing one way or another about whether they’re complying with their income tax requirements,” Nitikman, of Dentons Canada in Vancouver, told Business in Vancouver in a phone interview. “If a person is paying the tax that they’re supposed to pay, what do you care if they set up a trust in China or Russia or the Caribbean or wherever? Who cares? They’re paying their tax. If they’re not paying their tax, they should pay the penalty.”

Meanwhile, for both critics and defenders of offshore finance, the Paradise Papers have added more fuel to an already heated debate in Canada and abroad about the use of tax havens, legally or otherwise. Those opposed sound the alarm as billions of dollars are purportedly sapped from public coffers, squirrelled away in foreign tropical backwaters to protect corporate profits at the expense of schools, hospitals and roads at home.

On the other hand, tax avoidance by corporations or asset protection measures taken by individuals can simply be seen as logical steps in a modern global economy fraught with perils.

But no matter where one’s views align, soul-searching among tax professionals and policy-makers in the wake of the Paradise Papers and the Panama Papers abounds as so-called “taxpayer morale” takes a hit when the names of three former prime ministers and wealthy friends of the current government show up in leaked lists from far-off, low-tax or no-tax jurisdictions, only to be met with shrugged assurances that everything was above board.

In Nitikman’s view, outlined in an article in the most recent issue of the Canadian Tax Journal, legal tax avoidance and illegal tax evasion are easily conflated, and he warns against steps made for political gain that could easily translate into policy missteps that exacerbate problems they’re supposed to alleviate.

“The rules are the rules,” he states in “Tax Evasion – Does Anyone Know What It Means? Does Anyone Really Care?”

“It doesn’t matter how close the ball is to the line – if it’s in, it’s in, and if it’s out, then it’s out. There’s no ‘morality’ about it. If you don’t like the rules, then change them, but don’t whine about fairness and morality, because they have nothing to do with it.”

While the Justin Trudeau government gets hammered by critics over proposed tax changes such as banning income sprinkling, other changes have received considerably less attention, such as a proposed revamp to the Canada Revenue Agency’s (CRA) Voluntary Disclosure Program (VDP) announced back in June. The changes, for example, would exclude applications from people reporting income from the proceeds of crime and applications from corporations with revenues in excess of $250 million.

Nitikman is a signatory on a letter opposing the changes sent to Minister of National Revenue Diane Lebouthillier in August by the joint committee on taxation of the Canadian Bar Association and the Chartered Professional Accountants of Canada.

“While we are in full agreement with the government’s objective of ‘cracking down on tax cheats’ and ‘ensuring that those who break the law face the consequences of their actions,’ there is no evidence that denying the benefits of the VDP to large corporations in all circumstances serves to achieve those objectives, especially where inadvertent error or oversight is involved,” the letter states.

Nitikman told BIV that changes to the program, which offers taxpayers amnesty for coming clean with undeclared income, could have a devastating effect on its efficacy.

“I think the program was working very well the way it was set up many, many years ago and they changed it for political reasons without thinking about the actual affect that the change is going to have on the point of the whole program in the first place,” he said. “The odds of [the CRA] catching anybody are not very good because they have very small manpower, relatively speaking. Even if you gave them another billion dollars, the number of audits they can do out of the 30 million tax returns that are filed each year is very small.”

According to numbers provided by the CRA, use of the VDP has ramped up in the last five years, with taxpayers reporting 12,981 “issues” in fiscal 2012-13, ballooning to 19,502 in fiscal 2015-16,

“You can get political points for revamping the program, but what good does it do you if now you have fewer people using the program and coming in from the cold?” Nitikman said, adding that he’d wager a “fair amount of money” that use of the program will decrease if the changes are adopted.

Critics, though, take the opposite view of the Paradise Papers leak, building public awareness of offshore wealth on momentum created by the Panama Papers.

Diana Gibson, a researcher with Canadians for Tax Fairness, an advocacy group that has long sounded the alarm about the use of tax havens among large corporations and wealthy individuals, is also quick to point out that the bulk of offshore financial activity by Canadian corporations is legal.

But the debate about tax havens points to an even more important issue, Gibson said.

“I think what we need to discuss is not what’s legal or illegal or ethical or unethical; the issue is it’s wrong for large corporations and the wealthy to pay lower tax rates than middle-income Canadians and small business, and that’s what this is really showing us,” she told BIV in a phone interview.

“It’s not just about fairness. There’s going to be some level of inequality in our society. The question is, at what point do we cross a threshold into something that’s harmful to our economy and the people? And we’ve crossed that line.”

Gibson’s most recent report, called Bay Street and Tax Havens: Curbing Corporate Canada’s Addiction, warns of increased use of offshore subsidiaries by some of the biggest companies on the Toronto Stock Exchange, though the data may be incomplete.

“The use of shell and numbered companies makes the data more opaque. Leaks of actual bank account data from countries like Panama and the Bahamas show the numbers of subsidiaries are orders of magnitude higher,” Gibson writes in the report’s executive summary. “This is no small concern. Financial flows to tax havens rose dramatically from the early 1990s to 2015, dipping down only slightly after 2015. Canadian foreign direct investment … in tax havens grew from $2.1 billion in 1994 to $284 billion in 2016. Barbados, Luxembourg, and the Cayman Islands feature in the top three.”

She said it’s encouraging that the federal government has injected more money in the CRA to strengthen the agency’s auditing efforts, and applauds the work of NDP MP Murray Rankin, who has proposed a private member’s bill, Bill C-362, to curb the use of offshore tax havens by introducing an “economic substance test” to transactions.

“What needs to be noted is, a lot of what we’re worried about is perfectly legal activity, and this is the problem. We need to criminalize behaviour that is designed, essentially, through an elaborate series of ruses to avoid people paying their fair share, and I think Canadians are outraged at that,” Rankin, a former law professor, told BIV in a phone interview. “It’s ridiculous that this is permitted in our society.”

Moreover, Rankin also thinks the ease with which companies can be set up is problematic, whether they’re registered offshore or on Canadian soil.

“We can’t allow tax shifting any longer,” he said. “The only reason they’re in the Cayman Islands with this little postbox company subsidiary is to not pay taxes in Canada. Why isn’t that wrong? Why don’t we change the law to make that illegal?”

“It’s very easy to incorporate these sham companies, these numbered companies; Canada’s famous for allowing that,” he added.

The CRA has nearly 1,000 audits underway in addition to 42 criminal investigations related to offshore activity, spokesman David Morgan told BIV in an email.

“In regards to the Paradise Papers, while such lists are extremely helpful to the agency, it’s important to reiterate the CRA does not simply sit idle waiting for these lists to attack the problem of tax evasion and aggressive tax planning,” Morgan wrote.

How much do Canadians have stored in tax havens? The CRA can’t say.

“Tax avoidance and evasion through the use of offshore accounts and structures is a major concern for the CRA,” the agency’s Heidi Hofstad stated in a followup email to BIV. “By their very nature, tax evasion and tax avoidance are very difficult to accurately quantify, since they involve people hiding money from the government.”

The CRA’s track record in the area has been criticized as ineffectual.

“While the CRA refers roughly 200 cases per year to the Crown’s office for prosecution, it is not clear how many – if any – of these cases involve offshore tax evasion,” writes Queen’s University’s Arthur Cockfield in a recent issue of the Canadian Tax Journal. “Taxpayers at times take advantage of the technical complexity of tax law to structure their affairs in ways that unfairly reduce their tax liabilities, making it difficult for CRA auditors to distinguish between lawful and illicit behaviours.”

Journal editors Brian Carr and Alan Macnaughton, writing in the same issue, admit that “a large segment of Canadian society blames [tax professionals] for allowing offshore tax evasion to happen, whether or not we are directly complicit in such activity.”

Carr and Macnaughton, though, want to dispel the “widespread view” that the sector is ignoring the problem because there “seems to be something about offshore tax evasion that brings out a great divergence of views in the Canadian tax community and the population at large.”

The NDP’s Rankin says Canadians should question whether the current system is ethical and serving stated public policy goals.

“People should be outraged at what we’re discovering from the Panama Papers and the Paradise Papers,” he said. “I don’t understand why we don’t rise up and change the laws and make it better.”

Canadians for Tax Fairness’ Gibson echoed Rankin’s pleas for change.

“We need to create an environment where tax fairness trumps secrecy and the good of the Canadian economy and people trump secrecy, because at this point we are seeing that the secrecy is enabling a system that is inherently harmful to our economy.”

Coalition pushes for resource-sector transparency, financial accountability

Key findings in a new report from Publish What You Pay Canada, a coalition of civil society organizations dedicated to making the resource extraction sector more transparent and accountable:

•Laws in Canada enable people involved in business transactions to obscure beneficial ownership and are out of step with global efforts to address money laundering and terrorism financing.

•Canada is falling short of global standards on beneficial-ownership transparency, including its G20 commitments and Financial Action Task Force Recommendations.

•An effective anti-money--laundering and terrorism financing regime would legally require all trustees, agents and nominees to disclose their status to government officials, financial institutions and designated non-financial businesses and professions (DNFBPs). However, Canadian laws allow one person to conduct business on another person’s behalf without disclosing his or her relationship, including agents, trustees, nominee directors and nominee shareholders.

•Powers of attorney are frequently used to perpetrate real estate fraud, and may be abused to obscure the true ownership or control of the holder of the power of attorney.

•Trust laws in Canada easily allow for the abuse of trusts to obscure true ownership or control for criminal purposes.

Report recommendations include:

•Requiring that DNFBPs collect beneficial-ownership information on entities and trusts when conducting transactions over $10,000.

•Requiring that those exercising powers on behalf of others disclose their status to financial institutions and DNFBPs, together with identities of all registered owners and all beneficial owners of property/funds involved in the transactions.

•Introducing measures to make it harder to obscure beneficial ownership through agents and nominees.

•Making it more difficult for trustees to obscure the beneficial ownership of trust property.

Background documents

Canadian Tax Journal: Offshore tax evasion

David W. Chodikoff: Whistleblowers and the Evidentiary Challenges in Offshore Tax Evasion Cases

Arthur J. Cockfield: Examining Canadian Offshore Tax Evasion

Joel Nitikman: Tax Evasion – Does Anyone Know What It Means? Does Anyone Really Care?

Canadians for Tax Fairness: Bay Street and Tax Havens

Canadian Bar Association and Chartered Professional Accountants Canada: Letter to Diane Lebouthillier