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Wary of scrutiny, Canadian firms think twice about tax-saving strategies

As tax strategy increasingly becomes fodder for front pages, large corporations are asking themselves: What will clever tax fixes mean for their reputation?

Corporate tax lawyers are bracing for increasing scrutiny on their work in the wake of public outcry and Ottawa's pledge to clamp down harder on evasive practices.

Caches of leaked files, from Liechtenstein's LGT Bank in 2008 to the recent Panama Papers, have exposed the ease with which wealth is moving across borders and into places that offer both discretion and little or no tax burden. In response, many countries have responded through concerted efforts to exchange information and co-ordinate laws.

Lawyers, who had grown used to toiling behind the scenes, say the intensifying spotlight – the March federal budget set aside $444.4-million over five years to boost tax enforcement at the Canada Revenue Agency, which has vowed to hire 100 more auditors – is changing client behaviour at the corporate level.

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While the CRA has struggled to rein in high-net-worth individuals who stash away their riches, lawyers say the agency's increased focus on big companies has already prompted executives and their boards to think twice about pursuing obviously audacious tax-saving strategies.

"The vast majority of companies are playing defence, not offence," said Steve Suarez, a tax lawyer at Borden Ladner Gervais LLP. "All [executives] want to do is comply with their obligations and not pay more or less than they have to. But there's a lot of grey area in the Income Tax Act ... a lot of judgment."

But they're not just worried about a more resourceful CRA. Tax strategy is increasingly fodder for front pages, a development that is raising a new concern among large corporations: What will clever tax fixes mean for their reputation?

"You didn't get that question 15 years ago," says Ash Gupta, a tax lawyer at Gowling WLG in Toronto. "And I'm getting it with increasing frequency now."

It's a question that puts companies at odds with a relatively easy – and perfectly legal – way to deal with what is seen as the single biggest threat to Canadian companies' growth prospects. In a recent PricewaterhouseCoopers survey of CEOs around the world, 80 per cent of those based in Canada said increased tax burdens present the biggest obstacle to growing their businesses, ahead of geopolitical uncertainty and currency volatility.

Of late, more of Mr. Gupta's clients are talking to him about steering clear of structures that are legal but could be perceived as abusive. They are telling him: "That is a great plan, but where on the aggressiveness threshold does it fall? If there is more than a per cent risk that this gets me a headline, we're not doing it," he says.

Mark Rosen, a forensic accountant and the co-founder of Accountability Research Corp., said he can understand why some companies would turn down tax savings in order to steer clear of problems, but added that it is difficult to know the intricacies of their tax practices by looking at a business's financials.

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"Looking at tax rates and what [companies] are paying, you are not getting a good idea of what they are doing or what they have passed up on," he said. "That just wouldn't be possible."

Still, Canadians for Tax Fairness recently reported that Canadian corporations invested nearly $40-billion in the top 10 tax haven destinations in 2015, bringing totals to $270.2-billion since 1990.

The rising use of tax havens has come as business has gone global faster than the tax laws have kept up, offering companies that have grown beyond Canada's borders to cash in on the world's disjointed system – and do so while keeping well within the rules.

When faced with the prospect of slashing millions in operating costs or trying a new tax plan that would save just as much without the heavy lifting, "it's a no-brainer," says Arthur Cockfield, a professor at Queen's University who studies tax law.

"If you could add to shareholder value by hiring your accountant friend on Bay Street, you'd have to be brain dead to enhance your plant efficiency," he said in an interview. "That's how the system has developed over the decades. They have realized that they have got to compete more and more on a tax basis."

But tax lawyers say companies are also realizing that cutting costs by trimming their tax burden can come with a whole new set of costs.

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"We're seeing many more questions now about reputational risk," Michael Friedman, a tax lawyer at McMillan LLP in Toronto, said in a recent interview. For the risk-adverse clients, "it's not simply a question of how do we minimize taxes within the law, but how do we minimize taxes, and if we're challenged [by the tax authorities], what will the consequences be, even if we're successful with the challenge."

One of the areas that has come under intense scrutiny is transfer pricing: the prices at which divisions of the same business sell to one another. Since fees can be manoeuvred to reduce taxes, rules require that related parties complete transactions as if they were arm's-length entities.

The gist of this temptation: If a Canadian company manufactures a product and sells it to one of its subsidiaries that is based in a tax haven, it would be in the parent company's interest to sell to the foreign outpost at the lowest price and book the sale to the end user from there. The foreign subsidiary posts the bulk of the sale, pays a fraction of the income tax and pockets more in profits.

Transfer pricing has become the biggest area of tax litigation.

"The [Canadian] government has been really aggressive in challenging the pricing," Mr. Friedman said. "People will try to manipulate their pricing to get the lowest tax. Companies are still doing it. And so now in virtually every multinational audit, they immediately ask for transfer-pricing documentation."

As tax strategies also attract more attention in the court of public opinion, Gowling's Mr. Gupta sees his transformation from being just a technical specialist to more of a brand manager picking up speed.

"It's no longer going to be enough to present clients with your Plan A," he said. "It's also going to be that this [proposal] will legitimately save you x dollars, but we also prepared a Plan B and C should you want to ratchet that back because the optics don't look good."

BY THE NUMBERS

$444.4-million: Ottawa's pledge to boost tax enforcement at the CRA over the next five years.

100: New auditors the CRA has vowed to hire.

80%: Canadian CEOs in a recent PwC survey who said increased tax burdens present the biggest obstacle to growing their businesses.

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About the Author
Capital Markets Reporter

Christina Pellegrini is a reporter at The Globe and Mail and a regular contributor to Streetwise, covering capital markets, the exchange business and market structure.She writes about the capital markets divisions of BMO, CIBC and National Bank; independent brokerages such as Canaccord Genuity; and the Canadian operations of foreign dealers including JP Morgan, Goldman Sachs, Credit Suisse and Citigroup. More

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