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Corporate tax avoidance is a huge problem that the federal government should tackle in its 2023 budget with a minimum tax on book profits.
In 2021, tax avoidance by 123 of Canada’s largest corporations cost the public $30 billion, according to a 2022 report from the group Canadians for Tax Fairness, a non-profit that advocates for fair and progressive tax policies. That is $30 billion not available for public goods and services. That is $30 billion that could be used to narrow the gap between the haves and the have-nots.
The federal government recommitted in its 2022 fall economic statement to build an economy where “big corporations and the wealthiest Canadians pay their fair share, and where everyone plays by the same set of rules.”
While the government has introduced some modest changes to the tax system, the latest data show that these measures are not enough. Corporate tax avoidance nearly doubled in 2021, compared to the pre-pandemic average. More robust policies are needed.
A minimum tax on book profits is one such policy. In fact, the U.S. recently signed into law a minimum tax of 15 per cent on book profits, which takes effect this year. Book profit, also known as book income, is what corporations report to their shareholders. This value will differ from taxable income, which is the basis of a company’s tax obligation, because of differences between tax filing and corporate accounting.
A minimum book profits tax limits corporate tax avoidance
To understand how the tax would work, it helps to understand how corporations avoid taxes in the first place.
The term “avoidance” encompasses a variety of methods used to reduce tax payments. These can be broadly classified as legitimate deductions, questionable tax plans or illegal evasion. The problem is that the public cannot tell how much of the avoided tax is from each of these three methods.
Governments provide tax credits and deductions as part of public policy. However, each credit or deduction creates an opportunity for manipulation by tax planners, who use our tax system in ways that policymakers never intended. The schemes devised are technically complicated and often difficult to detect. They frequently do not violate the letter of the law, while trampling all over its spirit.
Trying to shut down each illegitimate loophole is a bit like “whack-a-mole” – if the carnival game required in-depth accounting knowledge and high-level detective skills. A minimum book profits tax would help the government pursue its goal of ensuring “everyone plays by the same rules.”
With a minimum book profits tax, a 15-per-cent base tax rate is applied to the book profits that companies report to their shareholders. Low effective tax rates tell us that taxable profit, as reported to the CRA, is much lower than what is reported to shareholders, thanks to corporate exploitation of loopholes.
Corporations have huge incentives to create innovative ways of avoiding taxes. A minimum tax on book profits does not eliminate the creation and exploitation of loopholes and other tax avoidance tactics. But it does put a floor on how low the tax bill can go. That’s important when you consider the rate that corporations are paying right now with no floor in place.
Lower effective tax rates translate into less goods and services for the public
Corporate profits have been trending higher while corporate contributions to public revenue have been trending lower.
The combined statutory federal and provincial tax for corporations is about 26.5 per cent, although that varies by province. However, many corporations are paying well below that level. In 2021, despite profits rising to record levels, 53 of Canada’s 123 largest companies had an effective tax rate below 15 per cent. Several highly profitable companies actually paid a negative effective tax rate, i.e., they collected tax benefits.
The effective tax rate has been trending lower for decades. A minimum tax on book profits will limit the ability of corporate tax planners to push it even lower.
A minimum tax on book profits is the major revenue generator within the Biden administration’s Inflation Reduction Act. Canada has already followed the U.S. plan to implement a tax on share buybacks, which was also part of the act. It should do the same with the minimum tax on book profits.
A minimum book profits tax would generate additional revenue
Corporate tax avoidance widens Canada’s “tax gap” – the difference between what the taxpayer actually pays in tax and what they would pay at the statutory tax rate stipulated in the tax code. If Canada had a 15-per-cent minimum tax on book profits in 2021, it would have reduced the tax gap by $11 billion.
The chart below lists some of the 53 of Canada’s largest corporations that had an effective tax rate lower than 15 per cent, as well as how much tax they actually paid in 2021, and how much more they would have paid with a minimum tax on book profits.
A minimum tax on book profits should not be a substitute for closing tax loopholes. However, given the resources that corporations can devote to avoiding taxes, authorities will always face an uphill battle. A minimum tax would ensure that profitable corporations will always contribute a fairer share toward the public goods and services on which they depend, such as reliable infrastructure, a functional legal system and a healthy, educated population.