Outdated Tax Laws Threaten our Prosperity

Taxation co-operation on a global scale may be needed to avoid a fiscal crisis.

Never before have we seen so many countries struggling under excessive debt loads and an inability to support their costs. Some euro zone countries, such as Greece and Ireland, are already facing a full-blown tax crisis, while others, such as Spain and Portugal, are on the brink. U.S. Federal Reserve chairman Ben Bernanke – named by Time magazine as the 2009 Person of the Year for having saved the U.S. from financial ruin – told Congress in February, “We’re much closer to total destruction than you think.” He also raised the spectre of a “looming or actual fiscal crisis.”

Canada could also be in trouble if it gets pulled in by the U.S. current. But several signs indicate that at the federal level we have much more room to manoeuvre before reaching the crisis point, because our deficit and debt aren’t as large. This is somewhat comforting to know as we approach 100 years of taxation in 2017.

Some provinces are in a shakier position. In 2010, for example, Quebec’s debt amounted to 49.9 per cent of its gross domestic product (GDP) – far ahead of Nova Scotia’s (35.1 per cent) and Ontario’s (30.1 per cent), not to speak of Alberta’s (4.2 per cent). Quebec’s population is also the most heavily taxed. That might explain why 12,000 taxpayers marched in the streets of Montreal last April 1 to protest the provincial budget.

If the books don’t balance, it has to be because expenses are too high, revenue is too low, or both. On the expenditure side, people often point the finger at health-care costs, inefficient government management, and debt servicing. But on the revenue side, the main problem is that our tax systems are no longer suited to the 21st century. Under the Organization for Economic Co-operation and Development (OECD) Model Tax Convention, which serves as the foundation for most tax systems in Canada and elsewhere, two main taxation principles come into play: the taxpayer’s physical residence and source of income. But how do you apply these principles in a global economy, where many transactions cannot be pinned down to a geographic location, and where companies can shop around for the best tax treatment? That’s the problem we face in a world of corporate tax competition, e-commerce, and tax havens.

Tax havens

New methods of communication, combined with mobile capital, have made it easy for high-income earners and multinationals to establish (or pretend to establish) their tax residence or source of income in tax-free locations. They have three main ways of doing this:

1. Tax exile: A taxpayer moves, or pretends to move, his or her tax residence from a country with a very high tax rate to live in a tax haven.
2. Asset holding: A trust or company is established in a tax haven for the purpose of holding assets. This is a very popular method – one that leads to some eyebrow-raising results. For example, in Ireland and Switzerland, total corporate asset value per employee is $4.5 million. In Barbados, this jumps to a whopping $22 million, and, in Bermuda, to $45 million. One of the primary vehicles used to hold assets is an International Business Corporation (IBC) – a legal entity that is free from all local taxes, except small fixed annual fees. With IBCs, owner anonymity is guaranteed. There are more than 500,000 IBCs in Hong Kong and 60,000 in the Cayman Islands.
3. Export of business activities: Many businesses that are not tied to a specific location and have no need for a large workforce set up shop in tax havens. These businesses often operate in sectors such as insurance and reinsurance, finance, internet-based services, and oil. For example, Deepwater Horizon, the oil rig leased by BP that caused the explosion in the Gulf of Mexico on April 20, 2010, was owned by offshore drilling contractor Transocean. In 1999, Transocean moved its jurisdiction of incorporation from the U.S. to the Cayman Islands, and then to Switzerland in 2008.