'A cat-and-mouse game': Why closing tax haven loopholes is a challenge

The revelations pouring out of the Paradise Papers have once again raised questions about the use of tax havens and how wealthy individuals and corporations are able to use such structures to legally shelter their money from taxation.

The huge leak of more than 13 million records was obtained by German newspaper Suddeutsche Zeitung and shared exclusively in Canada with CBC/Radio-Canada and the Toronto Star via the International Consortium of Investigative Journalists (ICIJ). It shows how individuals and corporations have used offshore accounts, engaged in creative bookkeeping and exploited loopholes to legally avoid taxes.

These structures are there to help Canadian companies.— Walid Hejazi, University of Toronto

But the laws that allow the use of tax havens exist for a reason. 

"You don't want to throw the baby out with the bathwater," said Walid Hejazi, associate professor of economic analysis and policy at the University of Toronto's Rotman School of Management.

"These structures are there to help Canadian companies do business in the global economy.

"When the structures are used in the way they were intended to be used, it's good for the Canadian economy, Canadian employment."​

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But some argue that such structures end up costing the government billions of dollars in potential tax revenue, money that could be used to support much-needed social programs. 

As well, critics argue such tax havens have given rise to aggressive and controversial tax avoidance schemes, through which firms are created in name only, with no staff or offices, and used solely to lessen their parent company's tax burden.

​For example, the Paradise Papers revealed the case of Stephen Bronfman and his ties to an offshore trust in the Cayman Islands. One of the issues raised here is whether the trust was really managed offshore, meaning it would be eligible for a huge tax break, or in Montreal, where it would be subject to taxes.

The Paradise Papers also shed light on Nike's scheme to shift billions of dollars in profits to Bermuda from Europe. According to the ICIJ, Nike created a subsidiary in Bermuda which held ownership of the company's Swoosh logo and other trademarks for markets outside the U.S. This meant the Bermudan subsidiary was able to charge trademark royalty fees to Nike's European headquarters. And this shifted billions in profits away from Europe to tax-free Bermuda where Nike has no staff or offices. 

Meanwhile, the Paradise Papers also revealed how the Bank of Montreal discussed cutting the number of executives it needed to be flown to Bermuda a couple times a year so one of its subsidiaries, based there with no staff or premises, would still be eligible for tax breaks.

Here in Canada, companies are indeed encouraged to use offshore havens, said tax law scholar Arthur Cockfield. The argument goes that such offshore accounts allow corporations to go global and compete in the international marketplace. Those in favour of tax havens say that if an international competitor was able to take advantage of a tax haven, and a Canadian company was not, the latter would be at a competitive disadvantage. 

However, Cockfield says, while big business is often correct to say it needs tax breaks, "often the tax breaks are overly generous."

'Economic purpose'

Efforts have been made to rein in the use of such tax havens. Recently, NDP MP Murray Rankin introduced a private member's bill that, if passed, would require companies to prove that their transactions with offshore accounts have an "economic purpose" other than to avoid tax.

But such efforts touch on what Cockfiled says is an ongoing "cat-and-mouse game" which, also, explains why the Income Tax Act is "far and away the most complicated piece of legislation in Canada."

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Lawyers and accountants are able to exploit loopholes in the tax laws or interpret them in an overly generous manner. This leads to the government attempting to pass a law to close such loopholes. Industry stakeholders cry foul, argue such measures would hurt business, and the laws are scuttled.

As well, some lobbyists have political connections. A CBC News/Toronto Star investigation, for example, found that a Montreal law firm representing clients closely connected to the federal Liberal Party was a leading player in a campaign to block offshore tax legislation passed by the House of Commons.

Since domestic efforts to clamp down on use of tax havens may be challenging, there have been suggestions that the best solution would be to develop some sort of world tax organization in order to level the playing field and require countries meet minimum standards of taxation.

However, taxation is different from other kinds of laws. Governments use the tax system to pursue differing socio-economic agendas, meaning it's unlikely any government would ever agree to be bound at the international level, Cockfield said.

"It's really a kind of chicken and egg problem. Unless you have a world tax organization that creates all common rules, the problem won't get fixed."

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Cockfield said he doubts moves to go after countries that allow such tax havens would be fruitful. Barbados, for example, is Canada's third largest outward, foreign-directed investment destination, where thousands of Canadian companies do business. 

"So we're saying they're key to our global success strategies. We can't really then start to try to punish them."