Some Canadian high tech companies may be paying more tax than necessary, and through careful planning and the creation of off-shore companies, they may be able to drastically reduce those payments.
Canada’s corporate tax rate is the third highest in the corporate tax world, exceeded only by Italy and Japan, according to KPMG’s Derrick Novis, a partner in the company’s taxation services.
But by planning an international strategy, Canadian companies can reduce the amount of tax they pay and become more competitive with foreign companies, Novis said.
Countries like Barbados, Cyprus, the Netherlands, Hungary and Ireland offer favourable tax regimes. By setting up an off-shore jurisdiction in a company such as Barbados, which has a corporate rate of 2.5 per cent, Canadian companies can reduce their taxes by about 40 per cent, Novis said.
Income generally belongs to the risk taker, so if a Canadian software company establishes an offshore jurisdiction in Barbados to engage the risk, it can take advantage of the low tax rate. For example, the entity in Barbados can engage the Canadian arm conduct research and development (R&D).
To meet legal requirements, the structure of the company in Barbados must be properly documented. The Canadian arm can’t be responsible for the day-to-day running of the foreign company, but it can still retain control over that company through its shareholdings. Key executives can sit on the foreign company’s board of directors and remain in Canada. But the majority of board members cannot reside in Canada, and the foreign company has to be given real powers and the ability to make decisions for Revenue Canada to recognize it as the risk taker, Novis said.
If Canada has a tax treaty with a certain country, such as Barbados, then the profits earned by the company can eventually be repatriated into Canada tax free.
Done properly, companies can structure their taxes to get the best from both countries. It might still be possible for the Canadian R&D company engaged by Barbados to take advantage of R&D tax incentives, Novis said.
Companies can also reduce the withholding taxes paid on the sale of software if they sell their software through the right countries, Novis said. For example, if a company in Barbados sells software directly to South Africa, there’s a withholding tax of 12 per cent. But if that company sells software to South Africa via a company in the U.K., then the withholding tax is reduced to zero.
The current Canadian tax laws help make Canadian companies more competitive, but that may come at a cost, Novis admitted.
“It is making us more competitive, so therefore the Canadian parent company is being strengthened, but on the other hand maybe some jobs are being lost in Canada. Take Ireland (which has a low tax rate) for example…(it) really attracted so much new business that it has actually created jobs and wealth.”
One of federal governments’ “key objectives” is to reduce personal income tax and corporate taxes, said Jean-Michel Catta, a spokesperson for the Department of Finance in Ottawa.
At the same time, the government is looking at proposals to create tougher tax rules for Canadians who use foreign investment funds and off-shore trusts. “It’s a question of fairness. Every dollar of tax that a Canadian resident evades by hiding income off shore is a dollar some other Canadian has to pay,” he said.
John Reid, president of the CATA Alliance in Ottawa, believes that personal tax rates are too high.
The take home pay at the end of the day in Canada, after marginal tax rates and factors such as stock options, unemployment insurance and user fees are taken into account, is much lower in Canada than in the U.S., Reid said. In order to attract and retain valued skilled workers, Canada needs to lower taxes and other costs levied on employees, he said.
But a recent study by the Canadian Association of University Teachers (CAUT) in Ottawa found that this often-heard brain drain is a myth.
The study examined information collected by Statistics Canada and the U.S. Bureau of Census Data. It found, for example, that only 139 computer scientists leave Canada each year, whereas 113 enter from the U.S. and over 6,000 enter from the rest of the world. The result is a net brain gain for Canada, said David Robinson, the public policy director at CAUT.
He added that lower taxes come at a high cost, and a quick glance south of the border, where the poor and middle class are much worse off, shows what those costs would be.
“We’d have a much meaner society” if we copied the U.S. structure, Robinson said.