Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce
Issue 33 - Evidence - May 1, 2013
OTTAWA, Wednesday, May 1, 2013
The Standing Senate Committee on Banking, Trade and Commerce, to which was referred Bill S-17, An Act to implement conventions, protocols, agreements and a supplementary convention concluded between Canada and Namibia, Serbia, Poland, Hong Kong, Luxembourg and Switzerland for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes, met this day at 4:19 p.m. to give consideration to the bill.
Senator Irving Gerstein (Chair) in the chair.
[English]
The Chair: Good afternoon and welcome to the Standing Senate Committee on Banking, Trade and Commerce.
This afternoon our committee will continue our study of Bill S-17, the tax convention implementations act, 2013. The purpose of this enactment is to implement four recent tax treaties that Canada has concluded with Namibia, Serbia, Poland and Hong Kong. This act also implements amendments to provisions for the exchange of tax information found in the tax treaties that Canada has concluded with Luxembourg and Switzerland.
We heard previously from officials from both the Department of Finance and Canada Revenue Agency. They spoke to the policy development and implementation of tax treaties respectively.
We are pleased to welcome today Cyndee Todgham Cherniak, Counsel for LexSage Professional Corporation; and Nick Pantaleo, Partner of PricewaterhouseCoopers LLP. By video conference, we are delighted to welcome Jack Mintz, Director and Palmer Chair in Public Policy at the University of Calgary School of Public Policy.
Mr. Mintz, we would be delighted if you would like to say a few opening words. You may say even more than a few.
Jack Mintz, Director and Palmer Chair in Public Policy, University of Calgary School of Public Policy: Thank you very much. It is a pleasure to join you from afar here in Calgary.
Normally when you are asked to talk about four bilateral treaties, as in the case of these ones with Namibia, Serbia, Poland and Hong Kong, you kind of wonder why you are doing such a long study of that, but of course there is now extreme interest in understanding issues around the taxation of foreign-source income and what Canadian public policy should be around that, particularly as there has been heightened interest in people with offshore accounts and also some of the questions that often get raised about some companies parking money abroad and not paying tax in Canada.
I will say a couple of words about that, and then I will be pleased later, when the discussion takes place, to be able to discuss or answer any questions that might be relevant to these issues.
Let me first start from a very broad brush point. It is very important to make the distinction between what you might call tax evasion and tax avoidance. Tax evasion is when people actually misrepresent their income or misreport their income in order to avoid paying taxes. It is illegal; it is subject to criminal or civil penalties, and it is, therefore, a very specific type of issue that needs to be dealt with.
Of course, that is one concept that one talks about, and some of the discussions we have seen in the press about offshore accounts is the concern of whether people are actually paying their tax on their offshore accounts that should be reported to the Canadian government as part of their personal income or potentially corporate income, if that is the case.
The other issue is a different one, and that is tax avoidance. Tax avoidance is really quite legal ways of trying to avoid paying taxes by taking a different type of action that would lead to a reduction in tax. Economists often talk about the behavioural effects of taxes, and tax avoidance, in a way, applies to any time someone tries to make decisions that are influenced by taxation. For example, if you tax beer more than wine, people will then drink more wine relative to beer. You can almost call that a form of tax avoidance.
At the international level, of course, we think of tax avoidance as companies or individuals who decide to shift income from one jurisdiction to another, let us say from a high-tax jurisdiction to a lower-tax jurisdiction, in order to reduce the amount of tax they pay or to avoid some of their tax. It could be perfectly legitimate; it could be perfectly part of public policy in understanding it and tolerating it or even encouraging it, but that is a completely different issue from tax evasion.
When you look at the bilateral treaties, as in these four cases, they have two purposes. One is to avoid double taxation of income, and that can arise when two different jurisdictions want to tax the same income and so then apply different taxes on it. Most treaties either allow one country to credit foreign taxes against taxes that they would normally levy on foreign-source income earned by their residents, or they would have what is called an exemption system where you allow let us say a resident, if the resident is earning income abroad, to not have to pay home tax on that income; instead the presumption is they will be paying tax in the foreign jurisdiction on that income. Those are two different mechanisms of trying to avoid double taxation. That is usually engrained in treaties.
In addition, there are withholding taxes often applied on non-resident income so that the host country can get some money that is being paid as, for example, rents or fees or royalties or interest or dividends to a multinational or to an investor in the home country. In that case, there is a view that again those types of taxes would be credited against the income tax that would be paid in the home country by the resident to their own government.
That is clearly one role of these treaties. The other role of these treaties is exchange of information. Treaties can help reduce the potential for tax evasion because a government does have the right to go to another government requesting information on a taxpayer that could lead to actions taken to ensure that the taxpayer is paying the amount of tax owing to the home government where the investor might happen to live. That is a very important part of these tax treaties. In some ways it can help in dealing with tax evasion in that sense.
In the case of these four treaties, I have one final point with respect to Hong Kong. About 12 years ago I wrote an article arguing that Canada should have a treaty with Hong Kong. Hong Kong has a relatively low income tax rate. At that time, it was around 16.5 per cent. When I wrote the article, Hong Kong had no withholding taxes and a very different type of treatment of income compared to other parts of the world. They have what is called a source-based tax, an owing tax on income at source and no tax on foreign-source income, and they do not allow any deductions from foreign sources to be taken in Hong Kong. It really does operate as a pure source base.
However, because there were no withholding taxes there was a view of ``Why should Canada have a treaty with them because we cannot negotiate lower withholding taxes given they already have zero withholding taxes in Hong Kong?'' However, from the point of view of exchange of information, that treaty would be very valuable. I had argued that we should be moving into that sort of treaty. It also might deal with some of the other issues that arise in trying to determine where income is sourced. Another part of the role of double taxation treaties is to make clear what we mean by permanent establishment and other kinds of distinctions that are important in determining that.
I am pleased to see this Hong Kong treaty and think it is exactly the right thing to do, and I very much support it.
Mr. Chair, I am happy to finish my comments at this point.
The Chair: Thank you very much. We will hear from the next two members of our panel and then move to questions. I will turn now to Mr. Nick Pantaleo.
Nick Pantaleo, Partner, PricewaterhouseCoopers LLP: Good afternoon. I am a chartered accountant and lead partner at PricewaterhouseCoopers Canadian National Tax Services group. I am also the current president of the Canadian branch of the International Fiscal Association. I have specialized in international taxation for most of my 27 years as a corporate tax adviser.
In December 2007, I was appointed by Finance Minister Jim Flaherty to serve as a member of his Advisory Panel on Canada's System of International Taxation. The panel's final report was issued in December 2008.
I want to thank the committee for the privilege of being before you today to speak about and to answer your questions on Bill S-17. Similar to all of Canada's tax treaties, the tax treaties covered by this bill are based on the Organisation for Economic Co-operation and Development Model Tax Convention on Income and on Capital.
I do support the enactment of Bill S-17 and the government's continued efforts to enter into new tax treaties and tax information exchange agreements, or TIEAs, with Canada's existing and future trading partners and also its efforts to renegotiate and update existing treaties and TIEAs to ensure that they reflect current international norms and practices.
As the honourable senators of this committee know, Canada has one of the largest tax treaty networks among developed countries. By my count, the enactment of Bill S-17 will bring the total number of Canadian tax treaties in force to 93, to go along with 30 TIEAs that are either enforced, signed but not yet enforced, or under negotiation.
Tax treaties play an important role in Canada's tax system by helping to create a level playing field for domestic business activities carried on in Canada by foreign and Canadian businesses while helping to ensure that Canadian- source income is properly measured and taxed in Canada.
As the Advisory Panel on Canada's System of International Taxation further noted in our final report to the minister:
. . . tax treaties can provide important tax benefits to investors, such as lower withholding taxes on cross-border payments, reduced taxation of capital gains in the countries where these gains arise, and double tax relief in their home countries for taxes imposed abroad.
Tax treaties also enable governments to exchange information, provide mutual assistance in tax collection and encourage foreign investment.
Also, a key objective of the Canadian government is to pursue new and deeper international trade and investment relationships. This is not surprising given that more than 60 per cent of the Canadian economy and one in five jobs in Canada are generated by trade. In my view, tax treaties contribute toward the success of such global trading agreements.
It is important that Canadian businesses be provided with greater unfettered access to foreign markets, foreign investment protection and fair tax treatments in foreign nations, particularly with emerging markets in Asia, South America, Eastern Europe and Africa. These factors are critical to Canadian business decision making and competitiveness. Access to more and bigger markets will help Canadian companies be more productive.
The Hong Kong treaty is a good example of this. As PwC wrote in our 2011 pre-budget submission recommending that the government commence treaty negotiation with Hong Kong, it is the gateway to Eastern Asia and a hub for many Canadian businesses with interests in that part of the world. The Hong Kong tax treaty will ensure that Canadian businesses have the same opportunities as their competitors in other countries that do have a tax treaty with Hong Kong. The new treaty will help ensure that Canada, through the exchange-of-information provision, has the ability to better enforce compliance with its tax laws.
Thank you very much. I look forward to your questions.
The Chair: Thank you, Mr. Pantaleo. Ms. Todgham Cherniak, please go ahead.
Cyndee Todgham Cherniak, Counsel, LexSage Professional Corporation: Thank you for inviting me here today. I am a lawyer, and I have founded LexSage, a boutique international trade and sales tax law firm in Toronto, after 20 years on Bay Street.
I am not here on behalf of a client; I am just a tax lawyer who happens to be a trade lawyer, who also happens to be a director of the Canada China Business Council, and I teach law school courses on free trade agreements. Trade is my specialty, and that is where I add flavour today.
Bill S-17 is good law and should be supported and passed by the Senate.
I would like to make a few points for your consideration. Tax treaties facilitate trade. Tax treaties are symbols of cooperation, trust and friendship between nations. Tax treaties prevent double taxation, and Mr. Mintz spoke to that. They improve stability, transparency, fairness, procedural fairness and tax certainty relating to international trade and transactions. Tax treaties are good for Canadian businesses with activities abroad through branches, subsidiaries and other business enterprises. Tax treaties are good for individuals, employers, directors of corporations, students, shareholders, et cetera.
As Mr. Mintz mentioned, the Canada-Hong Kong tax treaty is long overdue, and I, too, have written in the past about this, wondering why we did not have a tax treaty yet with Hong Kong, given the extensive business activities between Canada and Hong Kong and Canada and China.
The Canada-Poland tax treaty is long overdue.
When passed, Bill S-17 will allow for the implementation of four new tax treaties, five protocols, one agreement and one supplementary agreement. It does a lot.
One of the tax treaties — Namibia — was signed on March 25, 2010. That was a while ago. The other agreements were signed in 2012.
Some of these treaties provide significant opportunities for Canadian businesses doing business abroad. For example, the Canada-Hong Kong tax treaty provides many opportunities for savings in Asia for businesses that operate in Hong Kong and in China. We are in negotiations for the Trans-Pacific Partnership Agreement. This will be a hub to Asia.
The Canada-Poland tax treaty provides a foundation stone for the Canada-EU TIEA, which is currently being negotiated. Canada does have tax treaties with other EU nations.
The Canada-Namibia tax treaty will benefit Canadian mining and petroleum companies doing business in that country.
There is greater tax certainty when it comes to the withholding tax on dividends for all four of the new tax treaties, and there is greater certainty when it comes to withholding tax on interest. There is a lot of other tax certainty; I just will not list it all.
Bill S-17 also helps Canada's tax authorities. The tax treaties prevent tax avoidance and combat tax avoidance and evasion. The protocol on agreements between Canada and Luxembourg incorporate mutual assistance, the exchange of information, cooperation and coordination. The Canada Revenue Agency will have a better, improved enforcement tool to obtain information about Canadians with assets in Luxembourg and doing business abroad in that nation. The supplemental convention between Canada and Switzerland also provides a better enforcement tool.
As previously mentioned, the four new tax treaties also contain provisions that deal with the exchange of information. Therefore, in all of these cases, Canadian businesses doing business abroad will do good business, and for anything that is improper, there can be mutual cooperation between Canada and other nations.
Canada's tax treaty negotiators have been very busy. If you review the various agreements carefully, you will see that each of them is customized. While they follow the OECD model, they are not identical in all respects. For example, the Canada-Hong Kong tax treaty provides for a 0 per cent withholding tax on interest between arm's-length parties. The Canada-Namibia tax treaty covers petroleum taxes, income taxes and capital taxes. The Canada-Hong Kong tax treaty covers all the taxes covered by the Government of Hong Kong, the Special Administrative Region under the Inland Revenue Ordinance. The Canada-Serbia tax treaty contains provisions for independent personal services and dependent personal services while the other three tax treaties speak to income for employment.
The Canada-Hong Kong tax treaty includes in the definition of a permanent establishment the assembly or installation projects and the supervision of such services. This is good for Canadian businesses involved in architectural design, structural engineering, construction, project management, et cetera; those are some big, important Canadian companies.
I have read these tax treaties with interest — the protocols, the agreements, the supplemental conventions. I support them for what they are and what they do. The details show the benefits to Canadian businesses and the Canadian economy. Passing Bill S-17 is a vote for opportunities for Canadian businesses, and they all represent progress in the right direction. Thank you.
The Chair: Thank you, Ms. Todgham Cherniak. Thank you all, witnesses, for your comments. We will start our questions.
Senator Black: Dr. Mintz and witnesses here in the room, thank you for those tremendous presentations. I have a question for each of the witnesses, if I may.
I will start with my great friend in Calgary. Before getting under way as a senator from Alberta, I want to remind everyone in the room that Dr. Mintz has founded and leads the University of Calgary School of Public Policy, which I am sure we all agree has become within a short period of time Canada's leading school of public policy. Thank you very much for that.
You spoke about, and I think we are interested in, the distinction in your mind between tax avoidance and tax evasion. I am particularly interested in hearing any policy recommendations that you might have to ensure that Canada can maintain an open economic trading environment while reducing incentives for tax avoidance.
Mr. Mintz: First, as you probably know from many things I have said in the past, I am a great believer, when it comes to business taxation, in two principles. One of those is neutrality, which means similar levels of tax burdens on different types of business activities and decisions. The second is keeping rates low.
Those are two things that I always talk about; I keep harping on those points all the time. For that reason, I get some people upset when I go after special credits and exemptions in the system. I make people often very happy when I talk about lower rates. I think the two go together.
When it comes to international taxation, the principles involved with international taxation are very complicated. It is complicated because a country does not control the whole tax system of the world. When you are looking at someone who is investing in another country, it will be influenced by the taxes in that other country. It will also be influenced by the tax regime we have in Canada.
If you look at what we mean by neutrality, it is a much more complex subject. One part of neutrality is that you would like a tax system that does not, let us say, have lower taxes on foreign income relative to domestic income, and I am including the combined foreign and domestic taxes. One would not want to have that more than at home. Otherwise, you would be encouraging more capital investment abroad, or vice versa. This concept is called capital export neutrality, where you have equal rates of taxation on capital no matter whether it is invested abroad or at home. That actually gives rise to having a tax credit system, as I mentioned earlier on.
The other principle is what I would call capital import neutrality. When you are bringing capital into a jurisdiction, that capital should be taxed at the same rate as other capital, no matter where it comes from. In other words, everyone is on an equal playing field. That is also good from the point of view of neutrality.
The problem is trying to put all these things together. Unless you have equal rates of taxation around the world, in other words, everyone has the same level of taxation, you cannot ever get both these principles holding simultaneously internationally. That is where some people argue maybe we should get rid of these source-based taxes called corporate taxes or talk about other types of mechanisms that would try to get you to that position. It really is very difficult. As a result, countries have to do the best they can do relative to those issues.
When I ran the technical committee on business taxation 14 years ago, we made some recommendations on issues that we looked at, and there are some things that I find troubling around the world today. This is going to be reflected in the OECD base erosion exercise they are now looking at. The big concern I have is that the way international tax systems work — I am talking about them in total, all the countries and how they operate — I would be very concerned that, in the absence of taxation, you have a certain amount of investment that take place around the world, which is based on good economic decision making. Then when you have distortionary taxes, and I am talking about the whole system internationally, we may end up either getting too much or too little cross-border investment taking place because of the way the system operates.
In my view, we will need a certain amount of international cooperation, and I think Canada should support that in terms of trying to deal with what I think are some significant distortions that operate in the system. It is very hard for any individual country to try to put a limitation on what you might think is base erosion.
For example, I can make a very strong case for why we should put some limitation on interest deductions taken in Canada for investments abroad. It is not based on the principle that income abroad is not being taxed by Canada. That is not the argument, in my view. The argument is that there are certain tax structures that may be encouraging too much investment taking place, such as where you get double-dip financing. This is actually not only eroding Canada's base, and another base, but it is actually leading to too much capital investment. There is one thing I really dislike, and that is when you have negative effect of tax rates, when you can get double deductions for earning the same amount of income, or triple deductions, in some cases, if you do the right planning.
It is hard for Canada to put limitations on it because other countries might not do it, and then you put your own companies at a competitive disadvantage trying to operate in another country, and that is with respect to this principle of capital import neutrality and level playing fields. This is a good example of a difficult problem to get international cooperation on, but it is the only way I can see solving it. When one country tries to do it themselves, they could put their own companies at a disadvantage. Therefore, if you wanted to try to reduce some of the tax avoidance that takes place in this respect, then it may be that international cooperation will be the only way that one could maybe put some limitations on this. There are some countries that do put tougher rules on, like the United States with their interest allocation rules, but generally there are many countries that do not. As a result, it is hard.
Senator Black: It sounds hard. Thank you.
Senator Ringuette: My question is addressed to all three of you. Looking at the expertise you have in the area, it might be a simplistic question, but all three of you have indicated the importance of tax treaties with regard to trade, so why are we not including tax agreements when we negotiate trade agreements?
Ms. Todgham Cherniak: In 2007, I looked at over 125 free trade agreements in the world for the Asian Development Bank and wrote a report for them. There are no free trade agreements up to 2007, and I have continued to read free trade agreements as extra reading material, and it does not happen in standard practice. One reason why we do not do it is this is not the place where it is done traditionally, typically, and by our trading partners.
The other reason is that each country has international tax treaties, and there is the OECD model, and it is through this mechanism that the tax conventions are negotiated as a standard practice.
Mr. Pantaleo: As the titles of the treaties imply, the treaties are there to avoid double taxation and also to ensure compliance and eliminate evasion. It is probably more historical, treaties having been around as long as they have been, that this process has been done separately. Trade agreements have become a more recent phenomenon. I do agree with you that to have one without the other is not as efficient, and perhaps the policy-makers would say it is probably easier to do one at a time, given limited resources and time constraints and the like. Certainly, with respect to some of these treaties, we would urge that we be quick in getting them implemented if we are pursuing trade agreements, because they do go hand in hand.
Mr. Mintz: Actually, there is a deeper reason why this happens and the difference between trade and tax agreements, and this is around the world. One department tends to be the one negotiating the trade agreements and another department the tax agreements, in this case Foreign Affairs versus Finance.
Leaving that aside, governments tend to be jealous over their tax sovereignty, in part because taxation and the financing of public services raises a whole bunch of issues internally. That is one of the reasons you tend not to have governments willing to go into trade negotiations, especially on a larger basis that includes tax provisions. They tend to like looking at these things separately.
To give you a sense of that, when I was involved with some discussions several years ago on the Canada-Europe free trade agreement, that was a perfect example where it would be nice to have a multi-lateral tax treaty with Canada. A bunch of issues arise because of the lack of coordination that goes along with bilateral treaties that would be advantageous for Canadian companies operating in Europe, where they would not be hit with certain awkward types of withholding tax situations and other things that arise because of this lack of coordination. I actually did try to get some of these tax issues to be part of the free trade discussions with Europe, but it was almost impossible because immediately the view of each country was, ``This is our own tax system. We have sovereignty over this tax system, and we want to completely leave it to bilateral tax negotiations alone.''
It is endemic and something that, down the road, we might have some rethinking of. The one area where taxes do come in is the area of subsidies, under free trade agreement negotiations, because sometimes they do involve so-called tax subsidies.
Senator Ringuette: I have a short supplementary question. Mr. Mintz, you talked about the EU. I would suspect that many of the EU countries would have tax treaties amongst themselves that could, on the whole, be implemented as part and parcel of the trade agreement with Canada, notwithstanding their authority with regard to their own tax system. I am trying to find out how we could simplify and be more efficient in the process. It is somewhat ludicrous to spend so much time talking with the EU for a trade agreement if, at the same time, we are not discussing tax. On the one hand, efforts are being made to increase trade and the very close connection between trade and tax treaties. Notwithstanding a certain delay in the process and the jealousy of Foreign Affairs and Finance, for the greater good of the business community, it would be undesirable to wait until a trade agreement is signed and then move to a tax treaty, would it not?
Mr. Mintz: I would agree, but let me also add another element to what you are saying. When you look at the current bilateral tax treaties, you really focus on two taxes — income taxes and withholding taxes on non-residents. There are actually a number of other issues that arise with respect to other taxes levied by governments. To give you another example in the European-Canadian context, payroll taxes, social security contributions, medicare and other types of taxes like that are not part of these treaties. Yet, there are some significant issues that are involved around them, for example, when you have individuals who might be working between two jurisdictions and be subject to these taxes. However, there is no way of actually negotiating or having some sort of relief provided to them. In fact, a number of companies actually mentioned that to me.
There are a number of limitations we are facing now, and these are things that maybe need to have more attention paid to them in the future.
[Translation]
Senator Maltais: My question is for Ms. Todgham Cherniak.
I want to begin by commending you. You must be a very good teacher because, as I am sitting close to you, I see that you have taken all your notes by hand and that you are well organized.
We know that Hong Kong is Asia's biggest financial centre and that many Canadian companies have set up shop there. However, Hong Kong is only a point of entry to Asia. How will we take into consideration Beijing and Shanghai, for instance, and other countries close to Asia? Can Canadians who have set up in Hong Kong do business in all those cities? China is heavily populated, and Canadian companies understandably want to do business in different Chinese cities and nearby countries. So why not sign a treaty with China instead of Hong Kong?
[English]
Ms. Todgham Cherniak: I have to be honest with you; I do not know whether we have one with China already or not. I was thinking that we already have a tax convention with China.
[Translation]
Senator Maltais: An agreement with China covers Hong Kong, right? Is Hong Kong completely separate from China when it comes to finances?
[English]
Ms. Todgham Cherniak: For many purposes, Hong Kong is considered to be separate from China, even though Canada does have a One-China policy. For example, at the WTO, China, Hong Kong and even Chinese Taipei are separate members of the WTO, even though Canada has a One-China policy. There is some togetherness and some separation when it comes to China and Hong Kong.
Another thing I would like to raise is that China has its own tax treaty and also a free trade agreement. One of its very first free trade agreements was with Hong Kong, when Hong Kong joined China. A lot of structuring looks at the Canadian relationship to Hong Kong, where Hong Kong has the holding company, where the holding company then goes into China to do business and where the holding company's activities, vis-à-vis China, are pursuant to the China- Hong Kong taxation treaty. Then there has always been this small issue, given the withholding taxes, or lack thereof, in Hong Kong, to get the funds out of Hong Kong and back to Canada.
The Chair: I think Mr. Pantaleo has something he would like to add to that.
Mr. Pantaleo: I will just confirm that Hong Kong, in this respect, does administer its own tax system. They do have their own tax treaty with China, and Canada does indeed have a tax treaty with China. We have for a number of years. In fact, we are in the process of renegotiating it.
[Translation]
Senator Maltais: Can you give us the assurance that China will honour agreements signed with Hong Kong?
[English]
Mr. Pantaleo: Not from me.
Ms. Todgham Cherniak: I will not go out on that limb.
[Translation]
Senator Maltais: If we want to sign an agreement, a convention, with Poland, my understanding is that we would be signing it with the country of Poland and not with a Polish city. Does the same not apply to China? Explain that to me.
[English]
Mr. Pantaleo: We do have an existing treaty with Poland, I believe. This is a new treaty with Poland. It is just updating the existing treaty and making it more reflective of current international norms and changes that have been made to the OECD model convention.
The Chair: Thank you. Mr. Mintz, would you like to add to that?
Mr. Mintz: I just have a quick point that might help with clarity. Hong Kong is recognized by the Chinese government as a special administrative region. It is part of the deal that came after it got independence from Britain and became part of China. As a result, Hong Kong has been able to have its own quasi government but has been able to have its own treaties and function in many ways as it did before 1997. That is the reason Hong Kong has its own treaty network.
The Chair: Thank you, Mr. Mintz.
[Translation]
Senator Maltais: Mr. Chair, no one has answered my first question. How will you monitor Canadian businesses that set up shop in Hong Kong and do business in major Chinese cities? How will Canada apply its tax laws and recover its taxes in those situations? As you just said, companies will be doing business in Shanghai and other cities. How will our authorities bring the money back to Ottawa? Tell me how that will be done.
[English]
Mr. Pantaleo: As I stated, there is an existing treaty between Canada and China, one of the purposes of which is to allocate income between the two countries. To the extent that Canadian companies are earning income in China, China has the primary taxing authority to that income. The treaty, among other things, ensures Canadian companies' rights between jurisdictions.
[Translation]
Senator Hervieux-Payette: I want to begin by welcoming you. I think we all agree that it is a good thing this bill is not very disputed.
I would like to know why the U.S. tax authorities would want to tax Canadians born in the United States and permanently residing in Canada. Our agreements contain no barriers to that kind of recourse.
Recently, Great Britain started going after companies like Starbucks that were not paying taxes in the United Kingdom because they were sending all their profits to a tax haven. Do we have any safeguards against those types of situations? When Starbucks develops a coffeehouse network in Canada, we want them to promise not only not to hire foreign employees but also to pay taxes. How do we ensure that those foreign companies are paying their taxes? This morning, we were told that $29 billion in taxes was not paid in Canada. So someone must not be paying their taxes.
[English]
The Chair: To whom do we direct that? Did you direct it?
Senator Hervieux-Payette: It is for whoever wants to answer it.
Mr. Mintz: You are raising important questions in terms of policy. It goes back to my point about distinguishing between tax evasion and tax avoidance to understand what we are talking about.
First, if it is a matter of tax evasion where people are not reporting income that they should be paying, then this is where the treaties help because they allow for exchange of information. That is important.
If we are talking about tax avoidance, for example, a company is not paying tax in the jurisdiction, as in the case of Starbucks, that is related to an important aspect of tax policy, which is very complicated. For example, it has a lot to do with the transfer pricing rules that many countries have agreed to so far. I will not say they are opaque, but they are in some ways. They do potentially allow for a significant amount of income to be shifted from one jurisdiction to another. For example, if a company wishes to transfer its intellectual property rights to a subsidiary in another jurisdiction, it is not difficult under existing rules to be able to shift income from one place to another. There have been some other interesting ways that companies around the world have shifted income into low-tax jurisdictions.
In Canada, we have taken an attitude, which I have to admit I promoted strongly, which is to try to get down our corporate tax rates to try to prevent some of this base erosion that was happening at the international level. In fact, going back well before 2000 when Canada had the highest corporate income tax rate in the OECD, I strongly argued about the need for significant business tax reform where we bring rates down and broaden our tax bases as well as trying to have a more competitive system in Canada. Over the past 13 years since 2000, both under Liberal and Conservative governments, we have been able to achieve a significant gain in that, and our corporate taxes as a share of GDP, despite a corporate rate deduction that has gone from 43 per cent in 2000 to today to a little over 26 per cent, despite that major reduction in corporate rates, corporate taxes as a share of GDP have virtually been unchanged in the past 10 years. As I have shown in a recent paper, that has been due to profit shifting around the world in Canada. Those kinds of policy actions help. Whether we need to do more, things like transfer pricing rules and the way we introduce issues around the deduction of overhead expenses and interest deductions, will be important issues that we have to think about in the future. However, they go beyond what these tax treaties are all about. It has a lot to do with the way that we define or develop our own tax rules in Canada.
The Chair: Are there further comments?
Mr. Pantaleo: I was going to try to address the first part of your question, senator, because I think you were addressing an issue that has been out there for some months now, and that is the U.S.'s attempt to battle against what they perceive to be evasion of U.S. taxes.
The U.S. is somewhat of a different animal, as it is in most circumstances. In this particular case, they tax their individuals on the basis of citizenship. It is quite true that some Canadians recently found out that they are U.S. citizens or dual citizens as a result of having been born there while their parents were on vacation or whatever the case may be. They are getting caught up in the net that the U.S. has thrown out there, which is effectively to deputize foreign financial institutions to have them provide the U.S. government with information on U.S. citizens residing, in our case, in Canada.
Canada happens to have probably the largest number of U.S. expatriates; I think there is about a million. As you can probably imagine, this has caused much consternation amongst those Canadian individuals. For the most part, these Canadian individuals are not evading tax. Some may not have filed U.S. tax returns up to this point in time because they did not know they needed to. They might still not have an actual U.S. tax liability because being a resident of Canada would mean, under the treaty, that we have the primary taxing authority of their income in Canada. To the extent that they would be subject to tax in the U.S., the U.S. could give them a tax credit for the Canadian tax.
Having said all that, though, this new legislation, which is coined ``FATCA`` is still problematic because it still requires some reporting, and some fairly hefty penalties still could be assessed. From discussions that I have had with Department of Finance officials, this is very much at the forefront of their minds and of the minister's mind, namely, to come to some agreement with the U.S. and it would be administered.
The U.S. has signed intergovernmental agreements with other international jurisdictions to try to facilitate this particular law. Aside from the fact that it is very cumbersome and expensive for financial institutions to implement the necessary systems to capture the right individuals, among the positive aspects is that it has drawn increasing attention to the fact that information should be exchanged not as requested, but there should be automatic exchange. Currently under the OECD model treaty, the exchange of information happens upon request, so CRA asks the foreign jurisdictions for information on a particular taxpayer in certain circumstances. FATCA would result in and many critics have been advocating an automatic exchange. When a foreign country comes across tax information that it thinks CRA should know, it would automatically provide it.
The G20 and the OECD have been strongly advocating this, and it is probably where this is going next in terms of improving the existing treatment of exchange of information.
Senator Massicotte: Thank you for being with us today. This is obviously very useful.
Mr. Pantaleo, is your background as a tax expert?
Mr. Pantaleo: Yes.
Senator Massicotte: My interest is tax evasion, not tax avoidance. My particular concern is that the treaty being proposed with Switzerland is very specific relative to what information they will provide, and we must be very specific on what we need. Contrary to most of the other treaties, where we have more free-flowing information, with the Swiss it is very specific, and we cannot speculate on whom an account belongs to. They can only respond to specific questions.
Does that bother you? Is that adequate for our needs? Switzerland is saying they are opening it up, but they are doing so with strict procedures and methods. Is that good enough for us?
Mr. Pantaleo: We could argue that it is not, and we could argue, as I said a moment ago, that we are heading to something that will provide for more automatic exchange of information. One of the constraints under the current provisions, as laid out in the model treaty, is that it is not intended to allow countries, in this case Canada vis-à-vis the Swiss, to go on fishing expeditions. Many have argued that that is a significant constraint, particularly when some jurisdictions, such as Switzerland, Luxembourg and Austria, have historically had bank secrecy laws, which some would say they have hidden behind. Those domestic laws inhibit their ability to exchange information.
I suspect the changes to the Canada-Luxembourg and Canada-Switzerland treaties were to accommodate some recent changes to the model that has broadened this somewhat over what the existing treaties provided for. However, even as we are speaking I think we are beginning to progress to the next level of more automatic exchange of information. Indeed, recently Switzerland, Luxembourg and Austria have indicated that they are falling in line with international norms. They just have to go through a process to manage their domestic laws.
Senator Massicotte: This week Luxembourg announced that they are opening up, but not before 2015. I understand from CRA that with all our treaties, if the question pertains to money laundering, even if the money laundering relates to evasion of taxes — in other words, many people launder their money for the purpose of avoiding taxes — the other country has no obligation to report that. They need to provide information only on tax evasion, not money laundering.
The RCMP tells us that we have $15 million to $25 million a year of money laundering, which means it is probably $15 million to $100 million. Is that not a big hole we are missing? It may be nice to convince ourselves that it is good enough, but are we mature enough for this process?
Mr. Pantaleo: There are two points there, and Mr. Mintz alluded to them. Treaties are still fairly restrictive in terms of what they cover. They do not cover all the taxes, and they do not go to the level that you are suggesting. Other agreements have been reached on a multilateral basis. One is referred to as the Multilateral Convention on Mutual Administrative Assistance in Tax Matters. Canada signed that treaty in 2004, but we have not yet ratified it. I believe that is because of a technical hang up in our tax rules. The government needs the authority to get into multilateral agreements. It has the ability to get into bilateral agreements but not multilateral agreements with respect to tax matters.
That treaty has been signed on a multilateral basis; 50 to 60 countries have signed it, and it provides for the exchange of information that goes beyond income taxes. It covers many other taxes. Whether it will satisfy the point that you are making about money laundering, I am not sure. Those are the types of things that may have to be dealt with through other agreements.
Senator Massicotte: Mr. Mintz, do you have any comments on that issue?
Mr. Mintz: Mr. Pantaleo covered the ground very well on that. I agree with what he said about the way we are thinking about these issues.
Senator Patterson: We are fortunate to have such distinguished witnesses. I think all of them have agreed on the importance of a tax treaty with Hong Kong.
Ms. Todgham Cherniak, I believe you said that having a tax treaty with Hong Kong is key for a Canadian business trying to get a foothold in the Chinese market. I believe you said that the treaty would make transactions from China to Hong Kong and then to Canada much smoother. Could you elaborate on how the treaty will assist, please?
Ms. Todgham Cherniak: Yes. I would not say that it is critical, but it is a tool that can help. Many Canadian businesses are currently doing business in Hong Kong and China. The tax treaty has not yet been passed and it will not be implemented immediately when the legislation takes effect.
All that being said, it is helpful because it is hard to get money out of China. When Canadian companies do business in China, the money stays in China and is reinvested there rather than coming back home so that we can have Canadian jobs and Canadian opportunities. Having certainty on money going through Hong Kong and transparency and certainty as a result of limits to withholding tax is helpful, and it will help that process along. It is going along right now, but it is another tool that will be helpful.
Senator Patterson: Thank you.
Mr. Mintz, Hong Kong is among the largest financial centres in Asia and an important conduit for financial investments, particularly in China. I believe many Canadian businesses use Hong Kong as a regional centre for their investments in China and other parts of Asia. Can you speak to the historical nature of that phenomenon in its extent today?
Mr. Mintz: I am sorry, but I would not have numbers to give you on that today; I would have to look it up. However, I will tell you about my own experience, because I have done work in this area over the past number of years.
You are absolutely right that Hong Kong is a significant conduit for money going into China. It has been important for Canadians. In fact, 10 years ago when I was in Hong Kong I met many Canadian business people who were doing business in China. They tended to go to Hong Kong before going into China because it was English-speaking and had many British-type institutions that we were used to. They had very good rule of law in Hong Kong, so it was a good stepping stone into China for Canadian businesses. That is one reason that Hong Kong, even today, remains a significant centre for money to go into China and then come back into Canada.
Singapore has also played an important role. I am not sure how much Canadian businesses use Singapore relative to Hong Kong, but it has been another important regional financial centre. Many companies from around the world that work in China go through Singapore. Of course, now China is trying to make Shanghai an important financial centre for so that people will go directly into China.
One of the things — and this is because of work that I did with the IMF for a number of years in China — that one needs to appreciate in China is that we talk about Canada being a federal country, provinces having their own important rules and sometimes barriers to free trade of capital, goods and services within Canada. China is an amazingly decentralized country in many ways. Just because you go into Shanghai, for example, does not mean you can go into anywhere in China after that. There are a number of local rules and regulations that must be dealt with as well.
The Chair: That concludes our questions in round one. I will move to round two where I have two questioners.
Senator Black: To all three witnesses and for the benefit of the record, I am very interested in your views. If we were not to pass this legislation, what effect would it have on competitiveness for Canadian businesses?
Mr. Pantaleo: We said a lot about the Hong Kong treaty, as you know. Going back to why a number of people pressed for a treaty with Hong Kong, one of the key aspects of Canadian policies in making Canadian companies competitive abroad is our exemption system on active business income. We afford that to foreign subsidiaries of Canadian companies that are carrying on active businesses, but only if they are doing so in countries that we have a tax treaty with or that we have entered into a TIEA with. That is the obvious competitive disadvantage that Canadian companies would have vis-à-vis a number of other jurisdictions that provide for an exemption for such activities but do not have the requirement to do so through countries with which their home jurisdiction has a tax treaty. That would be a significant one.
I think the other aspect, in particular with Hong Kong, is that it provides for lower withholding rates on certain payments. We do have some domestic laws on interest that provide for a zero withholding. Although we are becoming a net capital exporter and have been for the last 15 years, we still rely heavily on investment into Canada. That is the stated policy of the government and one of the reasons we pursued competitive tax rates. Certainly for investments coming into Canada through Hong Kong, retaining the higher rates would put us at a disadvantage. Those are two things I can point two, one from an outbound and one from an inbound perspective with respect to the Hong Kong treaty.
Ms. Todgham Cherniak: I will rephrase your question as to how I interpret it. What is the effect of the status quo, as where we are now these treaties are not in effect? First would be the negative effect of embarrassment. We have gone out and negotiated these treaties. Tax treaties are a symbol of cooperation, trust and friendship through nations. Not passing treaties that have been negotiated says something about that relationship. When you fracture a relationship, what are the negative side effects of that?
Second, we are in a time of budget issues for governments around the world, and countries need to raise revenue. They raise revenue by taxation. We have alluded to the fact that tax treaties do not cover all forms of taxation, but they do cover some. To the extent that countries may change tax rates on foreign businesses — these four countries where we have the tax conventions covered by this bill — we will have more tax uncertainty. At least having the conventions in place, we will have more tax certainty because the caps on the withholding tax and the rules will be established.
Third, when you look at the protocols with the agreement with Luxembourg and Switzerland, there are greater exchanges of information. This is something the Canada Revenue Agency has been asking for and said they need, so you are not giving them a tool that they said they need to have. There is also exchange of information provisions in the tax treaties as well. It is not just Switzerland and Luxembourg; it will be all six countries that we are talking about. That would be helpful.
Senator Black: Thank you very much.
Mr. Mintz: I would echo a lot of those things. To sum up, if we pass this legislation I see only upside; I do not see any downside to doing so. As my colleagues on this panel have mentioned, there are a number of positive gains: certainty, lower withholding taxes, exchange of information, et cetera. I would add two more points from an economic point of view. We always have to remember that things like withholding taxes are like a tariff to capital flow. If you have the view that free trade of capital is as important as free trade in goods and services, then there is a positive argument to saying if we can reduce our withholding taxes both for Canadian exports of capital as well as imports of capital, and that only has eventually positive impact or for the Canadian economy.
I think more importantly, going back to Ms. Todgham Cherniak's earlier comment, which I totally agree with, one has to think of this in terms of overall trade, the importance of global supply chains and the role that we have in those global supply chains. That is where even the Polish treaty can play a role, given the role Poland now has in the European Union. Certainly, it is critical for Hong Kong. I have less to say about Serbia, not knowing as much about the Canadian relationship with Serbia. With Namibia, we have important mining interests there and that has some implications for the mining sector in that sense.
I just do not see any negatives by passing this legislation; I only see positives.
[Translation]
Senator Maltais: My question is somewhat complex, but I will try to simplify it. Let us take the example of a Canadian company that sets up shop in Hong Kong while opening branches in Shanghai and Beijing, for instance. Will that company be taxed in China, Hong Kong and Canada once the profits are repatriated?
[English]
Mr. Pantaleo: Let me take a shot at that. I would say the activities in China would be subject to Chinese tax. The income would not be subject to Hong Kong tax. As Mr. Mintz indicated at the beginning, Hong Kong basically taxes on a territorial basis. If the activity is considered to occur outside of Hong Kong, then it will not be subject to tax in Hong Kong.
The income, on its return or patriation to Canada as a dividend, would be received tax-free. There may be some withholding taxes on the dividends from China to Hong Kong; I am not sure. There have been some changes to Chinese law and I cannot remember off the top whether the Chinese-Hong Kong treaty provides for a nil withholding rate.
[Translation]
Senator Maltais: So how is setting up shop in Hong Kong beneficial for a Canadian company? If Hong Kong is only a transit point, could the company not go directly to Beijing?
[English]
Mr. Pantaleo: As has been stated, China may be one of the locations where Canadian companies are carrying on business in the eastern Asian region. Canadian companies, for greater management simplicity and control, will typically set up regional headquarters to manage the operations on a regional basis. It does not take away from the actual on the ground management of the activities, but they will do so on a regional basis. That would also include treasury functions, dealing with foreign exchanges, procurement and those aspects of it. I could see some real advantages for using Hong Kong in that scenario.
You are quite right, senator. Not all Canadian companies will decide to hold their Chinese investments through Hong Kong. They could very well hold their investments directly from Canada, but many larger Canadian companies do hold their foreign investments through regional holding companies throughout the world, and Hong Kong would be a logical choice in that type of structure for Eastern Asia.
Mr. Mintz: Hong Kong has a sophisticated financial sector compared to many parts of China. As I mentioned earlier on, the rule of law is strong in Hong Kong. It has been based on British tradition for a long time. That is one of the reasons why many companies like to go through Hong Kong and to use Hong Kong for a base to go into China, as well as potentially other countries.
I just want to reiterate that that is an important reason why I argued 12 years ago why we needed this Hong Kong treaty, and I am glad that it is finally going ahead.
Ms. Todgham Cherniak: Going back to the initial question, I think we missed one piece of the answer. If you have a manufacturing operation in China, usually when a Canadian company sets up a subsidiary or something, manufacturing operations in China, it is to ship the goods back to Canada as opposed to sell the goods within China. When the goods are sent back to Canada and resold in Canada, there would be Canadian income taxes with respect to those activities.
It is not 100 per cent of the time that there is no Canadian income tax paid. It depends on the facts and circumstances of each arrangement and what they are doing. When you have a manufacturing operation, based on what I have seen, a lot of the goods are eventually sold in Canada where we get Canadian sales taxes and Canadian income taxes, individuals are involved in the distribution network where there are payroll taxes. It is not a situation where there is never any Canadian tax paid. I am not sure whether we covered that part off.
[Translation]
Senator Maltais: I never said that no taxes were being paid in Canada. My question is clear. If a Hong Kong-based company opens factories in China, I just want to know how many times it will be taxed — in Canada, Hong Kong and China. That is all I want to know. I do not want any additional explanations, as my question is very clear.
[English]
The Chair: I think Mr. Pantaleo answered the question on the first round.
Thank you very much, panel. You have been very helpful in our deliberations today. On behalf of all of the members of the committee, I would like to express our great appreciation for your appearance today.
(The committee continued in camera.)